The increasing cost of state pensions -
"The demographic time bomb"
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The money needed to pay state pensions comes from
taxation. The
system operates on a Pay As You Go (PAYG) basis. This means that no
state 'pension fund' exists, the government just maintains a small
working balance to make sure it has enough money to meet all the
payments due. Money from taxation is collected one
week and paid out to pensioners the next, its as simple as that.
Therefore people who are pensioners today have their pensions paid
for by people who are working today. When the people who are working
today come to retirement their pensions will be paid (hopefully) by
the people working at that time.
This system has worked for many years however events today are making this system of paying for
pension problematic and this is likely to be the case for many years
to come. On average people are living longer than they were
when the state pension system was put in place due to improved
healthcare and coupled with this
birth rates have fallen.
Therefore the ratio of people working to people retiring is becoming
much smaller (i.e. fewer people working and hence paying taxes and
more people retired because they are living longer). Therefore the
amounts raised in taxation have become smaller to pay an ever
increasing pool of state pensions. This problem is often referred to
as the "Demographic Time bomb"
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The UK
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The problem in the UK has been addressed much earlier than in
many Europeans countries through a lower level of state pensions and
the option to contract-out of the second layer of earnings related
pensions. What this means is that the UK government is in a better
position to maintain the state pension system than many European
countries. However this also means the responsibility of providing
for your retirement lies with the government to a lesser extent than
in Europe. Therefore in the UK much more pension provision must come from
sources other than the state and this generally means either from
companies or from individuals. However despite the UK being in a better position than much of
Europe the problem in the UK is still substantial.
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What can be done?
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Unfortunately there is no easy solution to the problem. The only
way to try and avoid problems in the future would be to build up a
retirement fund for the current workforce in anticipation of their
retirement. In much the same way individuals might build up a fund
for their own retirement. However this would of course require them
to pay more tax to build this fund. i.e. today's workforce would
have to pay for the current state pensions as well as their own
pension. Therefore this option is considered by some to be nothing
short of political suicide!
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If you have a pensions
related question then please let us
know.
If it's something other people
would find useful then we will post an answer in our Frequently Asked Question
(FAQ) area.
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