The framework is good but has too much to bear
The basic pension framework we have in place today was put together way back in 1956. In the intervening half-century, we've simplified the legislation to the point where practically no one can understand it any more, but that doesn't mean there's anything wrong with the underlying framework.
The idea that employers would provide workplace pensions to facilitate better income replacement rates in retirement for millions of employees was, and is, a good one. Likewise, the idea that the self-employed and those not in occupational schemes could get tax breaks to build up a decent level of pension savings in individual schemes.
The original individual pensions 50 years ago were 'retirement annuity contracts' and personal pensions are their modern-day replacements. In the years before the super-simplification that occurred on A-day in April 2006, the level of allowable contributions to both retirement annuities and personal pensions was determined by a table based on age, ranging from a 17.5% contribution for younger people, up to a 40% contribution for those approaching retirement age.
Many thought that the level of contributions increased with age because it was advisable for people to increase their savings levels as they got older, but that was not the case.
The maximum 17.5% contribution set for individual pensions by the actuaries back in the 1960s was deemed a sufficient level of saving to ensure a decent income replacement rate in retirement.
Broadly speaking, someone contributing at the rate of 17.5% of their earnings from age 16 to 65 would have had a reasonable chance of providing themselves with a pension equivalent to two-thirds of their final earnings. The increase in the level of allowable contributions for older people was there to allow late starters to catch up.
All of that should really come as no surprise to anyone today. If anything, the 17.5% figure is probably a bit on the low side since the recent increases in our likely longevity were announced. Good quality occupational pension schemes aiming at replacement rates of two-thirds of final salary for long-term employees require funding at or around the 20% level.
The simple fact is that good pensions cost money. They always did and they always will. The trends today seem to be that good occupational schemes are in decline (in the private sector, at least).
Employers are replacing them with schemes that have lower contribution levels. Even the government's new pension reforms that are due to begin in 2012 have set the contribution level at only 8%. None of this bodes well for the future.
First published in Pensions Week, 23 February 2009