Iain Duncan Smith is a man on a mission to mend Britain’s broken society. A society, he warns, that is splitting in two due to the development of a dependency sub-culture. He describes a growing underclass totally reliant on the welfare state with lower life expectancy and low general expectations for life.
His solution is to get people back to work by making sure that it is financially worthwhile to earn a living, rather than to rely on benefits. Mr Smith understands that working and earning your own living increases self-respect, self-reliance and greater independence. Overall, this will encourage a greater sense of belonging to society.
But if Mr Smith is to truly banish the dependency culture then he needs to apply these sound ethics and financial incentives to another area in his portfolio, pensions. Over 50% of people working in the private sector are not currently saving for a pension, so getting people to save in the first place is a priority.
To achieve this, new rules requiring companies to automatically enrol their staff into a pension scheme are being phased in from October 2012. Staff will have the option to opt-out but the hope is that millions more people will be nudged into saving for a pension.
Better off on benefits?
Currently, the average size of a pension fund used to buy an annuity is under £30,000 – an amount that many people brought into pension saving through the new regime, especially those who sign up mid-life, are unlikely to reach. And even if they did, £30,000 is depressingly impotent when it comes to financing your retirement.
Under the current system a pensioner whose income is under the poverty line of £132.60 per week qualifies for a benefit payment to top him up to that level. Hence a person, whose sole income is the basic state pension of £97.65 a week, will receive an extra £34.95 a week. This benefit is of course index-linked. To put this into perspective, a man who has just retired aged 65 and used his £30,000 of savings to buy an index-linked annuity is likely to receive £23 per week. He would, of course, qualify for benefits of £11.95 to top his income up to £132.60 per week.
We have a situation where the first £40,000 – £50,000 of a person’s pension saving simply goes towards reducing the Government’s benefits bill. For some it is the equivalent to a 100% tax on their pension.
Creating an incentive to save
Last October Iain Duncan Smith announced the intention to raise the basic state pension to £140 per week. This would bring everyone that receives it above the poverty line and help resolve this unjust and ludicrous situation. A green paper was set to be published in November 2010 but we are still waiting.
The Government needs to act quickly to resolve this situation; currently they are continuing to encourage millions of people to save in the knowledge they are unlikely to be better off than if they had simply relied on the state for financial provision in later life: it is appallingly cynical and unethical.
But even if the situation is resolved – and it must be – the relatively small amount that most people can save and the high cost of a pension annuity means that ultimately, the pensions they receive are likely to be small. As many savers have found out, all you need is a recession to come along and knock the stuffing out of your investments to make you wonder why you bothered in the first place.
Currently in the UK there are 25 people of retirement age for every 100 of working age; by 2050 this is forecast to rise to 38. The economic and social benefits to having a solvent retired population are obvious and the only way this will happen is if people make their own provisions by saving. Without providing a secure way to ensure that they can obtain a reasonable and safe return on their pension savings and affordable index-linked annuities, this is not to going to happen.
Back where we started
Unless things change, those who respond to the welfare reforms and haul themselves out of the dependency culture are likely to find themselves right back in it once they retire and no better off for any retirement saving they have done. They will also be joined by millions more who have worked their whole lives.
The current welfare reforms are underpinned by the promise that it will always be more financially worthwhile to work than not to work. To complete the job and also to be fair to those who sought work even though it would have been the easier and sometimes more financially rewarding option to fall back on the benefit system. We need another commitment from the Government; you must always be better off if you have saved than if you had not.