New OAPs to be hit by 'quantitative easing'

Hundreds of thousands of people approaching retirement will be offered far lower pensions for the rest of their lives as a direct result of the government's decision to "print money" in an attempt to stimulate the economy.

Experts have told the Observer that those who use their pension funds now to buy annuities - which guarantee them a set income a year until they die - will receive much lower pensions than they could have just a few weeks ago.

Experts also warn that final-salary pension schemes, which guarantee employees a set percentage of their income at retirement, for life, are heading deeper into crisis because of the government's experiment with quantitative easing, the banking term for printing money.

The latest cut in annuity income comes on top of a collapse in pension funds since the autumn as the credit crunch has bitten and stock markets have tumbled.

Pension income from annuities had already dropped by about 10% from its height last July before the government announced its plan to print more money. Calculations by leading investment firm Mercer show that a 60-year-old male with a pension pot worth £500,000 would now be offered an income close to £28,900 a year by an insurance company selling annuities, compared with £30,600 if he had struck a deal before the government began the quantitative easing experiment earlier this month.

Deborah Cooper, head of Mercer's retirement resource group, said the difference between levels now and earlier in the month could be attributed to quantitative easing - the policy under which the Bank of England is buying back £150bn of gilts and bonds at high prices to flush more money into the economy and kick-start activity.

But because the policy drives up bond and gilt prices, the set income (or yield) from these assets falls proportionately. Crucially, the pension industry uses these yield levels as the basis for calculating pension income, meaning that if the yield falls, so do annuity rates.

Ros Altmann, an economist and pensions expert, said quantitative easing had been "a disaster", not just for people taking out a pension annuity but for the economy as a whole, because much of the money being used to buy back gilts was then being invested overseas.

"What the government has done is effectively steal some of people's pensions on a policy that does not work," she said. "For the half a million people who are due to retire this year it is a disaster."

Clive Fortes, of pension consultants Hyman Robertson, said: "The government is trying everything to kick-start the economy. If this works, pensioners will be the collateral damage for getting the economy moving again. If it does not work, it will look like it was bonkers."

Quantitative easing has also had a serious impact on company pension schemes, pushing them billions of pounds further into deficit. The yield on gilts is an important factor when company schemes work out their obligations to future pensioners: when the yield falls, it pushes the liability figures up.

Shadow work and pensions secretary Theresa May said: "One of the side-effects of quantitative easing will be a negative impact on pension funds and pensioners. Yet again pensioners are having to pay the price for Gordon Brown's age of irresponsibility."

Vince Cable, the Liberal Democrat Treasury spokesman, said the government should scrap or suspend rules that force pensioners to buy annuities by the age of 75.

• Protection fund faces biggest drain in its history
• Multibillion cost could fall on taxpayer

The government came under increasing pressure last night to guarantee the pension lifeboat scheme after administrators for collapsed telecoms company Nortel revealed a £1.5bn pension deficit had ballooned since last year to £2bn.

Pension experts said ministers should consider accepting responsibility for the growing deficit in the Pension Protection Fund after a series of corporate failures - a move that could leave the taxpayer with a bill for billions of pounds.

The scale of the Nortel deficit should help push concerns about the sustainability of the PPF to the top of the political agenda. The deficit of the Nortel scheme, which is expected to join the PPF, is estimated to be more than seven times the combined likely losses from recent, higher-profile corporate failures Woolworths and Waterford Wedgwood.

Nortel Networks UK, formerly known as STC, owes a record £2bn to the 43,000-member pension scheme it left behind when it went bust two months ago. The deficit is far higher than previous estimates and a third more than the figure sent to creditors by Nortel's administrators a month ago.

Once assets have been recovered from the insolvency and the reduced guarantees of the PPF are taken into account, the £2bn deficit will equate to losses for the PPF of £800m - the largest ever.

The PPF, an industry-funded body set up by the government three years ago, is already deep in the red, running a deficit of £517m last year.

John Ralfe, an independent pension expert, said the hit to the PPF from Nortel was now likely to be "significantly above" his previous estimate of £500m.

Steve Bee, head of pensions research at life insurer Royal London, said the time had come for the government to give the fund its explicit support. He said the PPF was sweeping up more failed schemes than was originally envisaged.

The UK division of Canadian telecoms company Nortel Group, Nortel Networks UK employed about 1,000 people when it failed, but its pension scheme had a further 42,000 retired staff members - a reflection of the company's scale in its heyday when it was a FTSE-100 company.

Administrators from Ernst & Young were appointed on 14 January, only weeks after the firm's pension deficit showed a shortfall of £273m. In administration, however, pension trustees are required to seek a revised valuation on a legally prescribed wind-up basis.

Papers filed with Companies House show Ernst & Young, as required by law, sent a statement of its proposals to all creditors on 23 February that contained an estimate of the deficit, on a wind-up basis, of £1.5bn. But a creditor who attended a closed meeting three weeks later told the Guardian the administrators had told them that figure was out of date.

It is understood the figure of £1.5bn - the only amount put in the public domain by the administrators - was calculated by actuaries at the request of pension trustees as long ago as March last year. The deficit has since widened to £2bn, leaving the pension fund representing about 90% of total creditor claims.

Others owed money include suppliers such as Flextronics, owed £9.5m, and Northern Ireland's regional grant provider Invest NI, owed £7.4m. Public relations firm Weber Shandwick is owed £184,000.

Administrators have given away little information on the assets within Nortel Networks UK, making it hard to calculate how much they could recover for creditors. Major assets include claims on Nortel Group, which is in bankruptcy protection.

It could be up to two years before the Nortel pension scheme enters the PPF. Until then the operation of the fund will be overseen by an existing trustee board chaired by David Davies, a former trustee of the BT pension scheme. They are assisted by actuaries Watson Wyatt and investment advisory firm Mercer.

Legal & General today criticised the government's plans to inject cash into the economy by condemning moves which it claimed would cut bond yields and drive up pension fund deficits.

The insurer, which made a loss last year of almost £1.5bn, argued that the pensions industry would be a victim of the plan when other costs were rising and markets remained volatile.

Tim Breedon, its chief executive, said the Bank of England's policy of quantitative easing would make "a bad situation for pension funds that much worse". He said the central bank should rethink how it handles the new scheme to offset the worst effects. "The industry has been pressing for more long-dated government bonds and mortality bonds, but there has not been a meeting of minds on this subject."

Breedon said the government wanted to drive up demand for gilts, which would cut yields and increase the liabilities of pension funds. His criticism followed comments that the insurer was preparing for an even more severe downturn than the Great Depression, after heavy stockmarket losses sent it tumbling into the red. It made a pre-tax loss of £1.49bn last year, down from a profit of £883m in 2007. It is halving its final dividend in an effort to conserve cash.

L&G said the loss was primarily caused by the turmoil in the stockmarkets. It was forced to sell more than £1.1bn worth of equities in 2008 and the first quarter of 2009 – a time when the FTSE 100 index fell by over a third. But its capital position was also hit by its decision last month to double its provisions against losses on credit defaults to £1.2bn.

Some analysts fear that the life insurance industry could become the next victim of the financial crisis, if a sharp rise in bankruptcies leaves it holding worthless corporate debt. Breedon said that L&G was braced for a surge in bankruptcies.

Shares in L&G fell by 7.24% to 39.7p.

Phillip Inman, the deputy editor of Guardian Money, was live online answering readers' questions

In the second part of our series on the Road to Recovery, Phillip Inman addresses the problem of pension provision in the UK.

How does society need to change to balance the financial demands of the younger and older generations? And how can we fund a comfortable retirement in an era of sliding annuity rates, disappearing final salary schemes and the growing disparity between private and public sector pensions?

Phillip Inman was live online answering readers' questions.

Britain's generation gap in retirement savings is a ticking timebomb. But what is the solution?

The government should force older workers to delay retirement or accept lower occupational pension incomes to close a growing rift between the generations and help lead the economy out of the recession, according to two former government advisers.

Alan Pickering, a former independent Treasury adviser, and Ros Altmann, a former adviser to Number 10, fear the demands of affluent pension savers will rapidly become a massive drain on the exchequer, threaten the survival of many businesses and damage the prospects of younger workers.

They say people over the age of 50 in final salary pension schemes must take a cut in income of at least 10% or work longer as a gesture to younger workers, many of whom could be forced into poverty to pay for guaranteed retirement schemes.

Without significant pension reforms and other key shifts in government policy, Pickering said Britain would emerge from the crisis with unsustainable retirement promises to a privileged group of public and private sector workers, which would act like a tax on younger generations.

Altmann said the government needed to "redraw the pensions landscape" to avoid creating a wider gap between haves and have-nots in retirement than already exists among people of working age.

Steeply rising pension costs are an issue for most governments in the developed world, where postwar promises to the baby boomers have become unaffordable.

Increasing life expectancy and poor investment returns have pushed up the cost of retirement. Baby boomers, as the name suggests, will swell the numbers of retired people between now and 2040.

In the UK alone, private sector pensions are more than £200bn in deficit, while the shortfall in guaranteed pension promises to public sector workers has topped £1tn.

The system in the UK is unique in Europe and would need its own set of remedies. Five options that could begin to bring about a more equitable and sustainable situation are outlined below:

Option 1

Raise income tax. Until a couple of years ago, it was Liberal Democrat policy to tax earnings above £100,000 at 50%. This policy could be resurrected. Another band at £70,000 would levy a 45% rate. Together with the crackdown on tax havens expected to be agreed at the G20 summit, a rise in income tax would stifle the bonus culture and help address growing income inequality.

VAT - a regressive tax prone to fraud - could also be maintained at its new lower level of 15%. All the major political parties have resisted such proposals, believing them to be electorally damaging, but with the government running out of funds, it will need to look again at raising tax, especially for the more affluent.

Option 2

Tax on land or property. House price gains are not taxed, which means housing has a tax advantage over other types of assets, even after stamp duty and inheritance tax were taken into account. In 2006, at the height of the last boom, inheritance tax and stamp duty raised £8bn, just 2% of the £340bn gain in house prices.

Property has become a key savings vehicle for many people, who expect to use buy-to-let flats or their main residence to generate a pension income. A land value tax could be the best way to forestall a much predicted return to sharply rising property prices in 2011. A tax would drain 1-2% from the total value of land each year, encouraging land owners to be more productive. Combined with stricter lending rules on banks, this could end the British obsession with generating "magic" profits from dealing in land and property.

A land tax could replace capital gains tax and inheritance tax. Depending on the rate, it could also be used to abolish council tax and reduce corporation tax.

Option 3

Focus on younger workers. David Blanchflower, the influential economist and member of the Bank of England's monetary policy committee, who predicted the recession, said the government should undertake "a substantial fiscal stimulus focused on jobs as soon as possible".

Large cuts in national insurance contributions targeted at the low-paid and the young would be coupled with encouraging the under-25s to be in education rather than becoming unemployed. To prevent long-term unemployment, Blanchflower backs those who propose a job guarantee scheme after 12 months' unemployment for 18 to 25-year-olds and, after 18 months, for 25-plus.

Blanchflower argues we will all be worse off if we let unemployment soar, thinking it is someone else's problem.

Option 4

Scale back pension commitments. An immediate cut in pension commitments by employers could allow manufacturers that have maintained final salary plans to weather the credit crisis and save jobs.

Final salary schemes disproportionately reward staff who retire on large salaries as they are linked to pay immediately before retirement. Public sector workers, especially those on higher salaries, should also have their commitments reduced to fit the new economic environment.

More radically, pension payouts could be held to a maximum of £28,000 a year. This would be combined with the 10% cut and would be seen as a much more direct attack on the retirement living standards of senior managers in the private sector, Whitehall and the broader public sector.

Combined with a state pension, it would mean workers could aspire to a retirement income of almost £33,000 a year from tax-free pension savings. The average private pension generates between £1,500 and £2,000 a year. The average local government pension is about £4,200. Obviously higher paid workers could save out of taxed income for their retirement.

Option 5

Scrap pension subsidies, especially tax relief on contributions for higher rate taxpayers. About £30bn a year is spent subsidising pension contributions through tax breaks. Contributions are paid out of gross income, which means higher rate taxpayers avoid paying 40p in the £1. More than half the subsidy is spent on higher rate taxpayers.

The move could be combined with scrapping the government's planned occupational scheme "for all". The Department of Work and Pensions has issued tenders to private sector suppliers for its new scheme of personal accounts. The pension plan, designed in 2006 by Lord Adair Turner, the new City regulator, is due to sweep up the 8 million low-income workers not in an occupational pension.

Critics of the scheme argue it will prove complex and costly with a price tag on the system of between £500m and £1bn. It is also flawed because hundreds of thousands of workers will save in the scheme only to miss out on means-tested benefits when they retire.

Graphic: How Britain's population will age

• Tomorrow: How do we end the banking crisis?

In the 1970s, put simply, there were more young people than old people. Now, we're all living longer and costing society more. Phillip Inman, writing today says

Increasing life expectancy and poor investment returns have pushed up the cost of retirement. Baby boomers, as the name suggests, will swell the numbers of retired people between now and 2040.

Here are the raw numbers from the Office for National Statistics, which show the number of people in each age, predicted in the past and in the future.

DATA: UK estimates
GRAPHIC: how we visualised the data

• Can you do something with this data? Please post us your visualisations and mash-ups below or mail us at datastore@guardian.co.uk

See all our data at the Datastore directory
• Follow us on Twitter

Administrators to Nortel Networks UK, the telecoms business formerly known as STC, have revealed that the one-time FTSE 100 firm that collapsed in January has a pension deficit of £1.5bn - more than five times the value of the shortfall carried in the company's last accounts.

The revised pension deficit valuation confirms the worst fears of experts, leaving the government's lifeboat scheme facing its biggest loss.

Nortel's UK division had only about 1,000 employees when it failed, but there are a further 42,000 retired employee members of the firm's pension scheme - a legacy of its dominance in earlier times in large parts of the British telecoms market.

According to independent pensions consultant John Ralfe, the Pension Protection Fund (PPF) is likely to take a £900m hit from the collapse of Nortel, which should fall to about £500m after taking into account likely recoveries from the administration process. This would at a stroke double the PPF's last reported deficit a year ago.

There is mounting concern a wave of corporate failures expected this year will push the PPF to breaking point. The collapse of Nortel follows hard on the heels of the failure of Woolworths, which had 9,000 people in its pension scheme. The retailer's collapse is expected to add about £100m to PPF losses.

Previous valuations of the Nortel pension deficit on an ongoing accounting basis showed a deficit of £273m. But administrators from Ernst & Young this month told a meeting of Nortel creditors that a revised valuation, carried out on the legally prescribed wind-up basis, showed a deficit of £1.5bn at the end of December. The dramatic increase reflects both the increased buyout cost of pension liabilities and the depressed value of fund assets, particularly investments in shares and gilts.

Ralfe suggested that the December figure may well have ballooned further, owing to the effects of a 10% decline in the value of the stockmarket since the start of the year.

The latest proposals from administrators do not disclose details of the assets and liabilities of the business, making it difficult to assess the likely recovery of funds, but Nortel had $400m of cash at the end of last year.

Ernst & Young explained: "It would prejudice the conduct of the administration to make full disclosure ... in view of the fact that a restructuring of Nortel Group [the Canadian parent company] is being pursued."

Creditors were told that the huge size of Nortel Group's obligations to its former UK employees had been a contributory factor in the company's demise, leaving the group with "a high cost structure and limited access to public markets due to below-investment-grade credit ratings".

Ernst & Young confirmed that the pension fund is now the largest creditor within the UK administration.