The Big Question: Why is there a pensions crisis, and what are we going to do about it?

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The Independent Online

What's the problem?

The biggest factor in Britain's pensions crisis should really be a cause for celebration: people can expect to live much longer than was expected when our pensions system was designed. In 1950, a 65-year-old man, on average, was expected to live about 12 more years. Today, the figure is more like 19 years, and by 2050 it could be as high as 24.

Not only are life expectancy figures rising dramatically, but the birth rate in the UK is falling. The result is we have a rapidly ageing population: every year there are greater numbers of retired people compared with the number of working people around to pay taxes to support them. In 1950, there were four people of working age for every one pensioner. Today, the figure is 2.7, and it is expected to fall to 1.1 by 2050.

There are only three possible sources of finance to meet the rising cost of supporting older people. Either the Government increases spending on state pensions, employers step into the breach or individuals save more of their own money for the future.

Who should take responsibility?

That's the second part of the crisis. So far, no one has been willing to step up to the plate. Individuals have been reluctant to save more; the Association of British Insurers estimates Britons are saving £27bn a year too little for old age.

Meanwhile, with fewer workers to pay for an increasing number of pensioners, employers are cutting back on pensions, particularly after the poor stock-market returns of recent years. Many firms have abandoned guaranteed pensions altogether.

As for state pension spending, the UK commits a smaller portion of its gross domestic product - less than 7 per cent - to pensions than most other countries in Europe. And Gordon Brown has consistently refused to countenance reforms that would significantly raise this figure.

What does the Government plan to do?

John Hutton, the Secretary of State for Work and Pensions, will publish a White Paper today on pension reform. His proposals are based on the recommendations made by Lord Turner at the end of last year. Mr Hutton is expected to announce a gradual increase in the state retirement age, in line with Lord Turner's suggestion that this should increase from 65 to 69 by 2050. At the same time, state pensions are expected to become more generous, with the restoration of the link between increases in the basic state pension and earnings, though this may not happen until 2012, later than Lord Turner had suggested.

Private pensions will also be reformed, with the launch of the National Pension Savings Scheme, a new fund into which all employers would have to pay if they do not offer staff a decent level of pension. Employees will be automatically enrolled, although they will be allowed to opt out.

Will that work?

The reforms will make a difference, but they certainly won't transform people's lives in old age. The basic state pension, under the proposals, will rise in value, but only to about 17 per cent of the pre-retirement salary of an average earner. The current second state pension will continue, but it will pay out a maximum of a further 14 per cent of average pay.

As for the National Pension Savings Scheme, employees who don't opt out will pay 5 per cent of their salary into the scheme - though the Government will pay one-fifth of this in tax relief - and employers will have to contribute 3 per cent.

Lord Turner reckons a 35-year-old joining the scheme on a salary of £23,000 could expect a pension from the National Pension Savings Scheme of just £3,000 a year in today's money. In other words, those who depend on the state and the National Pension Savings Scheme will not be well-off in retirement. Some people may actually be worse off than today. Changes to the rules of the second state pension mean higher earners will get less.

Will women be any better off?

The Pensions Commission specifically investigated the issue of women and pensions. Currently, women tend to retire on much lower incomes than men, having earned less, on average, while they were working, or having taken years out of the workforce to look after children.

Mr Hutton is expected to announce that the number of years of National Insurance contributions required to qualify for a full, basic state pension will be reduced. That should help women who take time out of work. However, Lord Turner's recommendations were more radical: he suggested state pensions should be paid to everyone who meets basic residency requirements, irrespective of the tax and National Insurance they have paid. That would have helped a greater number of women.

What's this going to cost?

Lord Turner said his state pension reforms would lead to an increase in public spending of £200m in 2010, rising to £2.1bn by 2020. It is thought that a deal between the Chancellor and the Prime Minister has delayed the restoration of the link between state pensions and earnings by two years, which will reduce the bill slightly.

On the other hand, Lord Turner has assumed that the savings generated by theplanned increase in the female state pension age, which will rise to 65 between 2010 and 2020, will be ploughed back into pensions. Without those savings, the cost of Lord Turner's reforms will rise to £7.6bn by 2010, the equivalent of 2p extra on the basic rate of income tax.

Will this ever be sorted out?

The best-case scenario is that by 2012, the new National Pension Savings Scheme will be up and running, providing basic benefits for people without access to more generous occupational pensions. Pensioners, meanwhile, will be benefiting from pensions that go up in line with earnings each year, and those of us still in work will have accepted a gradual rise in the retirement age, probably by a year every decade from 2020 onwards. Plus most people will have got the message that they need to save more for themselves.

On the other hand, the proposed increases in the value of the state pension will not, in isolation, deliver a decent standard of living for people in old age. If the benefits on offer from occupational pension provision keep falling, more pensioners will have to rely on means-tested benefits in old age.

Confidence in pensions must also be restored, after the collapse of many final-salary plans. While mistrust continues, people are unlikely to be willing to save more for old age. Ongoing arguments over pensions reform could undermine confidence further.

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