Dear Gordon, here's how to solve the pension crisis

But the government must shoulder a large part of the blame for the crisis. In his first budget in 1997, Gordon Brown dealt a blow to millions of investors when he scrapped tax relief on dividends paid to pension funds worth £5 billion a year.

His record hasn’t improved. Brown’s stakeholder pensions have proved a flop and his introduction of the means-tested pension credit has been roundly criticised. He also stands accused of penalising investment success with the imposition of a lifetime cap on pension funds.

Alan Johnson, the new works and pensions secretary, pledged last week to encourage people to save more for retirement in a speech to the TUC. But this did little to restore confidence. Something must be done — and soon.

Ros Altmann, an independent expert, said: “We need a radical overhaul of the entire way we think about pensions. Everybody seems to have recognised that — except the government.”

The Sunday Times spoke to leading experts to draw up its own five-point pensions manifesto.

Yes to more incentives: At present, you get tax relief on your contributions at your highest rate. If a basic-rate taxpayer contributes 78p, the government tops this up to £1. Higher-rate taxpayers receive a further 18p through their tax return.

The Conservatives recently suggested a simpler “buy one, get one free” pension in which the state would match your contributions. So, if you put in £10 a month, so would the government, up to a certain level.

David Willetts, shadow work and pensions secretary, said: “People would be able to see more clearly how they were being rewarded for saving.”

No to compulsion: Trade unions believe employers and employees should be compelled to pay more into pensions. The government has already appointed a pensions commission, headed by former CBI chief Adair Turner, to examine the case for compulsion. Its initial report is published on October 12.

But many experts disagree with the idea. Joanne Segars at the Association of British Insurers said: “Although many people say they support compulsion in principle, support falls away when the likely impact on wages becomes clear.”

It would in effect become another tax. Even if only employers were forced to pay more they would have to get the money from somewhere. It would almost certainly result in lower pay or poorer benefits.

Scrap means testing: Last year Labour introduced the pension credit, a complicated system of means-tested benefits. Half of all pensioners currently qualify and the Institute of Fiscal Studies predicts that within 20 years it could be up to 75%.

It is paid to people with modest savings as well as no savings. Single people aged between 60 and 65 with weekly income of up to £105.45 — £5,483 a year — and couples with up to £160.95 — £8,370 a year — are eligible. Income includes all pensions, earnings, savings and investment income.

When they reach 65, single people with weekly income of up to £144 — £7,488 a year — and couples with £212 — £11,024 a year — can claim.

But the credit can act as a disincentive to save. The more you have in savings, the less pension credit you receive. For example, a single person aged 65 who has no savings and receives the full state pension of £79.60 a week would receive a weekly pension credit of £25.85, taking his or her income to £105.45.

If the same person has a weekly income of £10 on top of the basic state pension he or she would get £21.85 pension credit. This would take the income to £111.45, making him or her only £6 better off than someone who had saved nothing.

Many pensioners do not claim it and it is also expensive to administer, costing more than £600m a year to run.

Means testing should be scrapped. Instead the basic state pension should be raised to bring it up to the basic level of the pension credit — £105 a week for a single person.

The most sensible way of funding this would be an increase in the state retirement age. When today’s state pension was introduced in 1946 a 65-year old man lived on average for another 12 years. Now a 65-year old male is expected to live almost 16 more years.

The CBI wants the state pension age to rise to 70 by 2030. That might be a step too far; gradually raising it to 67 would be more palatable to voters.

Abolish compulsory annuities: From 2006 you will no longer have to buy an annuity with the bulk of your pension fund by the age of 75. However, the government will still dictate where you put your money.

After 75 you will have to opt for a type of income-drawdown plan — the government calls it “alternatively secured income”.

If you die before 75 you will be able to pass anything left in your drawdown fund to your heirs, less a 35% tax charge. But you will not be able to pass on a lump sum on death after your 75th birthday. Instead, any unused funds will have to be used to buy an annuity for your wife, husband or a dependant.

The system is too restrictive. The government should only insist that you buy an inflation-linked annuity up to the level of state benefits.

Scrap the lifetime limit: A £1.5m lifetime cap on the value of your pension fund will be introduced in April 2006. Any savings above the cap at retirement will be hit by a punitive tax charge. This limit should be withdrawn because it will complicate pension planning and penalise investment success.

Tell us what reforms you think are necessary.
E-mail: david.budworth@sunday-times.co.uk.