Pension posers 

By: Jane Falkingham and Katherine Rake
The Guardian , April 16, 2001 

Rather than taking out a stakeholder pension, you might be better off spending now and relying on means-tested benefits in your old age

The stakeholder pension launched this month signals New Labour's commitment to the privatisation of old-age provision started under Margaret Thatcher. Indeed, Labour says it intends to reverse the current balance between the state and private sector so that in future the private sector makes up 60% of all pension provision, compared to its 40% share now. The Blair government calls this a new partnership. Individuals take greater responsibility for their financial well-being in later life by saving more in private pension schemes. 

This privatisation is risky both for the individual considering buying into a stakeholder pension and for society at large. 

Choosing the right pension for your circumstances is complex. There are now at least seven distinct vehicles for providing income in later life. Stakeholder pensions increase this choice without making provision for better advice; it is likely more people will end up with the wrong sort. At first sight the 1% cap on charges levied by companies offering stakeholder pensions works in favour of the consumer. But it gives pension companies scant incentive to make advice available at a time when people are in need of more information than ever. They have already begun to lay off their direct-sales teams. 

It is difficult to plan for events such as the needs of children or older relatives, unemployment and early retirement. Things happen that may make a stakeholder pension a bad savings vehicle. People might be better off remaining in the state system or putting their money into an ISA, which offers more flexible access to savings. 

People may not be able to contribute enough to their stakeholder pensions to make them worthwhile. The table estimates how much you would need to save from a given age in order to secure a weekly income. It assumes a 3% real rate of return and 6% annuity rate. Focus on that £30 a week figure. Gordon Brown has increased the generosity of the minimum income guarantee for older people (MIG) - but by doing so the government has ensured that more and more will find themselves dependent on the state in later life. 

Currently, to avoid making a claim on the means-tested MIG would require a stakeholder pension income of at least £30 a week. By 2060, this figure is more likely to be in the region of £100 (in current prices). That means a person who saves continuously from the age of 25 would need to put aside approximately £22 a week to achieve such an income. Delaying this decision is going to be costly - the required amount of savings rises to £62 a week for those who save for only 20 years. Are such levels of saving realistic? Stakeholder pensions are meant for those on low and modest incomes, with the typical case taken to be someone with annual earnings of £12,000. At this level, a 25-year-old would need to contribute 9.5% of gross earnings, the 35-year-old 15%. A 45-year-old would need to contribute more than a quarter (27%) of gross earnings to make a stakeholder pension worthwhile. Spending today and relying on the state tomorrow might be a more attractive choice. 

Taking out a stakeholder pension also exposes individuals to risks related to the City's performance. You may be unfortunate in the choice of provider, as Equitable Life policy-holders have found. Pension companies may invest in poorly performing shares or you may retire on a day the stock market takes a downturn. 

The fact that those with a stakeholder pension, just like those with other forms of private pension, are obliged to purchase an annuity adds another form of risk. Annuity rates fluctuate widely. In 1990 a pension pot of £100,000 would have purchased an annual income of £11,000. Today the same amount will produce just £6,000. Annuities are calculated according to predicted life expectancy: because women live longer on average, they receive a lower income for their pension pot. The current sex differential in annuity rates means that women need a pension pot between one-fifth and one-sixth higher than men in order to achieve the same income. But interrupted working lives and lower earnings mean women are less able to build up pension savings. 

Taken as a whole, these risks will have important consequences for the level of income and welfare enjoyed by the older population. As the basic state pension declines in real value over time, additional pensions will have to work harder to fill the gap. Individual welfare will increasingly depend on the pension pot you personally accumulate. The scope for redistributing between rich and poor, men and women, employed and unemployed is reduced as we shift further towards private provision. As a consequence, inequalities in working life will be perpetuated into later life. 
State pension systems were originally conceived of as a mechanism for pooling risk, and spreading its consequences across society as a whole. A pay-as-you-go pension system is effectively a government promise based on the tax money of those not yet born. Privatisation of pensions substitutes this promise for that of returns from the financial markets. Striking the right balance between public and private depends upon how you view the trade-off between the risks of financial bad weather and those of political u-turns. Whether stakeholder pensions and increasing reliance on the private sector turn out right remains to be seen. 

• Jane Falkingham and Katherine Rake are at the London School of Economics 

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