Private pensions industry is an utter failure and needs reform

Amazingly, the private pensions paid in that same year were very slightly less – at about £35 billion. In other words, not one penny of private pensions paid in that year was at cost to the private pension sector: all were paid at cost to the government.

Our guest writer is Richard Murphy, founder of the Tax Justice Network, who regularly blogs on UK taxation issues at Tax Research UK

There’s an item of government spending which has been subject to almost no review, which with only the very smallest of changes, recently announced in the Comprehensive Spending Review, will carry on at its existing level, apparently unchecked and beyond government control, and which amounts to the biggest and most ineffective subsidy to an industry that we have perhaps ever seen.

I’m talking about the subsidy that is given each year by the UK government to the private pension industry. As my research has shown, the total cost of tax relief for pensions in the UK – all of which arise because of the need to support the private pension sector – amounted to about £37.6 billion in 2007-08.

Amazingly, the private pensions paid in that same year were very slightly less – at about £35 billion. In other words, not one penny of private pensions paid in that year was at cost to the private pension sector: all were paid at cost to the government.

This is an extraordinary circumstance. The finding is exacerbated by the knowledge that despite the fact that stock markets have paid no net returns for more than a decade the private pension industry remains dedicated to investing in them, whilst directing less than 15 per cent of their funds to lending to the state.

It appears that as a result of the massive state subsidy they receive the private pensions industry has not learned anything from the radical upheavals seen in the real economy, or in investment markets. What is clear though is that this failure to learn has been at cost to the members of those pension funds – many of which are in deficit as a result – and to the state.

The result is a revelation. What we can see, if we look at the pensions industry in this way, is that the current private sector model of pension supply is hopelessly inefficient. It has required a state subsidy to deliver any return at all – and that return is quite amazingly less than the subsidy received.

Over a decade maybe £300bn of state subsidy (half of all state borrowing immediately before the current financial crisis erupted) has gone into the pensions sector despite which the sum it manages has fallen on at least as many occasions as it has risen even though the scale of private contributions was roughly double the subsidy given and all pensions paid were at effective cost to the state.

There is only one explanation for this phenomenon. The state subsidy for private pension contributions is very clearly being captured by the pension industry and its related elements in UK banking and insurance companies to be claimed by them as fees that have massively supported the profits they make, whilst leaving those who might be dependent upon UK private pensions at risk of poverty in retirement unless the state continues to subsidise their pensions to the extent of a £1 subsidy for each £1 of pension paid.

As an intermediary the UK private pension industry is an utter failure: it adds no value at all in this process according to this evidence. That suggests that now is the time for radical reform of pensions. The proposed new National Employment Savings Trust (NEST) pension scheme to be introduced in 2013 will not be the answer. It was built on the foundations of the Turner report, which was written before the financial crisis erupted, and which assumed that the financial markets would pay increasing returns for ever.

What are those solutions? Well, first I make clear that I’m not asking for a withdrawal of pension tax relief. I think that would be unwise and create far too much disruption to the pension industry. But a subsidy of about £38bn a year from the UK government should have conditions attached.

Fundamentally that condition should be that a significant proportion of all pension contributions should be invested in ways that ensure that the funds entrusted for pension investment are used to create new jobs – with a bias to the UK to the greatest degree possible within the constraints of EU law.

This would mean that the funds in question would have to be invested in new share issues by companies that could show that the proceeds of the share issue were to be used to create new products and employment; in bond issues such as those Colin Hines and I promote to be used to replace Private Finance Initiative (PFI) and to fund local authority infrastructure and for infrastructure funds such as a genuine Green Investment Bank.

If this were to happen then we estimate that at least £20 billion a year of new investment funding would be released into the UK economy. The impact would be dramatic: this is the kickstart that the UK economy needs to get real job creation going again.

The funding is available. The political power to direct it exists. What is required is the will to use it for right purpose. That’s what has to be created.

26 Responses to “Private pensions industry is an utter failure and needs reform”

  1. Paul Seery

    RT @leftfootfwd: Private pensions industry is an utter failure and needs reform: http://bit.ly/bVx2Fj says @RichardJMurphy

  2. Shlomo Pines

    RT @leftfootfwd: Private pensions industry is an utter failure and needs reform: http://bit.ly/bVx2Fj says @RichardJMurphy

  3. Matt Jeffs

    RT @leftfootfwd: Private pensions industry is an utter failure and needs reform: http://bit.ly/bVx2Fj says @RichardJMurphy

  4. Anon E Mouse

    It might have helped if the financially incompetent Gordon Brown hadn’t stolen £billions every year from peoples’ private pensions…

  5. Philip Painter

    Harsh criticism of private pensions sector. http://bit.ly/b0mCmG via @leftfootfwd

  6. Ash

    And the Ugliest Sentence award goes to…

    “Over a decade maybe £300bn of state subsidy (half of all state borrowing immediately before the current financial crisis erupted) has gone into the pensions sector despite which the sum it manages has fallen on at least as many occasions as it has risen even though the scale of private contributions was roughly double the subsidy given and all pensions paid were at effective cost to the state.”

    Interesting (and alarming) stuff though.

  7. mark grip

    Private pensions industry is an utter failure and needs reform …: The private pension industry subsidy is the bi… http://bit.ly/bv9sMN

  8. Guido Fawkes

    Tax relief is not a subsidy. It is simply the case that pension contributions are untaxed. Similarly there is no basic necessities subsidy, they are just VAT free. Murphy’s constant analytical problem is that he would be happy for the government to take 100% of your income and give you back some “based on need”.

    There is no subsidy, ergo there is no “cost to the government”.

  9. Shamik Das

    This morning on @leftfootfwd: @ippr on clean energy investments: http://bit.ly/a41f0R & @RichardJMurphy on pensions: http://bit.ly/bVx2Fj

  10. Stephen Whitehead

    Richard Murphy suggests using our vast public subsidy as a lever to reform pensions industry: http://bit.ly/9xvFtD

  11. Wendy Maddox

    Private pensions just as tax expensive: RT @leftfootfwd: Private pensions industry is an utter failure and needs reform http://bit.ly/c2AcRy

  12. OldTrot

    RT @leftfootfwd: Private pensions industry is an utter failure and needs reform http://bit.ly/c2AcRy

  13. Michal Jaworski

    How about the fact that pension payments are taxable income? If the payments into the pension funds were after tax would that not in effect mean double taxation?
    Interest on savings is taxed but when you take that interest out of the account you do not pay income tax on it again, do you? Isn’t that what you effectively argue on for pensions?
    Additionally, if we assume that pension funds invest with a reasonable return (which your argument doesn’t disprove) is it not more profitable for the government to tax pension funds when they are paid out with the accumulated growth?

  14. william

    I am 59,have paid over £1 million in income tax,never visited a hospital, have no children, and am subsidising a lot of people.They, in return, permit me to put a portion of my taxed income in a tax free pot so that, in future,I will cost them nothing.Everybody’s property is nobody’s property.The Murphy view of the world is bonkers.

  15. John Whittaker

    Private sector pensions cost the government 10 times as much as public sector pensions: http://goo.gl/AW9b

  16. Richard Blogger

    Hmm, the Bank of England owns 20% of gilts. At some point they will have to sell that government debt. Why doesn’t the government find a way to sell the BoE holding to the pensions industry? Indeed, instead of subsidising the private pensions industry, why not create government bonds with a higher coupon that can only be held by pension companies? Surely that would kill two birds with one stone: we make sure that 20% of gilts are in domestic hands (and not foreign owned as our xenophobic government is so scared of) and the interest paid on those bonds go into our pensions rather than having to prop up the funds with a subsidy.

  17. Ash

    william –

    “I am 59,have paid over £1 million in income tax,never visited a hospital, have no children, and am subsidising a lot of people.”

    Hmm… it’s *possible* that you’re effectively subsidising the bloke next door who had two kids, earned a bit less than you over the course of his working life, and was in hospital with a broken arm last year; it’s equally possible that he’ll end up effectively subsidising you because you outlive him (and so claim your pension for longer), become a victim of crime (and so need to make use of the police and the courts), or develop health problems that are expensive to treat.

    Hence the wacky idea that rather than all fending for ourselves, we put a proportion of our earnings into a big pot to pay for things that make us collectively better and to ensure that there’s money there for those of us who, for one reason or another, end up needing it.

  18. FairPensions

    RT @leftfootfwd: Private pensions industry is an utter failure and needs reform: http://bit.ly/bVx2Fj says @RichardJMurphy

  19. FairPensions

    @leftfootfwd interested to read http://bit.ly/bVx2Fj – our CEO recently blogged about this: http://bit.ly/bH8AKI

  20. yaqub hanif

    RT @johnwhittaker: Private sector pensions cost the government 10 times as much as public sector pensions: http://goo.gl/AW9b

  21. Googlyfish UK

    UK Job Post Private pensions industry is an utter failure and needs reform … http://ow.ly/19LomF

  22. Tax Research UK » Pensions: a guest blog at Left Foot Forward

    […] had a guest blog on Left Foot Forward today. It […]

  23. william

    Ash,’we put a proportion of our earnings into a big pot…to ensure there’s money there… It’s called a PONZI scheme. The biggest one is in inthe US,closejy followed by the UK, and it is called Quantative Easing.

  24. Ash

    william –

    Well, I’ve never heard paying taxes described as a ‘Ponzi scheme’ before! I suppose it is, in the sense and to the degree that ‘investors’ (taxpayers) only see a return (either in cash in the form of pensions & benefits, or in kind in the form of public services) if new investors keep putting in more money. But 1 – much of the money paid in taxes is genuinely *invested* in things that help ensure new investors can generate money to put in (infrastructure, education etc.) and 2 – whereas Ponzi schemes collapse because they run out of new investors, there’s always a new generation of taxpayers to pay for the pensions and old-age care of the previous generation.

    I’m not quite sure what the thrust of your reply is, though. What you said originally was not that there was something structurally wrong with the whole idea of paying taxes, but just that you thought you’d paid so much in taxes that you were subsidising other people.

  25. Tim Worstall

    Dear lord almighty. Richard really does manage to get himself very confused.

    “In other words, not one penny of private pensions paid in that year was at cost to the private pension sector: all were paid at cost to the government.”

    No. The “subsidies” were to people putting money into their pension pots this year. This is what will fund pensions in the future. The pensions paid out this year are funded from money that was put into pension pots some years ago. We need to compare the pensions being paid out this year with the subsidies that were given when the money, some years ago, was put into the pensions pots.

    It really is a bit off when we’ve got an accountant apparently ignorant of the concept of accruals.

    “The finding is exacerbated by the knowledge that despite the fact that stock markets have paid no net returns for more than a decade the private pension industry remains dedicated to investing in them, whilst directing less than 15 per cent of their funds to lending to the state.”

    As I pointed out when Richard first published his little report: he managed to ignore dividends on that stock market return. This is akin to ignoring interest payments on bonds, ie, insane.

    “Fundamentally that condition should be that a significant proportion of all pension contributions should be invested in ways that ensure that the funds entrusted for pension investment are used to create new jobs”

    Essentially Richard is insisting that pensions must be invested in venture capital. This is asw a result of his entire ignorance of why we actually have secondary trading of shares in the first place. But then he’s never been quite up to speed on either economics or finance.

    We have secondary trading because it allows people to get out of the investments they have made: for example, after they’ve been saving for 40 years and want to start getting a pension.

    Finally, just to cap tha absurdity of the entire wibble, he’s forgotten to inform everyone that pensions contributions are not a let off of tax, they’re not a subsidy, they’re a tax deferment. For you have to pay tax on the pension you receive at the end. Nowhere in his numbers does Richard include this tax paid currently on pensions being received, nor does he point to the tax that will be paid in the future on those pensions currently being saved for.

    Amusingly, one Spad wrote to me when Richard’s report first came out:

    “Is it me, or is it the case that he has compared what the pensions industry pays OUT in any one year, and looked at how much relief is given (i.e. is paid IN), and compared the two, and used that to justify saying “this shows what a ripoff they are”?

    because that would seem nuts to me”

    Yup, it is, it’s nuts.

  26. Tim Worstall

    Oh, by the way, if we measured “lending to the state” in the same way that Richard measures returns from the stock market then you’d have lost 30% of your money by lending it to the State over the past decade.

    Inflation really does kill the returns from bonds you see.

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