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Are state pensions a liability we can't fund?

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Are state pensions a liability we can't fund?

The state pension has been the backstop of retirement in the UK since 1948 but according to some it is under threat, even as it is about to undergo a huge overhaul. How important is it and would it be worth drawing in more tax to pay for it?

In 2016 there will be a flat-rate state pension, ending the means-tested element, in an effort to clear confusion and give private savers a stable staple to build on. Means testing was seen as a disincentive to private saving.

A flat rate combined with auto-enrolment and the new pension freedoms are all part of the strategy to boost private savings.

But some commentators say the money used to fund the state pension is running out. National insurance contributions (NICs) provide an, arguably notional, pot for state pension funding. However, the Government Actuary’s Department has said the NIC fund will be exhausted by 2035-36 or sooner.

Raising tax for state pension

Michael Johnson, from think tank Centre of Policy Studies, says the solution is to merge NICs with income tax. He says the new tax rate would ideally be set at 32%, 42% and 47%, based on the personal allowance and three marginal income tax bands.

However, Steve Bee, chief executive of Jargonfree Benefits, says any merger of NICs and income tax would be huge step backwards, leaving the majority of taxpayers with no reason to save into a pension.

‘I’d be concerned. It’s been said “NICs are just another tax; tidy it all up”. The state pension age is a magic age, a point where you get access to your state pension entitlement, if you want it, but it is also the age where you stop paying NICs,’ says Bee. ‘That is crucial, certainly for me and the baby boomer generation.

‘When I started work the basic rate was 35%, now its 20%. If you merge tax and NICs, it puts you right back up there at 32%. So there is a danger that young people today getting 20% tax relief end up paying 32% tax. That’s some leap to take.’

One way of controlling costs is to raise state pension age. If the pension freedoms and auto-enrolment together deliver a new age of private saving, then state pension will be little more than old-age insurance for much later life.

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