Thanks to improved medical science and healthier lifestyles we are living longer and, while most of us consider this good news, it will put increasing strain on already stretched public coffers. Government spending on health, long-term care and state pensions will shoot up, and this at a time when less people are working and paying the taxes which fund the costs.
This “demographic time bomb” issue has been in the news again recently – and it’s not an issue that’s going to go away. This article focuses on the situation in the UK but it’s a similar story throughout much of the western world. Indeed, the UK’s Office for Budget Responsibility (OBR) said that Britain’s likely burden from ageing is better than most European countries.
As life expectancy in the UK continues to increase, children born today can expect to live 20 years more than those born in 1940. Over the last three decades life expectancy has increased by six years. Since 1985 the number of people over 85 has more than doubled to 1.4 million and it’s expected to reach 3.6 million within 25 years. While men and women are staying healthy and disability free for more of their lives, one in four people over 85 has dementia and this is creating a black hole in funding for care.
In July the OBR warned that the UK faces sizable tax rises or public spending cuts after 2016-17 to cope with the strains the ageing population will place on public finances. For public sector debt to return to 40% of national income (the pre-financial crisis level) by 2060, a tax rise of £22 billion will be needed each year from 2016.
The analysis builds on the new “whole of government accounts” which includes previously “hidden” liabilities and reveals that the UK has a £1.2 trillion gap between its assets and liabilities, amounting to 84.5% of gross domestic product (GDP).
While this sounds bad enough, OBR chairman Robert Chote advises that everyone “should be very wary of these liability figures” since they don’t present a complete picture of the pressures facing future governments. Ageing will increase public spending by 5.3% of income from the 2020s.
The government accounts reveal that the liabilities of public sector pensions have jumped from £770 billion to £1.1 trillion in two years. This will increase even more as people live longer. With the exception of local government pensions, the major public services pension schemes are unfunded, with the cost of payments met by future taxpayers.
Chief executive of Taxpayers’ Alliance, Matthew Elliott, commented: “Taxpayers cannot escape the terrifying bill that we now face for public sector pensions.”
Last year the government set up an independent commission headed by economist Andrew Dilnot to recommend a fair and sustainable funding system for adult social care. According to its report “Fairer Care Funding” released on 4th July, the current system is not “fit for purpose” and needs a substantial overhaul.
Dilnot recommends that, in order to prevent an individual from having to sell their home to pay for long-term care, his or her lifetime contributions to their care should be capped and all further costs then be met by the state. Based on a cap of £35,000 (“the more appropriate and fair figure”), this scheme would cost the Treasury £1.7 billion a year.
The report recommends that to raise the necessary funds, the government could prioritise existing expenditure and/or raise additional revenue through general taxation or by introducing a specified tax hike. It would “make sense”, it says, for any increase to be paid at least in part by those benefitting directly from the reforms and some of the burden should fall on those over state pension age.
Dilnot says this system would bring “peace of mind” in an era when people are living longer and many are seeing all their assets used up to pay for care. He insists both individuals and the state could afford to spend more on elderly care to protect people from the threat of the “catastrophic” costs in old age.
Considering the report comes at a time when budgets for other essential services are being slashed, the government unsurprisingly gave a cautious response to the report. Health secretary Andrew Lansley said that in the current spending environment the government had to “carefully consider the additional cost to the taxpayer… against other funding priorities”.
PricewaterhouseCoopers (PwC) also recently published a study into the cost of looking after the UK’s ageing population, saying it will become unsustainable unless younger people work longer (to age 70) and pay higher taxes (£20 billion a year).
PwC estimate that, at today’s values, costs for pensions and age related care will increase by between £68 billion and £75 billion a year by 2050.
If Dilnot’s plan is adopted the final costs will be even higher since the initial cost of £1.7 billion a year would increase as the population ages - and could cost £5 billion within five years.
PwC warns that the support ratio of working age to retired people is set to fall from 3.6 in 2010 to around 2.4 in 2050. The pensions, health and long-term care costs of the current retired people are paid for by the working population out of their taxes, but as the large baby-boomer generation retires there will be much less working people paying taxes.
Would you prefer to work longer or pay more tax? Neither probably, but in all likelihood we’ll have to do both. If you’re already retired you may have escaped working longer but could still get hit by tax hikes in future - it looks like we’re all going to have to contribute to the costs one way or another. In order to protect your wealth as much as possible you should talk to a wealth manager like Blevins Franks to discuss setting up your assets to be as tax efficient as possible and to provide an income as long as you will need it.
The tax rates, scope and reliefs may change. Any statements concerning taxation are based upon our understanding of current taxation laws and practices which are subject to change. Tax information has been summarised; an individual must take personalised advice.
By Bill Blevins, Managing Director, Blevins Franks
25th July 2011