How do we solve a problem like the state pension?
A report from the Government’s own actuary published towards the back end of last year made pretty terrifying reading for anyone interested in the UK’s future finances.
The Government Actuaries Department (GAD) paper, which you can read in full here, analyses the financial position of the ‘National Insurance fund’ – the difference between the money the Exchequer gets in from National Insurance Contributions (NICs) and pays out in benefits. The vast majority of these benefits (94% in 2015/16) relate to the state pension.
The ‘balance’ of the fund stands at around £25 billion at the moment, according to GAD estimates (see Figure 1), and in the very short-term the picture looks rosy. A combination of the end of contracting-out in April 2016 and the gradual increase in the state pension age to 65 for women by 2018, and then to 66 for all by 2020, means NIC receipts are expected to exceed benefit expenditure up until around 2025.
However, after this point a lethal cocktail of demographics and the impact of the state pension triple-lock – which guarantees the payment rises in line with the highest of average earnings, inflation or 2.5% - sees the size of the fund fall away from 2025 onwards.
Under the assumptions used by GAD, the fund is exhausted from around 2032 – that’s less than 15 years away. After that point the Treasury (i.e. taxpayers) will need to provide a grant in order to fill the gap between the amount coming in through NICs and the amount going out in state pension.
These grants will kick in at £11.6 billion a year and increase rapidly to £151 billion by 2060 and £482 billion by 2080 if the system stays as it is. Clearly this money will have to come from somewhere and the options open to policymakers to plug the funding gap are not particularly attractive.
The Government Actuary reckons a 5% increase in National Insurance Contributions would do the trick. However, given the controversy caused by a relatively small (and perfectly reasonable) change in NICs for the self-employed in the 2017 Budget, this is hardly a realistic route for any politician seeking election – regardless of their political hue.
Alternatively, the state pension age could rise further and/or faster than under current plans, or the value of the payment cut back (perhaps by scrapping the triple-lock). Again this would potentially be hugely unpopular and Labour has committed to halting planned increases in the state pension age and retaining the triple-lock.
If neither of these options is palatable, where does the current – or more likely future – Government turn? Cuts to the NHS budget anyone? Or education perhaps? In this environment of difficult choices it’s hard to imagine pension tax relief – which the Government spends approaching £50 billion a year on - staying out of the firing line.
But what we really need is a serious, cross-party, national conversation about the future direction of pensions in general. It may seem ambitious given the tribal nature of UK politics, but the success of automatic enrolment has shown the way in delivering lasting retirement savings policy. It is time for the rest of the retirement savings system to benefit from similar long-term thinking.
Only by attempting to build consensus, as was achieved through automatic enrolment, can such difficult long-term challenges be tackled.