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Last Updated: Wednesday, 23 November 2005, 12:28 GMT
Who pays for our pensions?
Fifteen years ago, most people gave very little thought to their pensions.

Lord Adair Turner
Lord Turner, leading the Pensions Commission.

The future of pension schemes rarely made news. But things have changed.

The forthcoming report of the Pensions Commission could trigger some fundamental alterations to the pension system in this country.

The commission was set up by the government in 2002, under the leadership of Lord Adair Turner.

Its aim is to make recommendations on what, if anything, should be done to improve our pension system.

And the final recommendations will be published on 30 November.

So where, exactly, does the money come from to keep us alive when we stop work?

State pensions

The biggest provider of pensions is the government itself.

In 2002 the basic state pension paid out nearly 38bn pounds to pensioners.

The source of that money is obvious: taxation, National Insurance contributions and borrowing by the government.

This pays for more than just the basic state pension.

It also funds the top-up version now called the Second State Pension (formerly the State Earnings Related Pension System or SERPS).

Chuck in the cost of giving pensioners a minimum income regardless of their National Insurance Contributions (the Pension Credit) and housing, council tax and disability benefits, and the government paid out in 2002 a grand total of nearly 64bn to recipients.

The problem for the government is that thanks to people living longer, the proportion aged over 65 will rise considerably.

In fact the Pensions Commission suggests the number of people over 65 will rise by 78% between now and the year 2050.

Too many not saving?

According to the report there are 15 million people of working age who are making no pension provision at all for their retirement.

We assume they (pensioners) will probably spend about 50% of that wealth
Carl Emmerson, Institute for Fiscal Studies

So unless they have money under a mattress, expect to inherit substantial wealth or have other plans - for instance a pension plan to which they are no longer contributing - they will be relying entirely on the state to give them an income in retirement.

However a recent study of people in their 50s or early 60s, who have not yet retired, said they at least would be much better off than Lord Turner assumes.

The report, by the Institute of Fiscal Studies, suggested this is because of things like the amount of property this generation owns and the money they are likely to inherit.

One of the authors, Carl Emmerson, said: "It is a bit extreme to assume that people won't use any of their housing wealth to spend in retirement. We assume they will probably spend about 50% of that wealth."

The biggest problem is to have politicians in charge of our pensions
Christine L

The IFS concluded that the vast majority of the age group it studied would have enough resources to provide themselves with a retirement income higher than the minimum adequate level suggested by the Pensions Commission.

State pension poverty

Would it matter if Lord Turner is right and millions of people are relying solely on the government to provide them with a pension?

Well, compared to many continental countries our state pension is rather meagre.

In France, Sweden, Holland and Spain the average pensioner receives at least 70% of their working income.

But in the UK the basic and second state pensions provide the average earner with just 37% of their former earnings from work.

So why aren't all pensioners very poor? Some certainly are.

A retired household can be defined as one where the income of the retired household members account for more than half of the household's gross income.

According to the most recent government research (Economic Trends 607, published by the Office for National Statistics in June 2004), the bottom 20% had an average gross income in 2002/03 of 7,280.

By far the biggest element of that was the state pension.

Private pensions

There are several other types of pension schemes which give millions of people additional income when they retire.

Currently 18 million people of working age are contributing to private pension arrangements (including public sector schemes), or who have partners who are.

The largest group among them are in schemes set up and run by private employers, and in personal pension schemes taken out by individuals, typically the self-employed.

Most have been shut because employers are reluctant to make the contributions needed

And in 2002 they paid out nearly 18bn to their pensioners.

The occupational schemes have long been part of the UK pension set-up and are familiar to many workers, especially those employed by big companies.

But they have been changing rapidly in the past 10 years or so.

Many were so-called defined benefit schemes, where the pension payout was determined by the pensioner's salary and length of service.

But a majority of these have been shut to new joiners because employers have become reluctant to make the high contributions needed to underpin their schemes' benefits.

Typically the schemes have been replaced for new staff by so-called money purchase, or defined contribution, schemes.

With these, the final payout depends on the accumulated investment return and is not related directly to salary or length of service.

And that illustrates the fact that investing the staff and employer contributions in shares, property and bonds (glorified IOUs sold by governments and companies) provides much of the money to fund the pensions of those in employers' or personal schemes.

By 2002, these funds owned assets worth an enormous sum - 1,300bn.

Public sector

The same approach to funding - investing the contributions and living off the return - is also true for staff in two of the big public sector pension schemes, for local authority workers and university staff.

However most public servants are in pension schemes that are not financed by any underlying investments.

The cost is rising and has become very controversial

Civil servants, NHS staff, teachers, fire fighters, the armed forces and police officers are all in schemes where the pension is paid directly out of contributions from current staff and their employers.

So to all intents and purposes they are funded by tax and council tax payers.

In 2002 these schemes paid out 8.4bn.

But that cost is rising and has become very controversial.

So to rein it in, the government has now gained the agreement of the main public sector trade unions to close the civil service, NHS and teachers' schemes to new members and replace them next year with new versions.

New joiners will have to work an extra five years, until they are 65 rather than 60, to gain a full pension.

Similar negotiations are underway about the other schemes.

Is that all?

Income from pensions alone doesn't give us the full story of what pensioners have to live on.

Earnings from investments and continued employment brought in nearly 20bn in 2002.

So what does the average retired household actually get to live on?

According to the study by the ONS, the average income for a retired UK household in 2002/03 was 14,820. And of that state and occupational pensions made up most - just over 11,000.

Despite widespread reporting of the so-called "pensions crisis" not everyone agrees it actually exists.

In a recent pamphlet for the Conservative Politeia think-tank, the economist, Professor Tim Congdon, examined the value of all forms of savings - and by the entire nation rather than just households.

His conclusion? That the country has been saving quite enough for its collective old age for more than 50 years - and is continuing to do so.

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