State pension system at risk of collapse, experts warn

Gordon Brown, the Chancellor, may be forced to water down the new state second pension because millions of people driven out of occupational schemes are likely to join it, a report warns today.

The Government provides two levels of pension, the basic state pension, worth £3,770 a year, and the new state second pension, or S2P, which was introduced this April to replace the state earnings-related pension scheme (Serps). This pays an extra £4,000 to £6,000 a year, with credits for career breaks.

Employees can opt out of S2P if they belong to an occupational pension scheme and in return they pay lower national insurance contributions.

But a growing number of financial advisers are recommending people to contract into S2P because in many cases the terms of their occupational schemes have deteriorated, according to a report by the ITEM Club, which is the only independent forecasting group to use the Treasury economic model.

Professor Peter Spencer of Birkbeck College, London, the ITEM Club's economic adviser, says the numbers of people are so great that they threaten to blow a hole in the Chancellor's budget projections.

"I think there will be a big move to S2P, he says. "The only thing Mr Brown can do is to degrade the system. I believe he will start to reduce the benefits of S2P.

"People are going to continue to shun funded pension schemes and rely on the state. Even if S2P is downgraded, it's a defined-benefit scheme, so people at least know where they stand. That penny simply has not dropped at the Treasury."

The problem has been made worse by the dramatic fall in share prices, leading to the worst bear market for nearly 30 years and shredding the value of many pension funds.

These funds were already struggling to cope with the cumulative effects of a tax rise imposed by Mr Brown in 1997.

In its latest assessment of the UK's economic prospects, the ITEM Club says: "The bear market has exposed the errors in pensions policy, finally destroying the illusion of a national pensions plan. The Treasury has only itself to blame because, incredibly, it allowed the Chancellor to ambush the occupational pensions funds.

"His hefty pensions tax allowed the demographics to collapse the occupational schemes, and if this is not rescinded quickly, the resulting burden could collapse the state system."

Professor Spencer believes that as many as 2 million of the 3.5 million people currently in occupation schemes could switch to S2P, which could mean a 5 per cent increase in national insurance contributions to help pay for it.

"It certainly has the power to collapse the system," Professor Spence says.

Shares are expected to have another turbulent time this week after a grim session on Friday which saw the FTSE 100 Index of leading companies in London give up three days of gains to slide 199 points. The gloom was compounded when the Dow Jones Industrial Average in the United States went on to tumble a massive 390 points, implying further falls when London trading resumes this morning. The FTSE 100 closed on Friday at 4098.3.

This week sees a host of heavyweight British companies, including the drugs giant GlaxoSmithKline and the banking group Abbey National, announce their results.