Can The State Pension Survive?

According to an international survey, the UK has the worst state pension in the EU. What does the future hold for British workers?

The UK has the worst state pension provision among 25 European countries, according to an international review conducted by Aon Consulting. This is the second year running that the firm's European Pensions Barometer review found UK pensions to be inferior to their European Union counterparts.

On average, British pensioners are paid a state pension which is worth just a sixth (17%) of average earnings. Across Europe, the typical pension comes to more than half of earnings (57%), so it appears that British workers are being short-changed when they retire!

Then again, although our state pension is inadequate for much more than basic survival, British pensioners on low incomes can claim various means-tested benefits. Adding in these extra payments moves the UK into fifth place in the European league table, with Denmark taking top honours.

The good news is that although the UK's basic state pension is miserly, we do have fairly good company and private pension options. Thus, employees of businesses with good occupational pension schemes fare much better, as do workers who save hard for retirement via private pension arrangements.

What's more, unlike many other European nations, the UK's government has already taken steps to tackle the `pensions timebomb' created by an increasingly elderly population. Between 2024 and 2046, the normal state retirement age will increase from 65 to 68 (which means that I won't qualify until I'm 67, worst luck!).

Of course, increasing the retirement age takes some pressure off the state pension system and helps to improve its affordability. In addition, it's worth noting that increases to the state pension are linked to inflation (rising prices) rather than wage increases. Thus, over time, pension incomes tend to fall away as a proportion of the average wage.

As well as reforming the state sector, the government is taking steps to improve the take-up and value of private pensions. By launching low-cost `personal accounts' in 2012, and through `automatic enrolment', it hopes to increase the number of employees who contribute to a work-based pension. Alas, the tax relief paid to basic-rate taxpayers who contribute to pensions is set to fall from 22% to 20% from 6 April 2008. Thus, in order to maintain pension payments at the same level, non-higher-rate taxpayers will have to pay more into their pensions.

So, what does the future hold for state pensions? Clearly, maintaining a reasonable state pension could be very expensive, especially as the number of pensioners is set to rise steeply from its current level of eleven million. Thus, unless we are prepared to shoulder a dramatic increase in taxes in order to pay for state pensions, then the logical conclusion is that pensions will continue to wither.

Fundamentally, there are three ways that the government can slow or reduce spending on pensions. I call this the "three hows" problem:

1.    for how long will pensions be paid;

2.    how many people will be paid; and

3.    how much will each receive?

Thus, the state could pay out pensions later, perhaps by hiking the retirement age to seventy or beyond. Second, they could ensure that fewer people qualify for state pensions. Indeed, it's possible that increased use of means testing could exclude wealthier folk from qualifying for any state payments in retirement. Third, the state could continue to erode the real value of pensions by letting them fall behind rising prices and wages.

Alas, regardless of the tactics that this and future governments adopt, nothing is going to make state pensions more generous. Indeed, I expect to see the state pension gradually whittled away until it is of little worth to all but the poorest fraction of society. This would be a great shame, but financial reality generally takes precedent over social harmony.

Finally, if you're worried about the decline of state pensions, then my advice is simple. The only person you can rely on to look after you when working life ends is yourself. Hence, I'd urge you to start making plans for retirement today, if you haven't done so already. It's up to you whether you contribute to a pension, a tax-free ISA, or invest in shares, property and so on. Just be sure to squirrel something away, or you'll live to regret this missed opportunity in later life!

More: Pensions Versus ISAs | Don't Put Your State Pension At Risk | Increase Your Pension Income By 48%