This piece first appeared in The Daily Telegraph on 8 June 2002
The text here may not be identical to the published text

When saving doesn't make a lot of sense

Uncomfortable anomalies at the hears of the pensions dilemma

The average pension pot is around £25,000. That will bring in an inflation proofed income of around £1200 a year for a man of 65. But if he saves nothing, the state will give him an extra income of around £1200 a year. So for the average man, what is the point of saving?

This is the dilemma at the heart of the Government’s pension policy. One hand encourages us to save for our retirement. The other promises us help even if we do not. And it will get worse. By October 2003, more than half of Britain’s ten million pensioners will be entitled to means-tested help from the State to top up their income. The number will grow each year of this Parliament, as the Government plans to raise the cut-off point for means-tested help faster than it raises the basic state pension.

At the moment, the Department for Work and Pensions guarantees to top up the income of anyone aged 60 or more to £98.15 a week. It’s called the minimum income guarantee or MIG. Someone who has worked and paid National Insurance contributions all their working life will get a state retirement pension of just £75.50. So someone who has no other income (and savings below £6000) will get an extra £22.65 a week given to them. So it is not worth saving up to provide an income of £1178 a year or less – the state will give you that much anyway.

Each April state benefits normally rise in line with the retail prices index. But the MIG rises faster than that. Until the next General Election the Government has said it will rise in line with earnings, not prices, and if Labour wins in 2006 that pledge may well continue. It is impossible to buy such an income in the commercial market. The closest you can get is to buy an annuity with the most generous annual growth allowed - 5%.

At current annuity rates, a man aged 65 would need a lump-sum of £22,720 to get an annuity of £1178 a year which rises by 5% annually. That is from the best annuity provider, Prudential. Most people do not shop around to find the best. The provider at the bottom of the top ten would require a lump-sum of more than £28,000 for the same pension. That means that the first £25,000 or so that you save towards a pension is a complete waste of money – the Government will give you the same income if you save nothing at all. And the Government estimates that £25,000 is about the AVERAGE amount for a pension fund which is converted to an annuity.

For a woman living alone the position is much worse. Women get their state retirement pension five years earlier than men and they live longer. A man of 65 can expect another 19 years of life; a woman at her pension age of 60 can expect almost another 27 years. So she needs a much bigger pension pot to match the state offer. With the best provider, Norwich Union, she would need just over £41,000 to get an annuity of £1178 rising by 5% a year. With a less good provider, it could be as much as £70,000.

The situation will get much worse from October 2003 when the new Pension Credit begins. Instead of means-tested help ending sharply as weekly income reaches around £5000 a year, it will taper off, finally ending at an income of around £7000 a year. That will bring another 3 million people over 65 into the means-test net and will make it even harder to calculate the benefits of saving.

8 June 2002

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