The best way to make pensions sustainable is to reduce the tax burden on saving

The Government consultation paper published yesterday on “defined benefit” (DB) pensions does its best to sound reassuring and even positive. There is no crisis in such final salary schemes, it soothes, suggesting that most companies can easily afford to meet the mounting costs of paying those pensions. Yet these assurances are undermined by the facts: many companies have closed their final salary schemes to new entrants, meaning that, in the words of the Office for National Statistics, “for the younger generation, the option of joining a DB scheme is much reduced”.

Now those who were fortunate enough to enrol in such schemes could see cuts in the value of pension payments they had thought were guaranteed. It may be the case that, in some circumstances, it makes sense to allow an employer to reduce pension payments below the rate of inflation, to ease the pressure on a company’s finances. But such measures should be an absolute last resort and must be policed tightly to ensure they are not abused. 

How much can you save into a pension in a year?

More importantly, any such changes to final salary rules cannot be done in isolation. What is needed is a wider overhaul of the rules on pension saving, to encourage and reward that saving. The best way for the Government to do that is reduce the burden of tax it puts on pensions. Lifetime and annual caps on pension saving unfairly penalise the most thrifty and thus deter savings. Pension funds themselves are also burdened: Gordon Brown’s infamous decision to tax the dividends they receive from shares still costs them tens of billions of pounds a year, money that would otherwise go to pensioners. Today’s Conservative Government should give thought to easing those burdens.

A proper debate about ending the Bank of England’s quantitative easing programme – which hurts pension funds’ bond investments – is also long overdue. 

And to be politically sustainable, any changes in the rules for private sector pension schemes must be accompanied by greater reform in the public sector. The gap in pension provision between private and public employees is now intolerably wide: talk of a “pensions apartheid” is growing. A situation where some workers retire in comfort, while others with comparable (or even greater) talent, experience and effort struggle, would be socially divisive and deeply unfair. If tough choices are needed on pensions, public sector workers must take their fair share of the pain.

Likely to exhaust a pension pot of £100,000