1st May 2015
Ben Kumar, investment manager at Seven Investment Management, looks at the implications of rising life expectancy for the state pension and your plans.
The basic state pension, in more or less the form we recognise it today, was introduced in 1948, as part of the 1946 National Insurance Act. The age at which one could begin drawing down the state benefits was 65 years old for men and 62 years old for women (this disparity between the sexes only began to be closed in the Pension Act of 1997 – for simplicity we’ll consider the male data, as that is the number that is being targeted by the government).
This age bound stayed in place for fifty-nine years, until 2007.
Now, stability in financial undertakings is to be welcomed – no-one likes moving targets. However to my mind, the previous approach to pension age progressed from stable to torpid, via lethargic, before ending up very much stagnant. Consider the following.
In 1948, average life expectancy at birth was 68.3 years. By 2007 this had increased by more than a decade to 79.4.
Similar statistics are recalculated for those who live to 65 – once you’ve made it that far, your chances of continuing are better than they were as a baby. In 1948, average life expectancy for a 65 year old was another 13.8 years. In 2007 a 65-year old could expect to be around for a further 18.7 years.
Considering that the average UK citizen now lives over a decade longer than when the pension age was first introduced, one might assume that this was accounted for, or at the very least acknowledged, in 2007 when the government changed the pension rules. After all, in cash terms, the government had gone from having a 3-year obligation (68 minus 65) to having a 14-year one (79 minus 65).
In fact, in the Pension Act of 2007 the upper limit of 65 was increased to 68…for all those intending to draw a pension after 2024.
Legislation that builds in a lag-time of 17 years seems to err a touch on the cautious side, particularly when one considers any future growth in life expectancy. If average life expectancy at birth continues to grow at similar rates to the last sixty years, it would be 83 by 2024. So the government’s obligation would still have increased, being committed to an average of 15 years of payments. (I should point out in fairness, the 2024 deadline has been changed since then – dropping to 2018 in the 2011 Pension Act.)
A well-constructed welfare programme in 1948 was rendered more and more irrelevant due to changes in technology that would have been unfathomable in that post-war period. Current generations of policymakers believe themselves to be more aware and adaptable to change – something that is probably true, but only within certain parameters of familiarity. What do I mean by that?
In 1946, policymakers knew about change. They’d lived through two world wars, watched aeroplanes, electricity and cars become common, seen the development of antibiotics and suffered a global depression to boot. In their policy drafts, I expect these developments and their impacts were mentioned, and judged for likelihood. Yet they weren’t ready for radiotherapy, mass inoculations or the sequencing of the human genome. Similarly, today’s planners won’t be ready for what happens in the next fifty years. As humans we’re great at taking the past and throwing a shadow of it across the future; we’re far less good at predicting entire shifts in the way society functions – unsurprisingly given the lack of need for long-term accuracy as an evolutionary trait.
The key point I wanted to make though, was how crucial consideration of inputs can be to a long-term plan, and how important it is to challenge them often. It’s not that one shouldn’t make assumptions – predictive models rely on them to have any use at all – it’s more that it is important to retest the thought process that led to those assumptions, and then be prepared to change them.
The average retiree at 65 today will live nearly 20 years. However 50% of retirees will live for longer than that, with a small percentage living a lot longer – 40 years or so. And that’s just on today’s figures. Things change, and a good financial plan (whether it be for retirement, annual budgeting or something like a house purchase) should be able to be stressed and changed as well.