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We can’t ignore the pensions time bomb

Younger workers could end up with higher taxes and poorer pensions while subsidising comfortable retirees.

By John Oxley

Protests in France have shown the danger of governments tackling pension provision head on, but ignoring the issue is just as risky. It’s a looming crisis with few easy answers.

Almost every Western nation faces the same problem. State pensions have been paid out of current tax incomes, with today’s workers funding the living of today’s retirees. But this bargain will break down as the demographic ratios between them change.

Declining birth rates and rising life expectancy is increasingly expected to skew. By the 2040s in Britain, the ratio of over 65s to workers will increase: the Office for National Statistics has estimated the proportion of over 65s in the population will be 24 per cent by then. Maintaining pensions at current levels will require significantly higher public spending, borrowing, or cuts elsewhere. The alternative is cutting provision, or pushing up entitlement ages – both of which are politically controversial, with neither Labour nor the Conservatives keen to jettison the “triple lock”, which ensures that pensions rise by the rate of inflation, average earnings or 2.5 per cent (whichever is highest).

Even if the government is capable of grappling with this – it may raise the state pension age to 68 by the end of decade – there are other issues with retirement provision. In Britain, a relatively modest state pension has traditionally been augmented by defined-benefit occupational pensions. These generous schemes are now in decline, with only around a million workers actively paying into them. More limited defined-contribution schemes have taken their place, but investment levels are lower than necessary to avoid a crisis in later life.

This is especially concerning as younger workers have been less able to build up alternative sources of wealth, most obviously in housing. Current retiree homeowners have benefited from rising house prices which have given them extra capital in old age. Younger workers are unlikely to share this, instead spending more across their lives on rent and mortgages. Additionally, those who don’t own their own home by the time of retirement will have higher expenses to cover.

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Already there is a gulf between the haves and have-nots in old age. Around a fifth of pensioners live in poverty, but a quarter live in millionaire households. This divide will be exacerbated as the ability to save for later life becomes harder. At the same time, there will be a growing gulf between the old and young.

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Without means testing, the pension could become a wholesale transfer from the young and poor to the rich and old. The median pensioner already has more disposable income than the median worker, and is likely to have greater wealth. There’s a real risk that younger workers end up with higher taxes, poorer pensions and more expensive housing while subsidising the lifestyles of comfortable retirees.

Raising pension ages is just the start. Unless Western countries find a way to swell the ranks of the working (and immigration has its own political challenges), the current system will become unsustainable. Without a radical reconsideration of how taxes are levied and spent, the system will simply break.

Protests might change some policies, but they won’t change the reality of the consequences of an ageing population. The demographic tide cannot be held back, it can only be managed. Any changes will draw protests, but ignoring the problem will only make it worse.

[See also: Nadhim Zahawi’s tax affairs undermine Rishi Sunak’s call for Conservative “accountability”]

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