State Pension is not a benefit - it's a liability without provision

 Increasingly the Government is trying to position state pensions as a benefit. Something which could be deemed optional and based on means testing.

For example just today the 10th August there is posturing that the state pension will cost more than education, policing and defence combined. Probably true.

The reality is that the for the majority of people, state pension is something they have paid into throughout their working lives.  It is far from being a benefit. It is not general taxation.  

If you have  made insufficient  contributions during your working life to the state pension, the payout will be pro rata reduced.  You can "buy" missing contributions or AVC. This is a voluntary payment - generally you don't volunteer to pay additional tax. 

It feels pretty much like a defined benefit pension scheme or at least a defined payout scheme. 

Now there are problems with the state pension

1/  The government has not saved or invested the contributions made by us so there is no magic ring fenced pot.  They simply pay out state pensions from general taxation.  Hence Tony Blair was hell bent on allowing immigration in order to fund this deficit.  Now if I paid into a pension fund and they didn't ring fence the money like the government, they would go to prison - it would be considered a Ponzi scheme. It makes Bernie Maddoff look like small fry.

2/ National Insurance is not ring fenced.  Governments treat it like general taxation.  For example the ad-hoc increases to "fund the NHS".  Healthcare is nothing to do with my pension - at least not directly.

3/ Successive governments have made the state pension a political voting tool.  Pensioners are more likely to vote. Pension increases are therefore generous with a triple lock.  They will get 10% increases matching inflation.  Pensions are locked to RPI which is increasing as a result of the Bank of England rate hikes.

So to illustrate this is not a benefit that should be means tested, I will illustrate the large sums of money involved here.

Lets take a typical 21 year old.  Assume they start working on minimum wage of £19k at age 21.  Between the age of 21 and 30 their salary increases and by the age of 30 they are on the median UK salary of £30k and stay on this salary until age 66. We will ignore inflation. I have picked age 21 because there are no NI contributions for under 21s.  Now a 21 year old will not be able to draw state pension at age 66 - more like age 68 but we'll use 66 for the time being. 

Employers have to pay 13.8% national insurance and employees have to pay 12% national insurance.

So this typical 21 year old will have accumulated £210,000 of pension contributions by their 66th birthday.  As I said we will ignore inflation and assume this money has been invested wisely and it keeps pace with inflation.

The current state pension is £10,600 per year.  Again we will ignore inflation so that's neutral to age 21 baseline.

So lets assume our 21 year old retires at 66 and draws the pension age 66 and lives to the age of 80 and dies on their 80th birthday.  A life expectancy of 80 is slightly about the median life expectancy for the UK.   

So the state pension for the period 66-80 will be £159,003.  However contributions will be £210,000 - approximately £51k more than they pay out. On paper this looks like a reasonable business case for the government. 

Now someone who is a high earner will pay significantly more than £210k to receive the same £159k payout.  Say our 21 year starts on £19k and increases to £50k by age 30 and stays on £50k until age 66. They will have contributed £416k to receive the same £159k.

The problem is not the payouts.  The problem is the government has not stashed the £210k away and made provisions for this liability.  The outlook for the future is pretty bleak.  An ageing population means  a smaller pool of young people have to fund the state pension out of the current account. 

In other words there's a shortage of suckers to join the Ponzi scheme.

Now lets just assume that I had this pot of £210k and not the government.  I could go and buy an annuity from an insurance company. Until recently annuity rates were about £4k per £100k so it would pay me around £8,000 per year - not quite as generous as the state pension but it's in the same ball park. Now with the Bank of England busily increasing interest rates, annuity rates have risen to about £7,500 per £100k so my £210k pot will now buy me around £15,000 per year - actually better than the state pension.  Ok I've ignored things like annuties dont usually increase with inflation but it does illustrate that this National Insurance contributions are real and material and not just a benefit.

Now this poor management of liabilities, that seems to be endemic in government,  is not limited to state pensions.  Civil servant pension liabilities are of the order of £2.4 trillion. Yet another  Ponzi scheme.  The size of the UK economy is £2.2 trillion so the civil servant pension liability is bigger than the UK economy. I'm not sure who said it but they referred to the United Kingdom as a pension scheme with an economy on the side.  How true.

So just looking at the news today, there were 141 civil servants on pensions  in excess of £100,000 per year.  That's a pretty serious pension.  In Jeremy Hunt's budget earlier this year, the ceiling on pensions was raised from £1M largely to appease Doctors in the NHS.  Many doctors aged over 50 were leaving the NHS  simply because of the tax penalties from exceeding a £1M pension pot.  Doctors and nurses get very generous pensions.

So let's briefly go back to these 141 civil servants getting £100k.  Lets assume annuity rates which rise are roughly £4k per £100k saved. Now this is not a good like for like comparison.  Annuity rates are not RPI linked for the whole term unlike gold plated civil servant pensions.  The reality is if you could buy one it would be more like £1,200 per £100k saved. However we will  use £4k to illustrate this.  In order to receive £100k pension you would need a £2.5M pension pot. Until very recently the pension pot cap was £1M. Hmmm.

 Lets assume these civil servants have done 40 years service (probably optimistic) then the pension contribution is effectively £62,500 per year.  The current limit on annual pension contributions is £60k and until recently was only £40k.  It seems there are one set of rules for us and another for civil servant cronies.

The problem really is final salary civil servant pensions (which includes the NHS, police, fire service, councils employees etc) are totally unaffordable.  The reality is the recipients of these really generous pensions really do not understand how generous they are.  In the real commercial word this would be referred to as a package - if employers offered such a generous package they would communicate exactly how generous this is.  

Now if governments didn't run like a Ponzi scheme and forward planned liabilities, I might have some more tolerance of them but right now there is a complete lack of transparency about how big a mess successive governments have created.  

When they do review schemes, we have cronies like Lord Hutton in 2011 claiming final salary pensions are affordable. Simply not true.

If the government does decide to means test the state pension I will start a class action against the government demanding they repay all my contributions so that I can buy an annuity with it. 

Do they think we are stupid?

<POST ARTICLE COMMENT>

Well Mr Hunt, the Chancellor, in recent budgets since this article has tinkered with employee National Insurance contributions.  He's left employer contributions unchanged at 13.8% but reduced the employee contributions from 12% down to 8%.  Has the cost of the state pension fallen by 4% so he can afford to do this?  Quite the opposite, the cost of providing the state pension has risen.  Yet more evidence that National Insurance isn't doing what it was intended.  On the one hand this is great news for the people - they are paying less to get the same State Pension.  Bad news on the other hand that there is less funding for the state pension so the long term reality is that it will be phased out.  

Pension funds really do need to be ring fenced to stop this Ponzi scheme tinkering !