End Pension Apartheid!

Lower-paid workers get the short straw when it comes to pensions. Here's an easy way to level the playing field.

Pension provision in the UK varies enormously from one organisation to another. Imagine a `pension pyramid' made up of these five blocks, from bottom to top:

The pension pyramid

1. The self-employed and those with no workplace pension provision, who are forced to make their own arrangements -- or keep working until they drop!

2. Employees in workplace-based pension schemes to which their employer doesn't contribute, such as a basic stakeholder scheme.

3. Those in defined-contribution schemes (also known as money-purchase plans) to which they and their employer contribute.

4. Those in final-salary schemes, where their employer guarantees to pay out a pension based on their annual salary and length of service.

5. The gold standard of pensions: generous, well-funded final-salary schemes with high accrual rates and other attractive benefits.

The millions of people at the bottom of this pyramid get little or no help from their employer (if they have one) towards their retirement planning. Many of these workers end up relying on the state pension - currently just £90.70 a week -- to make ends meet.

In the middle of our pyramid, we have rank-and-file workers, ranging from the lowest-paid employees to middle-management. At the very top, we have the `pension elite' -- the owners, directors and managers of organisations and companies. They can look forward to a handsome retirement, thanks to the generous pension arrangements they've put in place to feather their nest.

It's risky at the bottom

Our pyramid is also a `pyramid of risk', in that the people in levels 1, 2 and 3 take all of the risk and uncertainty regarding their future retirement income. Without final-salary guarantees, their post-work income depends on their contributions, future investment returns, fund charges and annuity rates.

However, at levels 4 and 5, the company takes most or all of the risk, providing gilt-edged pensions by making large pension contributions on behalf of its workers. Indeed, the average employer contribution into a defined-benefit scheme is a whopping two-ninths (22%) of salary.

Lastly, our pyramid is also divided into private-sector workers, who mostly fall into levels 1, 2 and 3, and public-sector workers, whose pensions usually appear in levels 4 and 5. In order to reduce their ongoing costs, private-sector employers have closed or downgraded thousands of final-salary schemes since the turn of the century.

However, the unfunded cost of providing guaranteed pensions to public-sector workers is estimated to add more than £1 trillion, or £40,000 per household, to the national debt. Hence, without massive tax increases, it is highly unlikely that the UK can continue to insulate public-sector workers from financial reality when it comes to future pension provision.

Time to end pension apartheid?

In 1997, this government abolished the dividend tax credits claimed by pension funds. This reduced the income made by these funds, damaging their long-term returns. Further tinkering, plus a weak stock market, has left our pensions funds weaker than they have been for a generation. Hence, I think it's high time that Labour did something positive to restore public confidence in pensions.

My suggestion is this: change the law so that all employees in an organisation-- from the most senior to the lowest paid -- must be members of the same pension scheme. In other words, no more `pension apartheid' between directors, managers and bosses on one side and their workers on the other. After all, most directors and managers already receive more than their fair share of benefits, such as higher salaries, bonuses, share options, plus other assorted perks and incentives.

For example, I know of a company where the directors and senior managers belong to a 1/30th final-salary scheme. In other words, for each year of work, they earn a pension of 3.33% of their final salary. Thus, after just twenty years of service, they earn the maximum two-thirds (66.7%) of their final salary.

Alas, their workforce is not quite so feather-bedded. In fact, their pensions accrue at half the rate earned by their managers -- only 1/60th (1.67%) per year. Thus, in order to earn a pension of 2/3rds of their salary, these workers have to stay with their firm for four decades, not two.

Were these two segregated schemes to be replaced by a single scheme for all employees, then the directors would have two choices. They could bite the bullet and accept lower pensions or, more likely, they could upgrade and improve the scheme's retirement benefits. This would benefit all workers and not just the most highly paid.

Fat chance!

Sadly, I imagine that this law would have no chance whatsoever of getting through the House of Commons. Why not? The simple answer is that Members of Parliament have voted themselves one of the finest pension schemes ever to grace this fair land. Hence, I think they would be hugely reluctant to surrender their own mightily attractive pension plan in favour of an inferior scheme shared by the masses!

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