Pensions: problems and solutions

There is much talk at present about the pensions problem.

The old age pension at its current level does not provide sufficient money for any pensioner to live comfortably without additional funds, either from the state, in the form of supplementary benefits or from private provision in the form of a private pension fund or savings and other investments.

As the population grows and people live longer, the present unsustainable situation will quickly reach crisis point. As a result, many politicians are advocating postponement of the retirement age for men (and probably women) to 67 or 70. This proposal has the attraction for politicians that it does not require anyone to pay more now, and it can perhaps be justified to some extent by the argument that when the Old Age Pension was introduced for men at the age of 65, they were not expected to live for more than a handful of years.

That said, it is a poor prospect for youngsters today that they may have to work until they are 70, especially when they realise that they are not contributing to a real pension fund for themselves but simply being taxed to pay for the pensions of their elders who have enjoyed the benefits of relatively early retirement.

Of course, the state pension system should have been properly funded from the start or, if that was at the time economically impossible, from the moment the country could afford it. (If any private pension fund had run their business the way successive government have maintained the state pension scheme, they would have been imprisoned.) We do not, however, have the ability to change the past, so starting from where we are now, we wish to propose an innovative solution to the pension problem.

We should say, first of all, that we take the following premises:

that any pension scheme should go with, rather than against, the grain of human nature
that the majority of the working population are more than happy to do their best for their family, especially their children
that it is generally better for people to provide for themselves if they can, rather than to depend on the state

On these premises, we base the following proposal:

Every individual should be offered the opportunity to set up a pension trust owned and managed by the individual - a personal pension trust fund (PPTF)
The government should provide realistic advice on how much each person needs to invest to generate various levels of income at pension age and should offer, as one option, a government bond with guaranteed rates of return for those who do not wish to manage the investment of the fund themselves.
The money paid into the PPTF should be tax paid - but the growth of the money in the fund and any withdrawal of the money in the form of pension at 'retirement age' should be tax free
At a 'retirement age' determined by the government, the individual should be entitled to withdraw money from the PPTF, either in the form of interest on the capital (if the fund is large enough) or in order to to purchase an annuity
Although at 'retirement age' the individual would be entitled to withdraw money, there would be no obligation to withdraw money. Any money remaining in the PPTF could be be bequeathed by the PPTF owner to any other individual (generally, but not necessarily, a partner or children) as a PPTF, tax free, subject to the same rules as applied when the trust fund was formed.
An individual who inherited such a Personal Pension Trust Fund would be permitted to add to the fund with 'tax paid' contributions throughout their lives or, if they already have such a pension trust fund, to merge it with their own.

The purpose of the scheme is

to encourage as many people as possible to provide for their own retirement
to enable those who can afford it to build-up a trust fund for future generations

Currently, elderly retired pensioners who are well off have every reason to spend their surplus money on themselves because of death duties. It would be better for the country if they provided that surplus wealth as the basis for a PPTF for their children, thus relieving the burden on the state.

Even those with modest incomes would be motivated to set up a PPTF as it would give them the chance to provide not only for themselves but also potentially for their children.

All contributions to the PPTF are tax paid, so the government does not lose revenue as it does with present pension contributions, but once the money is locked into the PPTF, it grows tax free and can be withdrawn, subject to the rules for withdrawal, tax free. The government would probably receive massive investment via the proposed government bond (see point 2 above).

Since each PPTF is owned by an individual, it is a personal asset. As such, in the event of divorces and remarriage, there would be a need to divide up the PPTF into smaller PPTFs. These smaller PPTFs would either provide the start for pension provision for the recipient or, if they already have a PPTF, would constitute an additional contribution.

Why is this idea worth considering?

The present practice of funding current pensions out of current taxes is unsustainable. In the end, taxpayers will rebel against a system that is heading for bankruptcy. This proposal motivates the individual to provide for themselves and their family. It taps in to a primal human instinct. It will encourage prudence and altruism; whereas the present system encourages irresponsibility and selfishness.

What will be the long-term effects? The aim would be to reduce very substantially the number of people who have to rely on the state pension. The state pension would become the last resort of those who simply hadn't been able or hadn't wished to provide for themselves. Families which had built up a decent PPTF could take pride in what they had achieved for themselves, their children and their children's children. Hopefully, people would brag about the size of their PPTF instead of the value of their house. Knowing they could provide the basis for a decent pension for their children would be a powerful motivator for the elderly better-off to place suplus money in their PPTF, rather than to spend it on themselves.

What would it cost the state? It would actually save the state money in the short term because the money paid into the PPTF would be tax paid, whereas current contributions to conventional pension funds are tax free. In the longer term, the state would lose the tax on the pension money when the pension is taken (because the money would be taken tax free) but, in return, it would have a much smaller pension burden to carry.

The individual would know the value of his/her PPTF and what benefits would be available; the state would know that the PPTF was funded with real (tax paid) money.

2010 09 14