A leading economist has hit out at the Turner Commission for wrongly focussing on a so-called ‘pensions saving' as the most relevant to the standard of life during retirement.
Professor Tim Congdon, chief economist for Lombard Street Research, believes - as everyone will eventually die - the act of saving has to two objectives, namely to support the time of dis-saving and to make bequests to the next generation.
He says: “So all saving is relevant to the determination of living standards in retirement, not specifically designated “pension savings” alone.”
Moreover, he says the relevant concept of saving must not be limited to the household sector, which he says the Commission has primarily focussed on, but instead should include companies, financial institutions and the public sector, which essentially serve no other purpose than to benefit the home.
He says focusing narrowly on the low household savings ignores the rise in the broader index of national savings.
Moreover, in its first report, The Pensions Commission stated: “Most people do not make rational decisions about long-term savings without encouragement and advice.”
Congdon believes this is not true. He argues British people are ‘remarkably rational’ in their forward planning for retirement, more so than the Commission gives them credit for, adding the ‘instabilities’ lie mostly in government policy.
He says the Commission’s concern over pensions saving follows earlier claims from the Association of British Insurers of a £27b yearly savings gap, defined as ‘the shortfall of savings from the level necessary to deliver pensions worth half as much as incomes in work’.
Congdon’s report throws skepticism over the “a voluntarist solution,” favouring increased state intervention and increased taxation instead.
Congdon’s solution is modelled on the Chilean system, where taxpayers have their own savings accounts, which can be invested in the markets.
In Chile, 10% of earnings is paid into a fund, with the State adding to this number, by tripling the number of units.
Of the Chilean pensions model, senior technical manager at Standard Life, John Lawson says the South American country has a completely different starting point from where the UK is today. He says Chile had an unaffordable pay-as-you-go state defined benefit promise and little private savings.
While similar to the UK basic State pension, the latter model is affordable because the benefit is eroded by the difference between wage and price inflation and the Chilean's wasn't affordable Lawson argues. Moreover, the UK has about £1.3trn in private savings.
Lawson says: “The Chileans switched to a 10% of earnings mandatory defined contribution system. This has been successful for the Chilean economy as pensions have created a stock of capital that has been used for economic expansion (similar success is claimed of the Australian reforms).
“The 10% contributions are placed in privately managed funds with risk controls (called AFPs). These are just like mutual funds and in this respect similar to the Swedish mandatory funded system.”
The new policy has seen increased coverage to over 90% in Chile, while also driving economic growth, Lawson says. It also enables individual preference over retirement age and those that want to retire early can save more than 10%.
But on the downside, administration costs are relatively high compared to other compulsory systems including Australia and Sweden. Lawson points to a lack of investment choice, while low earners do not do well out of the system and many have to be lifted up to a state guaranteed underpin.
Lawson also says many people are against a compulsory system at present.
However, he says: “It has increased savings without impacting on economic growth, which is very positive." One of the concerns expressed about forcing compulsory savings in the UK is the economy would suffer as people wouldn't be able to afford to go out shopping. "So maybe compulsion wouldn't hurt the UK economy as badly as predicted and it may in fact result in the opposite effect of greater economic growth," he adds.
Lawson says Chillie has also retained tax relief on compulsory contributions, which removes one of the worries about moving to compulsion here - that tax relief would be scrapped.
If you have any comments you would like to add to this story or would like to speak to its author about a similar subject, telephone Gareth Vorster on 020 7968 4554 or email [email protected].IFAonline
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