Now we can see how old age looks

A report out yesterday confirms that a radical overhaul of pensions and savings is around the corner; Demography dictates that we have to put more resources aside

Quite suddenly, we can glimpse in broad outline how our pensions will probably be organised for the next 50 years or more. For we seem to be in the early stages of a social and economic revolution as important as the rise of home ownership since the Second World War. We may even be starting to catch a feel for the way the developed world as a whole will cope with supporting its ageing population - how it will defuse the pensions time-bomb.

That is the real significance of a new report, Pensions: 2000 and Beyond, from a committee set up by the National Association of Pension Funds, published last night.

The problem can be described in three sentences. State pensions almost always rely on the present generation of workers paying for the preceding generation: those paying National Insurance today are not saving for their own future but financing the pensions of their parent's generation.

With a relatively young population and a high proportion of people of working age, there are enough contributions to make it work, but as fewer and fewer people of working age have to support more and more pensioners, the money doesn't go round. Either taxes on the workers will have to be raised, and raised - and we already know how voters respond to that - or pensions will have to be reduced to unacceptably low levels.

Now to the solution that seems to be emerging in this country. It is that we will move to some kind of government-backed "funded" pension scheme, so that people are encouraged, maybe forced, to save for their own pension, as well as contributing to the state one for current pensioners. We know this is the likely basis for a solution, partly because very similar ideas are being generated from different parts of the political spectrum, and partly because it is hard to see any other way out.

Why now? The sensible Labour MP Frank Field, has been advocating a funded scheme for some time, and Tony Blair, in his interesting Singapore speech, praised that country's compulsory savings scheme, where up to 40 per cent of people's salary is deducted and put into a savings account for their old age. We do not yet know what Labour policy might be, but we do know that such a scheme is being considered seriously.

Added to that, we have yesterday's report, which puts flesh on to the bones of such a scheme, and shows how it could be dovetailed into a modified basic state pensions scheme. We do not yet know what the Government thinks about this, but philosophically it would fit in well with its presumption that, as far as possible, people should be encouraged to save for their own retirement.

The recommendations of this report fall into two parts: what the state will itself do; and what it will force working people to do.

This country has managed to devise a state pension scheme that will not go bust about 2020 under the pressure of waves of retirees. Every other major developed nation has enormous unfunded liabilities: promises to pay pensions that the country cannot conceivably afford. The record in Europe is Luxembourg, where these liabilities amount to nearly two and a half times its GDP, with the Netherlands not far behind.

But Britain has achieved financial sanity at the price of parsimony. Our state pensions are pegged to prices, not earnings, so our pensions, small as they are now, will be tiny in relation to earnings in 20 or more years' time. It is hard to see that being acceptable in a decent society.

So the first part of the pensions report looks at ways in which state pensions might be targeted at those most in need, with the oldest getting more than the just-retired, and those with income from savings or other pensions arrangements receiving less than those without.

The more you can get people to save, the less of a burden there will be on this chunk of the pension. And that is where the second and more controversial element comes in. This is the compulsory savings plan, the new National Pension Scheme.

Those of us in work would be forced to save some proportion of our income, within top and bottom limits; that money would be put aside and invested on our behalf, and those investments would be used on retirement to buy an annuity that would pay the pension. So the size of our pension would depend directly on the amount we had saved. We would still get some small state pension, but the vast bulk would come from our own savings. This scheme would take over from the present state top-up pension scheme, Serps.

While you have to save, you don't have to save in the national scheme, and this report assumes that most people will not do so, preferring to take out a private pension scheme, if they don't have one already. But some kind of savings scheme would be compulsory. From that there would be no escape.

This is an idea whose time has come. I believe this for three main reasons. First, demography dictates that we have to put more resources aside for pensions. The choice is really between higher taxation now to build up a surplus in a proper social security fund, or some form of compulsory savings. I do not think that we trust governments sufficiently to give them more of our money. They cannot even balance their national budgets, so how on earth can they be trusted with the large surpluses such a fund would generate? So it has to be compulsory savings, supported by government but distanced from it and managed in a way that inspires trust.

Second, this idea fits in with the global trend for governments to do less themselves but be responsible for more. They no longer attempt to run airlines or telephone companies (let alone motor manufacturers), but they do increasingly regulate these activities. Paradoxically, they find it easier to police something they do not own than manage something they do.

And third, this idea fits in with the mood towards self-reliance that is evident in societies as diverse as Sweden or the United States: if people can do things for themselves, they should do so, while the state should direct its efforts at helping those who for whatever reason, are unable to do so.

Britain is interesting in a world context. We have a relatively old population, but we are not now ageing as fast as most other developed nations. We also already have a large private-sector funded pensions system. So our pensions problem is more manageable than just about anywhere else. We will be watched carefully for what we do next. If we head in the direction of compulsory savings for retirement, expect others to follow.