The top six worst snags with pensions

Cliff D'Arcy investigates the six biggest problems with pensions.

One of the biggest financial problems we face is putting aside enough during working life so that we can enjoy a comfortable retirement.

Decades ago, when life expectancy was far lower, pensions weren't so much of a big deal. After all, why worry about running out of money when the chances are you would die within five years of state retirement age?

Long lives mean big headaches

Fortunately, thanks to huge improvements in healthcare and living standards, life expectancy has risen steeply in the post-war era. On average, a 65-year-old man today has a 50% chance of living to age 87, which could mean funding 22+ years of life after work.

Of course, as we live longer lives, this puts an ever-greater strain on our retirement finances and, therefore, on pension schemes. Here are six of the biggest problems facing today's future pensioners:

1) The state pension is sinking

If you work for long enough and pay sufficient National Insurance contributions, then you'll qualify for a full state pension. At present, this is just short of £5,000 for a single person and £8,000 for a couple.

Today, state retirement age is 65 for men and 60 for women, but that's soon set to change. Already, the government is phasing in higher pension ages: 66 by 2026, then 67 by 2036 and 68 by 2046.

Even so, this may not be enough, because the state pension is unfunded. This means that pensions are paid from general taxation and not from a giant pot of invested contributions. Hence, the state retirement age may have to be increased even further - to 70, for example - in order to balance the books.

2) The government is broke

In 2009/2010, the government expects to spend £175 billion more than it will earn from taxes. This budget deficit means that our national debt, currently standing at £805 billion, is growing by £1 billion every two days. In other words, we're in a deep pit of debt and digging deeper every day.

Of course, the way to balance our national budget is to raise taxes and cut public spending. With more than 11 million people claiming the state pension, it is sure to come under sustained attack in the years ahead.

3) Baby Boomers are retiring

'Baby Boomer' is the term generally used to identify a member of the generation born in a post-Second World War baby bubble which lasted from 1945 to 1965. While female British boomers have already started retiring, the oldest male members of this group are set to retire in 2010.

In other words, between 2005 and 2030, there will be a huge wave of new pensioners claiming the state pension. This will boost the pensioner population to well over 12 million people. With rising retirement and unemployment shrinking the workforce, and higher taxes required in order to pay pensions, future generations of workers will be under extreme stress.

4) Public-sector pensions: The elephant in the room

Roughly three-quarters of the British workforce of 29 million -- almost 22 million adults -- work in the private sector. Of these, 4.4 million are members of final-salary pension schemes. In other words, only one in five private-sector workers has a guaranteed, defined-benefit pension.

On the other hand, 5.1 million of the 7 million public-sector workers belong to final-salary pension schemes. In other words, almost three-quarters of state workers (73%) have an occupational pension guaranteed by the government.

The big problem here is that while the private sector has already taken an axe to pension costs, the government is terrified to follow suit. Nevertheless, our leaders have no alternative, because the sums required to maintain public-sector schemes are spiralling out of control.

For example, more than a quarter of all council tax goes to pay the pensions of already retired local-government workers. What's more, most public-sector schemes are either unfunded or underfunded -- and accounting for the black hole at the heart of this problem would add £1 trillion to our national debt.

5) Employers pull the plug on pensions

As the cost of providing work-based pensions soars, organisations respond by slashing their pension spending. Putting it bluntly, businesses and other organisations have decided that they can no longer afford to write blank cheques for their workers and pensioners.

Thus, nearly three-quarters of all private-sector final-salary schemes have been closed to new members, with a few closing down completely. Other firms have demanded higher monthly contributions from their employees, or reduced payouts by raising retirement ages or moving to career-average benefits.

At the end of 2008, company pension schemes had a £195 billion shortfall. Therefore, this trend towards downgrading pensions is sure to continue. Indeed, some companies have taken to reducing or stopping pension contributions to the defined-contribution (alias money-purchase) pensions which replaced their superior final-salary schemes.

6) Personal pensions have been second-rate

Although personal pensions have been around since the Eighties, they've never really had a good press. Thanks to a toxic combination of high and multiple charges, poor investment returns and falling annuity rates, personal pensions have been a damp squib. In some cases, you'd have been better off sticking your money in a savings account.

In contrast, the new generation of low-cost stakeholder pensions and Self-Invested Personal Pensions (do-it-yourself plans) are a great improvement in terms of charges and transparency. Here's more about DIY pensions.

In summary, major social and financial changes are putting state and occupational pensions under an impossible strain. In the end, something must give. My advice is simple: take more responsibility for your retirement planning by saving more during your working life. Otherwise, you'll be forced to fall back on politicians' promises -- and we all know how reliable they are!

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