Pensions policy in the UK
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[audio:http://www.bris.ac.uk/Depts/CMPO/audio/sarahsmith4.mp3]In November 2005, the independent Pensions Commission published its second report, setting out a series of recommendations for reform of the UK pension system. Drawing on recent research from the Centre for Market and Public Organisation (CMPO), University of Bristol, Sarah Smith discusses the Commissions proposals.
What is the pensions crisis all about?
Population ageing has put increasing strain on the UK pension system. Unlike many other OECD countries, there has not been the prospect of rapidly growing state spending on pensions. But past reforms have created their own problems, notably:
· a rise in means-testing (projected to apply to 70% of pensioners by 2050), bringing with it complexity and disincentives to private saving;
· a decline in the value of state pensions relative to earnings, without the anticipated increase in private provision;
· and gaps in state pension coverage, affecting especially women and those with caring responsibilities.
What solutions does the Pensions Commission propose?
In its first report, the Pensions Commission concluded that, with people living longer, there were some hard choices to be made between saving more, paying more in taxes, working longer or facing lower incomes in retirement.
The recommendations, contained in their second report, contain elements of all four. Their proposed solutions are to:
· create a firmer (non-means-tested) base to the pension system, comprising an earnings-indexed and (eventually) universal basic state pension and a flat-rate, contributory state second pension, which will, together, provide a pension of around 30% of average earnings.
· spread the cost of population ageing over future taxpayers and future pensioners by increasing state spending on pensions from 6.2% today to a projected 8.0% in 2050 and raising the state pension age, from 65 in 2020 to 68 by 2050. Effective retirement ages should also rise.
· phase out the earnings-related element of the state system, and in its place, introduce the National Pension Savings Scheme a funded, defined contribution pension into which employees would be automatically enrolled (with an opt-out option) and contribute 8% earnings (employers would be compelled to contribute 3% of this and the government would contribute 1%). Together with the basic and second pension, this would produce a pension of around 45% of average earnings.
Who would be the winners and losers from such reforms?
The overall winners and losers under such a system will depend on who bears the burden of the increase in state spending, but the changes are likely to be of most benefit in retirement to those on medium/high earnings who have some private savings. Their eligibility for means-tested benefits would have been reduced by those savings, but they will receive the full amount of a higher, non means-tested state pension.
Those who are on very low incomes during their working lives are unlikely to get a higher income from the state in retirement, but will see means-tested benefits largely replaced by a flat-rate pension. Given inequalities in life expectancy by social class, they will be harder hit by the increase in the state pension age. The Commission has suggested making generous means-tested benefits available from the current state pension age to ease the burden on this group.
Will the proposed solutions work?
The proposed changes are intended to reduce dependence on means-testing and fill the gaps in pension provision among those with caring responsibilities, increase the proportion of people with an additional, funded pension and achieve a fair and sustainable pension system in the face increasing longevity. But there are still a number of potentially unresolved issues, particularly in relation to future retirement ages.
The system remains complex. The transition arrangements will inevitably be complicated, but, even in the long-run, there will be a two-tier flat-rate pension system, which could have different entitlement criteria, indexation arrangements and starting ages. And while the extent of means-testing will be reduced, it could still apply to up to 40% of the pensioner population by 2050.
Auto-enrolment may fail to achieve its objective of achieving comprehensive coverage of additional pensions. There is a growing body of evidence from the United States and UK showing that companies who introduce auto-enrolment experience significant increases in participation in their pension schemes. The conclusion is that auto-enrolment is an effective mechanism to overcome individual inertia.
But the decision to change is often motivated by employers desire to raise participation, and may be accompanied by other measures, such as increased communication. The effect of government-imposed auto-enrolment could well be a lot smaller, particularly if there is employer resistance. The evidence shows that the employer match should raise participation assuming that employers don’t offer wage compensation in its place although it may reduce individual contributions among those who contribute already.
Raising the state pension age is unlikely to be sufficient (or, indeed, necessary) to raise the effective retirement age. Most people currently stop working before the state pension age and fewer than one in ten men stop working at 65 and draw only a state pension at this age. So changing the state pension age will have a limited, direct effect on retirement.
The high levels of non-employment among those with no qualifications in their 50s, suggests that the real challenge in extending working lives is not to encourage people to work beyond age 65, but to get them to stay employed at least up to age 60. Much of the focus of researchers and policy-makers in the past has been on unemployment among younger workers; what is needed now is greater understanding of the demand for, and productivity of, older workers.
Notes
Pensions Policy in the UK is a commentary piece by Sarah Smith of the Centre for Market and Public Organisation at the University of Bristol.
Related information
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