This article was originally commissioned for the July 2016 edition of the Actuarial Post.
One of the earliest definitions of the word pension comes from the 1520s. A pension was defined as meaning a “regular payment in consideration of past service”. This is the definition that most people understood until the mid-twentieth century. Then, it switched to mean a method of tax-efficient saving devised to enable people to accumulate a substantial sum, which they could then turn into a regular stream of payments guaranteed to last for their lifetime.
Following that phase, the introduction of pension freedoms, on the back of a public outcry over poor-value annuities, meant that the word pension is now defined the tax-efficient accumulation of a sum of money over a working life which could either be used to purchase an income stream guaranteed to last for the rest of one’s life or could dissipate immediately upon reaching the defined age for penalty-free pension access.
The drift from the original meaning of a regular payment, representing a highly sought-after benefit which would secure one’s position for the remainder of one’s life, to a large lump-sum which would have to be actively managed to secure one’s future has taken place over the last few years, driven primarily by political opportunism. This was fuelled by the desire of the general public for the kind of money that they could never dream of outside of the lottery programme as a reward for a full working life.
However, this approach has already been trialled down under and has been found wanting. The Australians have had a compulsory Superannuation system for more than twenty years and it has not been an unmitigated success. True, the compulsion on employers to contribute to employees pensions has ensured that all Australians have a superannuation fund. On the 30th June 2015, there were over AUD$2 trillion (around £1 trillion) in superannuation assets.
However, the ability to draw this down at-retirement has meant that there have been significant issues with people running out of money in the later years of their retirement, just the point where their ability to earn is dropping severely and their health and care needs are rising. Research shows that this has been exacerbated by the fact that increasing numbers of Australians are entering their retirement with significant debts; debts which are taken out in the expectation that the pension lump sum can be used to clear them. The end result is that 20 years of compulsory saving is not resulting in the major reduction in state support for the elderly that was the primary goal of the project.
In order to counteract this, the Australian Government is starting to look at ways of changing what people are allowed do with their superannuation savings. As a starting point, the Australian Government are going to embed the objective of its private pension system – to provide income in retirement to subsidise or supplement its State pension – into a stand-alone Act of Parliament. Once this is in place, all future pension policy will be based on that premise.
This shows that Australia, with two decades head start into the mass pension market, is heading in the exact opposite direction from the UK. Here in the UK, we have removed the compulsion for people to buy annuities in order to provide a supplementary income stream to their state pension. In Canberra, they are proposing to force at least the first AUD$100,000 into some form of annuity to avoid the possibility of pensioners completely dissipating their resources within the first ten years of retirement.
Meanwhile, back in the UK, we are busy wondering whether ISAs are a better way to go with pensions, berating life and pension companies who put any barrier in the way of the newly retired getting their hands on their money and denigrating annuities as an expensive con.
The contradictions inherent in the current strategy are putting the whole retirement policy of the government under the strain. When you have the Chancellor telling the nation that people know best how to manage their own money whilst the regulator is getting worked up over the amount of people who are falling for pension frauds due to their lack of understanding of financial products and inability to afford financial advice, surely we can spot the looming disaster. Do we have to wait until we reach a point where there are substantial amounts of pensioners running out of money before we start to analyse the way forward?
It’s time to take a leaf out of Australia’s book. The original meaning of pensions as a regular payment for life is still ultimately what most people need. If the current political process makes it impossible for the parties to move back in this direction, then perhaps the policy making should be taken out of the political arena and given to an independent body, similar to the way that monetary policy is managed by an independent Bank of England. Otherwise, we might end up with the problem that Australia’s is currently trying to solve – huge amounts of effort to accumulate pension funds whilst the taxpayer still ends up carrying the majority of the burden of supporting pensioners when they inevitably run out of cash.
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