The 100 Year Old Buccaneer

The Daily Telegraph has recently launched a campaign to review and update the country's ISA regulations to try and improve on the current outdated, and rather creaky system. As someone with a more than passing knowledge of the intricacies and foibles of the ISA landscape, I largely agree with the aim. However, in passing, the Telegraph ISA champion has unfortunately dismissed a key question in the debate about moving away from pensions and towards ISAs. What do you do when people spend all their money in Vegas?

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Governments like pensions because they "lock in" someone's savings, and, upon retirement, force the purchase of an annuity which then provides a rest-of-life income. Its a way of forcing responsibility on to a population that, on the whole, is pretty irresponsible when it comes to spending decisions.

The moves to update the ISA rules to make them appropriate vehicles for retirement saving are, in part, being resisted because of concerns by those in the Treasury about people spending their retirement pot early. While those running the Telegraph campaign dismiss this as unlikely, I feel it is almost inevitable.

To build a healthy retirement income you really need to be saving throughout your working life; a lesson I, and many in my generation, who anticipate the state pension being abolished due to cost issues long before we ever get to claim it, base much of our financial planning around. Saving is something you do month in, month out, and not just to pay for holidays, cars or 80" plasma TVs, but so that thirty years down the line we have sufficient capital to be self-supporting.

A move away from forced pension contributions at work and through lower taxes, would therefore be welcomed by those who would channel the unlocked funds into their own nest eggs, earning both interest and dividends during their working life, and then in time being able to use a combination of income and capital erosion to pay for their retirement. It would also be welcomed by those who could use the extra money to buy a fifty-first pair of shoes and a bottle of vodka red bull.

What's the downside then?

In a harsh, lassie-faire type world the answer may be 'very little'. The government abdicates the need to provide a pension, slashes taxation by a comparable amount, and provides tax breaks equivalent to the cost of running the present system.  Individuals then have the choice to spend now and suffer later, or flatten their income over their lifetime, perhaps forfeit some of the highs now, in exchange for a more comfortable old age.

Sadly we do not live in such a responsible society, in our world many and more will simply spend all their income as they get it and then rely on government hand outs in old age. Any government which lets people die in the winters and on the streets because they spent all their money 30 years ago will quickly find itself vilified in the media and out of office, regardless of how self-inflicted the potential misfortunes are. A truly "open" system, such as the one presented by the Telegraph, where savers are free to make their own choices, with their money, and shoulder the consequences, seems remarkably unlikely.

In trying to resolve this issue my first thought was to advance some kind of National Pension Fund. The premise seemed reasonable, replace the ponzi scheme of the current system with a structured investment pot, and allow it too accumulate to the point where the interest and earnings can pay for pensions.

Pensions in the UK currently cost the government approximately £74billion, so to pay out this amount, plus reinvestment of around 2% to keep up with inflation, the National Fund would need capital of around £1,480 billion. (£1.4 trillion, or the equivalent of about 3 years total government spending). This assumes a rather generous return of 5% a year, at a more practical 3% the capital requirements soar to over £7 trillion. (In this instance you would need to reinvest 2% of your 3% to keep up with inflation, leaving only 1% to pay the pension costs). This of course also assumes you dump the triple lock which sees pensions rising at 2.5% even if inflation is lower.

While the first figure isn't entirely ludicrous (if you assumed you could accumulate funds for 35 years before you begin to pay out the Fund would need to gain around £42 billion a year in funding while it grew - possibly doable with significant reforms, debt reduction and cost cutting). The later - £7 trillion would be the work of generations to amass.

There are also political problems with a National Fund - who administers it, who gets the cheque book and how long would it before an enterprising chancellor decided the Fund had to lend to government at rock bottom gilt prices? And on a practical note how would you go about bringing this scheme into being? Even if today's taxpayers were moved over to a new accumulative scheme someone still has to pay for those who claim their pensions today.

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A brief derailment is required here to lay to bed a re-occurring comment about the nature of state pensions and how they are financed, the below is a fact:

"If you are currently receiving state pension, you did not pay for it."

More precisely - I and all current taxpayers like me, are paying for it, every month, when we get our salary, minus income tax, national insurance and so on.

The tax contributions that you made through your working life went towards the current spending of the governments elected while you were in office. This included, albeit on a much smaller scale, pensions for the previous generation of taxpayers to yourselves. None of it, ever, in any way, went towards investments, savings or projects designed to provide a means of funding your pensions.

This is because the state pension system is a ponzi-scheme of the grandest proportions, and it only works as long as people at the bottom keep paying in faster than the people at the top take the money out.

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An alternative seems to be to reduce the number of people claiming pensions. This then reduces the overall tax burden and may allow for some relaxation of the taxation of savings and investments, opening the door for those who want to save to do so, while still maintaining some level of safety net.

To put the numbers into perspective when the national pension was first launched at the beginning of the 1900s, the qualifying age was 70 (against an average life expectancy in the mid 50s). Most people never claimed state pension, they died too soon. And on top of that it was at a far lower level (equivalent to about £33 / week in today's money for a married couple). As such it wasn't an unreasonable assumption that pensions could be seen as a minor cost, spread across a wide base of tax payers.

Today's world however is very different; life expectancy is in the 80's, and in fact in some of the wealthiest parts of the country has topped 100. On top of that the pension itself has risen to as much as £110 / week per person - 6 and a half times the cost of the original pension, and paid for decades to whole swathes of the population (today there are about 10 million pensioners in the UK - or around 14% of the population. At the end of 1908 there were 600,000 pensioners out of a population of 38 million or 1.5%  (Its also worth pointing that the Empire was still alive and well in this time, so those 600,000 pensioners were not just 1% of the 38 million British, but 0.1% of the Empire's 420 million people) ).


Combining these two factors (6.5x more cost, and 10x more people claiming) and you have a pension system costing, conservatively, 65 times more than its originator; a number that only climbs higher every year as the population ages and the political death trap of the pension-triple lock ensures no chancellor has a hope of reigning in this particular item of spending.

If the number of people claiming pensions were reduced back to nearer its original level, some of the balance would be restored, and with it the potential for a more generous savings and investment regime. The easiest way to do this is to extend the retirement age, and indeed this particular idea has been floated. The retirement age in the UK is due to increase to 68 over the next decade or so, potentially delivering a saving in the £100s of billions. Yet this is still too little, too late. To rebalance an economy back to 1% or less of the population claiming pensions would need a pension age of around 85 or even 90. (2.3% of the population is currently 85+, though only 0.8% has reached 90). Some (very) cursory maths suggests such a move would save the Exchequer as much as £69 billion per year. Given that the cost-to-government of ISA tax relief is flagged at around £2.2 billion per year such a windfall would be more than enough to super-charge the ISA system into a tax-free whole-of-life savings vehicle, suitable for average investors looking to accumulate a tax-free income to fund the mid-late period of their life between wishing to finish work in the mid-60s, and starting to receive a pension in the mid-80s.

A similar outcome could be obtained by reducing the value of the pension from its current level of £100-odd per week back to its initial level of around £30 / week. While not as dramatic this could still potential save nearly 60% of the cost of pensions, or £44 billion per year. Again more than enough to fund a radical overhaul of personal savings.

Unfortunately both of these options, while working on a purely financial level, suffer from the same problem as the Telegraph's more general calls for a wider, more powerful, savings vehicle - what do you do with the people who don't save? If the pension age rises to 85 what does the state do with all the 65-80 year old's who are going to struggle to find employment, and didn't accumulate capital (for whatever reason)? 

This leads on to a more general point about the extent to which the government should support people. I, genuinely, don't think we should have people starving on the streets or dying of the cold in their houses because they can't afford heating. On the other hand, just because I would willingly reach into my pocket to fund a warm room and three basic meals a day, doesn't mean I think you should be able to enjoy the benefits of consumerism (whether that be TV's, computers, smart-phones, cars or anything else) at the expense of others having to forfeit those same benefits due to the burden of taxation.

My proposal on this issue is therefore one that has been hinted at elsewhere, but never explicitly stated - we should move to a non-cash welfare system. Welfare of all kinds (unemployment benefit, low income benefits, pensions) should all be in the form of services and goods not cash. If you really don't have the funds to put clothes on your back and food on your plate, the state will, after all your assets have been used up, provide you with a warm room, three meals a day, and basic amenities, in the fashion of a retirement home (though more basic since this is state funded). This applies regardless of your demographic, if your 20 and can't afford rent and food then fine, again I don't begrudge you a roof over your head, soup on your plate and access to the kind of basic training which should enable anyone to get entry level jobs (or at least make up for the debacle of your education system to some extent).

This isn't the time or place to expand on this system in its entirety, however I will make a few final points in passing -

Firstly, even if the cost is not incomparable to the modern system it provides an incentive to save. If you want to live in your own house, have nice things and travel to interesting places in your retirement you have to save for them. The state will step in to stop death, and that's about it.

Secondly, it means work will always pay. In cash terms money comes from working (or investing), if you don't work you don't have money, full stop. You can't go down the pub, you can't bet on the grand national, you can't smoke, drink, play bingo or anything else.

Thirdly, this is not a charity, and the state does not have a requirement to support those who don't play ball. Any kind of state-funded accommodation has the potential to descend into ghetto-ism and  petty crime, this must be rigorously and forcibly resisted. While I may feel some sympathy for the plight of those who find themselves homeless, friendless and penniless through poor (but legal) choices, or plain bad luck, I have no sympathy with those who try to bend the rules or take liabilities while existing on the state's support. In a very real way you are under the collective roof of every taxpayer and supporter of the British state, and as the saying goes "my roof, my rules".


Happy Trails,

/Z