The pension fallacy (Part 1)

By Slow Dad - March 25, 2017

Think you're entitled to a government pension? Think again. If it were being established today the eligibility age would be between 100 and 112!
Did you know that living beyond your means used to be against the law?

Under the Vagabonds and Beggars Act of 1494 the penalty for being able bodied, yet unable to support yourself, was to “be set in the stocks for three days and three nights and have none other sustenance but bread and water and then shall be put out of Town”.

“be set in the stocks for three days and three nights and have none other sustenance but bread and water and then shall be put out of Town”
Upon completion of the sentence you were forced to return to the place of your birth, where the expectation was that friends and family would put you to work or otherwise support you. Now that was certainly an incentive to treat people how you would like to be treated!

be set in the stocks for three days and three nights and have none other sustenance but bread and water and then shall be put out of Town

Life was tough.

People fended for themselves.

The difference between survival and financial oblivion was just an illness or injury or poor harvest away.

For much of the world’s population that remains the case today.

Government pensions arrive

The government pension is actually a relative new idea, first introduced to the United Kingdom in 1908.

The pension kicked in when you reached age 70, which it is worth noting is 5 years later than it does today.

Like some many things in life the promise of the government pension was better than the reality. If you made it to your 70th birthday you had exceeded the average life expectancy at the time by more than 40%!

To put that in context if the same life expectancy + 20 years formula were applied today then the government pension age would be around 100. If we applied the life expectancy + 40% formula that eligibility age would instead be around 112!

Think about that for a second.

By design the vast majority of the population were never intended to receive the government pension.

In fact the economic sustainability of the arrangement depended upon it.

That didn’t happen in practice.

By the 1950s average life expectancy actually exceeded the age at which the government pension kicked in, in no small part because the qualifying age had reduced to 65 for men and 60 for women.

The argument at the time was that people weren’t expected to live much past retirement age, so this wouldn’t be a problem. This proved to be a complete load of bollocks.

Average life expectancy has continued to increase, currently exceeding retirement age by around 15 years. Don’t forget life expectancy is just an average, many people will live longer… much, much longer.

At the time of writing the oldest living person in the United Kingdom was aged 112. This remarkably resilient lady will have been eligible to receive the government pension for 52 years, approaching half her life!

eligible to receive the government pension for 52 years, approaching half her life!

Pensions went from being an appreciated reward to a taken for granted entitlement

In the time since the introduction of the government pension there have been some remarkable changes in how society views it.

In the beginning it was seen as a bonus or reward for achieving remarkable longevity, something that very few people realistically expected to ever receive themselves.

Today many people view the government pension as an entitlement, one that the average person fully expects to receive. The prevailing logic from dickheads across the nation being along the lines of “I worked hard, paid my taxes, now I’m entitled to have society provide for me”.

Unfortunately there are some technical problems with this world view.

Spend more than you earn as a recipe for sustainable financial success?

The Financial Times recently wrote that by the year 2050 approximately 24% of the population will be eligible to receive the government pension. By the same date there is estimated to be just 2.9 people of working age people for each person eligible to receive the government pension age.

The practical solution to the problem would be to significantly push out the age at which people became eligible to receive a government pension.

At the moment the government is just tinkering at the edges, gradually raising the retirement age to 68 over the course of the next 30 years. This week the Cridland report, which had been commissioned by the government into pensions, recommended amongst other things increasing the pension age back up to the original 70 years.

The main problem with this scenario is retirees vote, and if are going to make up over a quarter of the voting population then any elected government is unlikely implement a change that would likely piss the vast majority of them off.

Government pensions should only be for those who need them

Another approach would be to introduce a means test for government pension eligibility. The logic behind this approach is that only those incapable of supporting themselves should be receiving the government pension, meaning that the pension should form part of a social safety net in much the same way unemployment benefits do.

Personally I think a safety net should only be in place as a temporary measure, supporting folks while they get back on their financial feet. It should not be a permanent thing.

My issue with a means test is it potentially rewards incompetence. Somebody who successfully manages their money over the course of their lives, accumulating sufficient net worth to sustain them would not receive anything. On the other hand somebody who lived large, frittering away every pay cheque buying crap they didn’t need, would be rewarded with a government pension. To me that doesn’t encourage the correct behaviours in people.

Another issue facing a means test is what it should be based upon.

Many older folks could be described as being asset rich but cash poor, with a large proportion of their net worth consisting of equity in their homes. For example my neighbour is a little old lady who struggles to pay her gas bill, yet lives in a house she has owned outright for 40+ years that is today worth comfortably over £1 million.

It doesn’t seem right to rewarding somebody with a government pension because they lack cash flow, when they could readily support themselves were they to adjust their asset allocation. Therefore I think any means test should include all assets, including the family home.

This would encourage retirees to swap their large family homes for smaller dwellings when they are older. While everyone hates moving, and change can be scary, it would have some additional benefits such as freeing up housing supply in catchment areas for good schools and so on.

Free up equity... or copy the French?

Another alternative would be the development of fairer equity release products, or adopt the French Viager system where a buyer acquires a property for a bargain price in return for agreeing to support the previous elderly owner for the rest of their life.

Copy the French?

This post ended up being much longer than I would be able to comfortable digest in a single commute, so stay tuned for the next thrilling instalment.

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  1. Hi Slow Dad

    Thanks for this interesting 3-parter on pensions.

    As someone who didn't discover FIRE until I was the ripe old age of 44, I see retiring at 55 as being 'early' as that's still 10 years before I can draw on my company pension, 12 years before state pension. In fact, I think anything before 60 is early and this was my initial goal. I'm aiming for 55 as a stretch target, but 59/60 is the more realistic goal.

    I have a feeling that at some point, the state pension will be means tested. Where I've included it in my plans, I've just used an arbitrary figure of £5k, which is a bit less than what the government website says I'm entitled to after paying 25 years of National Insurance. I'll continue to use this number so it'll be a bonus if I end up getting more!

    I'm likely to support myself with a combination of passive income and selling off capital. Slowly building up my passive income so that I won't have to sell off too much capital.

    With there being a longer period before you can touch your private pension, I was wondering where you save/invest once your ISA has been maxed out?

  2. Thanks weenie. It sounds like you're doing well, I think anyone who manages to get their finances together enough to finish working prior to reaching the state pension can consider themselves an early retiree.

    Regarding your state pension you mention you have will have 25 years National Insurance contributions under your belt by the time you reach 65. It may be possible to top up your NI contributions to add to your government pension, but do check your own eligibility and run the numbers to check if doing so makes financial sense.