The government’s pension reform – an intergenerational balancing act

25 Mar 2016

Along with abolishing the Money Advice Service, the government has revealed plans to restructure the delivery of pension guidance, with the introduction of a new pensions guidance body to replace the existing Pensions Advisory Service and Pension Wise. The government believes this will be a beneficial restructure that will provide the right guidance for all pension related questions in one place.

The government has come under fire for its recent budget rollout, however, as many labour MPs have criticised it for focusing too little on working class people, or too much emphasis on protecting pensioners. Former Work and Pensions Secretary Iain Duncan Smith has noted that the government is risking dividing society by focusing on pensioner protection, while also cutting disability and welfare benefits.

Why focus on pensioners?

Prime Minister Cameron has continuously pledged to continue protecting pension benefits and there are many arguments one can make for why it might make good policy to do so. One argument is that good pension reform reduces the risk of individuals not properly saving for retirement. One of the biggest financial challenges for young people of working age today is taking steps to save for retirement. With disposable incomes low and living costs high, the younger generation is forced to prioritize the small amounts of savings they have between funding a future home and saving for retirement. By guaranteeing a safety cushion for pensioners through policies like the ‘triple lock’ and auto enrolment, the government is essentially promising a good retirement, allowing the younger generation to focus on funding a home instead. With the newly introduced Help to Buy ISA and the newly introduced Life ISA, the government is trying to manage the trade-off between saving for a home and funding retirement, and work on both frontiers. Both allow you to get a government bonus of 25% on your savings, with the former focusing on housing, while the latter can be used to either buy a home, or fund retirement.

Another argument is that pensioners are the most vulnerable group when it comes to debt and financial stability. According to Age UK 1 in 6 pensioners (1.8 million or 16% of pensioners in the UK) live in poverty, with another 1.2 million on the brink. The combination of poor health and mobility, being more likely to live in rural areas with limited public transport, and having fewer social networks often makes it much harder for older people to manage financially.

Furthermore, although the UK economy has begun to show recovery – albeit a slow one according to the Bank Of England – the global financial crisis of 2008 revealed that household finances were under far greater stress than the previous two decades. Low financial returns post-crisis have led to disappointments for people investing prior to 2008, who were expecting higher returns to fund their older years. Accumulating retirement wealth has become harder, as the older generation gets less than what they initially expected. As a result, those who experienced affluent pasts prior to retirement and now left with a more modest income in pension age may find it harder to adjust, resulting in difficulties in managing attitude, wellbeing and income.

Why is the government under fire?

There has been discussion on how sustainable the government’s pension policies are, with critics saying that pension protection is too great. These sorts of policies include the ‘triple locked pensions’, a policy which increases the amount of state pension every year in line with wage growth, price inflation or 2.5%, whichever is the highest. Critics claim that such policies are unsustainable, causing inequality between the old and the young, coming with an added pressure of £6bn extra a year to the benefits bill.

Low income in retirement is often linked to low wages during working age years, which critics are using as the main argument to direct the government in its policy making. The current low interest rate environment, which results in low returns of investment, coupled with longer life expectancy, is negatively affecting the savings of workers in the UK which analysts say means a negative effect on the pensions industry. The current investment environment has led to a “black hole” of £800 billion in defined benefit (DB) pension schemes, despite employers pumping in contributions worth £160bn. The fact that the UK is an aging society, with more people living longer in retirement, means that the black hole will continue increasing, with the government having to pay out for longer.

Is the government being fair?

An “intergenerational fairness” inquiry by The Work and Pensions Committee launched in January this year and has revealed that the baby boomer group born in the 50s and 60s is forecast to receive from the welfare state 118% of what they contribute, while the younger people are on course to have less wealth at each point in their lives than earlier generations had acquired by the same age. This calls for questions on whether the current government policies to support pensioners at the expense of the younger generation are fair.

Frank Field MP, Chair of the Committee asks an important question which Cameron and Osborne will need to ponder over and be accountable for: “Is it fair and affordable to divert a large and growing sum of public expenditure toward pensioners – regardless of their circumstances – while mainly poor families with children face year-on-year restrictions on their income?”

Yet considering the fact that the government has already backed away from disability welfare cuts and spending cuts, a more important question (and a headache) for the duo now is how they are going fill the multibillion finance gap.