Pensions for Millennials: reviving the principle of contribution

The architect of the British welfare state, Sir William Beveridge, contended that “benefit in return for contributions, rather than free allowances from the State, is what the people of Britain desire”. His words are as true now, as they were three quarters of a century ago. Society only functions when all individuals and groups honour the written and unwritten agreements that underpin our collective life. They deliver on their commitments: their expectations are met reciprocally.

Structural inequities between different sections of society – real or perceived, transient or enduring – only lead to mistrust and disenfranchisement. It is one of the many responsibilities of government to prevent this happening. The competing demands of contribution and entitlement, aspiration and expectation, and universalism and need must be balanced; this is never harder than when considering pensions and how we as a society provide for retirement.

 There are essentially three basic types of pension within the UK: the universal state pension, paid for out of general taxation; occupational pensions, paid for by employers and employees; and private pensions, paid for entirely by the individual. This tripartite system presents a number of challenges, including: poor expectation management; poor value for money; a misallocation of resources; off-book government pension liabilities of over £5 trillion; insufficient personal provision for retirement; and, most recently, inter-generational resentment.

 Over the last quarter of a century, Labour, Coalition and Tory governments have all tried to reform the way we prepare for life after full-time work, but have failed to address its fundamental problems and injustices. Most recently, Cameron and May have also managed to add to them. They have underfunded both the NHS and adult social care – two critical public services that disproportionately affect the elderly and are best delivered universally. They have shifted the pension age of an entire generation of tax paying women too late for them to adjust their financial planning accordingly. And they have made annuity buying – by far the best way of ensuring the certainty and continuity of income in retirement – optional.

 But the uncomfortable truth is that although any tinkering that disproportionately affects working people and the vulnerable is unacceptable, many of the problems are strategic, systemic and not in the gift of a single government to alter. The types of changes necessary will require long-term consensus; not just between the parties of the day, but over successive governments that must commit to seeing the solutions through, rather than abandoning them for short term political gain.

 One such solution is to begin gradually to change, over the next half century, the very nature of state pension provision from one of universal benefit to one of universal contribution and nationalised insurance. This would mean that those under the age of thirty-five – the so-called Millennials – would join a new Combined Defined Contribution Pension System. Such a system would be built on the successes of international best practice and would be based around six key elements:

 1.       Individuals of working age would be mandated to join a collective defined contribution scheme at a minimum contribution level, but would be free to increase their own payments to any level they wished; therefore reviving the contribution principle so fundamental to the resilience of our welfare state.

 2.       Both the state and employers would match individual contributions up to a maximum limit, therefore combining the contribution of all the three key contributors to the current pension system, and enabling a lifetime of compound interest to apply to a larger pot.

 3.       Individuals would have a choice over which pension provider to use – including both collectivised and non-profit making ones – and the ability to move between them.

 4.       The state’s role would shift to one of contribution and insurance, rather than the provision of a universal benefit.

 5.       In its role as ultimate guarantor the state would underwrite the investment funds to a minimum level of return equivalent to government bond yields. In return for being underwritten, providers would be mandated to invest a minimum percentage of their portfolio in bonds issued by a National Investment Bank; so enabling the additional social benefit of purposeful investment.

 6.       Finally, through what would effectively be an extension of working age benefits, the state would support anyone who had been unable to work and contribute consistently.

 To suit individual needs and circumstances, the new system would also have to ensure a great deal of flexibility, for example allowing the transfer of funds to partners and tapered early release.  It would also be naïve to think that changes to the pension system of this scale and over such a prolonged period would not raise a number of technical challenges; such as the optimal size for collective pension pots, and how to compensate millennials, and the next couple of generations after them, for essentially paying twice – though the latter could be done through increasing the state’s contribution and reducing the personal contribution for those affected, and altering that ratio to a ‘normalised’ level over time. Yet, while there are still issues to be worked through, the ultimate prize is clear: individuals that work with both employers and the state to provide for themselves in old age, and so allow the welfare state to be focussed on those most in need.

 In the Labour Party we believe that “by the strength of our common endeavour we achieve more than we achieve alone” and that “the rights we enjoy reflect the duties we owe”.  I believe that a Combined Defined Contribution Pension System is not only a clear practical expression of both these principles, but one of the ways in which we can tackle the problems that old age provision is facing today and, unless we act, will continue to face tomorrow. It is time for radical progressive change and, as the Chinese Proverb says, "The best time to plant a tree was 20 years ago. The second best time is now."