Many future generations of pensioners are likely to face substantial financial difficulties in older age – unless there’s policy action. So what are the challenges facing the UK pensions system, and how can they be overcome?
Current pensioners are doing well, on average, and many of the recommendations of Lord Turner’s Pensions Commission (from 2004–5) have been successfully implemented.
Yet the future looks risky at best for many current workers hoping for a comfortable retirement, according to The Pensions Review report – produced by the Institute for Fisca Studies (IFS) – which makes the case for a major review of the UK pension system.
The last 20 years have seen:
- the continued decline of defined benefit (DB) pensions in the private sector
- the abolition of state-earnings-related pensions
- low interest rates
- falling homeownership
- low average contributions to defined contribution (DC) arrangements
- the introduction of pension freedoms that offer flexibilities but reduce risk-sharing in retirement
- a collapse in pension saving among the self-employed
Standard Life supports the call for a major new review of the pensions system, in light of the aforementioned changes – some of which were never anticipated by the Pensions Commission.
To understand more about the challenges that may lie ahead for future generations of pensioners, we spoke to Paul Johnson, CBE, Director at the Institute for Fiscal Studies.
You can watch the full video here: Challenges facing the UK pension system: Is it time for a new review?.
Key points from The Pensions Review report include:
- Many employees are saving very little for retirement
Almost a fifth of working-age private sector employees (around 3.5 million people) do not do any pension saving in a given year. This is particularly true of low earners who are below the threshold for automatic enrolment.
And most of those participating in a pension save small amounts. More than half (61%) of middle-earning private sector employees who contribute to a pension save less than 8% of their earnings. And 87% are saving less than the 15% that is more in line with what Lord Turner’s Pensions Commission considered appropriate.
- Fewer than one-in-five self-employed workers are saving in a pension
This compares with around a third when the Pensions Commission reported in 2004–5. This is particularly concerning given the growth in self-employment. Also, the decline in pension membership among the self-employed is greatest among those who have been self-employed for a long period. And those who do save in a pension often save relatively low amounts that remain fixed in cash terms over several years.
- Most private sector pension participation is in the form of DC pensions, which leave individuals bearing risks that are difficult to manage well.
DC pension schemes, combined with pension freedoms, offer members much more flexibility than DB arrangements. But unlike in DB plans, there is no risk-sharing with employers, other members or other generations.
Decisions around how to draw down pension wealth are high-stakes and will need to be made with care. Currently, a man aged 66 is expected to live for a further 19 years; but 13% can expect to survive until age 95. The equivalent figures for 66-year-old women are 21 years; with 20% making it to age 95. There are risks of running out of private resources, or of being so cautious as to end up suffering a needlessly austere retirement.
- Increasing numbers approaching retirement live in more expensive, insecure, private rented accommodation.
At age 65, only 3–4% of those born in the 1930s and 1940s lived in private rented housing. This compares with 6% for those born in the 1950s. And this figure looks likely to be 10% for those born in the 1960s. This share could be even higher for younger generations, leading to a combination of a low standard of living in retirement and greater reliance on housing benefit.
- Higher State Pension ages are a coherent response to the challenges of increased longevity, but they pose difficulties for many.
Additionally, longevity improvements have not been as big as predicted a decade ago. The higher State Pension ages rise, the harder it will be for some to remain in paid work until that age. Among those in their late-60s, 35% of men and 40% of women are disabled. These rates rise to 43% and 46%, respectively, for those with low levels of formal education.
A higher State Pension age also pushes up income poverty rates among those in their mid-60s, in part because the working-age benefit system is less generous than the support available for pensioners. For example, the increase in State Pension age from 65 to 66 led to a more than doubling of the income poverty rate for 65-year-olds.
- Spending on state pensions and other benefits for pensioners is projected to rise by £100 billion a year by 2070, with even bigger increases in health and social care spending.
If the State Pension age is increased as legislated, the share of adults over the State Pension age is projected to rise from 24% today to 27% in 2050, and 30% in 2070. State spending on payments to pensioners is set to rise from 5.6% to 9.6% of national income over the next 50 years, according to the most recent projections from the Office for Budget Responsibility. This increase is equivalent to £100 billion a year in today’s terms.
The UK is, however, in a better fiscal position on this issue than many western European countries, with less public spending on state pensions and more favourable demographic trends.
Some initiatives already underway will help to address some of the challenges outlined above.
For example, legislation is passing through parliament that will lower the minimum age for auto-enrolment to 18 and make employees eligible for the scheme from the first pound of earnings. This will go some way towards addressing under-saving in the long term.
Some policy ideas being floated may also help. For example, the longevity think-tank Phoenix Insights has argued persuasively for a means-tested bridging benefit that would top-up to Universal Credit for those worst affected by State Pension age increases.
The challenges outlined by the IFS are thorny issues, but there are some reasons for optimism as different solutions are either actioned or are gaining momentum through public debate.
There are also opportunities for pension providers to extend the support they provide to members through tailored communications and wider financial wellness – ensuring that people are supported during all the financial moments that matter most.
To understand more about the challenges that may lie ahead for future generations of pensioners, watch our discussion with Paul Johnson, CBE, Director at the Institute for Fiscal Studies: Challenges facing the UK pension system: Is it time for a new review?.
You can also find out more about thought leadership programme at Thinking forward | Standard Life.