We speak to Paul Johnson, Director at the Institute for Fiscal Studies, about the Pensions Review report, insufficient pension contributions, the State Pension age – and why the UK pension system needs a review.
Sangita Chawla: Hello, I'm Sangita Chawla, chief marketing officer at Standard Life. Today, I am excited to have on as our guest speaker Paul Johnson. Paul has been director of the Institute for Fiscal Studies since 2011. He's also a visiting professor in the Department of Economics at University College London today. Paul and I are going to discuss the Pensions review recently launched by the Institute of Fiscal Studies.
Hi, Paul, and welcome to Thinking Forward.
Paul Johnson: Hi, thank you for having me.
Sangita Chawla: The UK pensions market has seen a tremendous amount of change over the past two decades. The introduction of auto enrolment has obviously been a great success for many. We've had many more people contribute to the workplace pension. And despite COVID, we haven't really seen opt out rates change. So do we need a pensions review?
Paul Johnson: Well, it's partly because we have seen so much change that I think there's a need to look again. So there's obviously lots of good news, and not least the current generation of pensioners are doing really well. But I think there's a real concern about future generations of pensioners. There was several reasons for that. One is that whilst, yes, you're absolutely right, auto enrolment has been successful, I think beyond the expectations of those who introduced it – and indeed Adair Turner and his commission who reported on this nearly 20 years ago – with something like 90% of those eligible are auto enrolling into pensions.
Paul Johnson: But there are some worrying issues as well, some really quite worrying ones. One, of course, is that our traditional defined benefit, occupational sector has collapsed almost completely. So that used to have almost half – certainly more than four in ten – of private sector workers contributing into one of these, it’s now less than one in ten. I mean, it almost doesn't exist in the private sector anymore.
Paul Johnson: The amounts that people are putting into their defined contribution pensions through auto enrolment, and so on, are very low. For most people, it’s less than 8% of earnings and even 20 years ago, the last pension commission felt the average earner might need to put more like 15 in. And, of course, actually rates of return have reduced since then. And then there are groups of people not putting money in at all.
Paul Johnson: You've had a big increase in the number of self-employed. And actually, their engagement with pensions has dropped off really dramatically over the last 20 years, so they’re a group not really covered at all. And then finally, put all of that together is this issue of risk. With those old defined benefit pensions, risk was held by employers quite often. Now it's really held by the individual.
Paul Johnson: And this is a very complex area for people to navigate, particularly when they're at the point of retirement. So actually there are lots and lots of issues to look at. And, of course, pensions is a long-term thing. If you don’t start thinking now for 30, 40, 50 years ahead, then it's too late.
Sangita Chawla: And we're not the only country that looks at contribution rates. I think Australia has been doing a very similar thing as well. So naturally we'll all be sitting here thinking: cost of living is going on at the moment, while your review says we may need to change contribution rates. Where's the tension? How do you resolve that sort of conflict at the moment?
Paul Johnson: Well, there's certainly a tension between putting more into pensions now and the cost-of-living crisis. In some ways, just looking back over the last decade, it's even more remarkable how successful auto enrolment has been, because we must remember that it’s not just been the cost-of-living crisis now. We've actually had more than a decade of incredibly slow growth in living standards, and earnings actually, so for auto enrolment to have worked over that period is perhaps even more remarkable than I think people realise.
Paul Johnson: I think given where we are now, I don't think it's going to be top of anyone's priorities to say we need to increase contribution rates now. But as we come out of this, as inevitably we will one day, then making some use potentially of the future increase in earnings to increase contributions is certainly something we would need to look at.
Sangita Chawla: And so you're essentially saying you have to start think about it now, because it's going to take a long time to actually implement as well?
Paul Johnson: Well, yes. Pensions are long term because they’re built up over decades. But even making changes to things like auto enrolment take a long time. It was more than a decade from the point at which the Turner Commission reported to auto enrolment being fully rolled out. So simply the implementation of things takes a long time.
Sangita Chawla: And you mentioned the risk sharing. So, more people are investing into a DC pension. They don't have the guarantee of a pension. What are you exploring specifically in that area?
Paul Johnson: It is a really difficult area. We know that there are some new schemes, some CDCs.
Sangita Chawla: Yes.
Paul Johnson: Collective defined contribution. Exactly how they're going to work, I think is still somewhat unclear. There's lots of work to do on how those might work there. There's obviously the issue around what happens at retirement. People are not buying annuities anymore, so there's a risk that they'll use their money too quickly or too slowly because there's great uncertainty about how long people are actually going to live.
Paul Johnson: Are there different products that can come to market to help? Can Government play a role, either through the State Pension or through insuring within the annuity market or supporting defined contribution pensions in one way or another. I don't know what the answer is, I really don't. But I do think it's, you know, it's a serious problem that we've moved from this world in which risk has been shared between state and employer, or an insurance company, an individual, to one where it's really very much held by the individual and probably they are the actor in all of this least able to cope with that amount of risk and complexity, too.
Sangita Chawla: And we see that from our own research, particularly with the cost of living at the moment. Many of our customers are saying they want more certainty of income, that there is a choice overload that's going on at the moment. They're not sure what to think around. I think another issue that we're facing right now is just the mental load for some individuals.
Sangita Chawla: So, not only are they thinking about what to do with pensions, they're also thinking about how to save for their current day-to-day expenses. So what you're looking for here is how do you really solve for over the long term with policy changes? And I guess a big part of what you're thinking about is this post retirement piece?
Paul Johnson: Yeah, I think the post-retirement piece is the bit that's been neglected, actually. I mean, auto enrolment is terribly easy. And actually we've been into lulled into a sense of security and I think an inappropriate one. First, that the default contribution rate is enough. For many people it won't be enough. And second, because it's completely automatic, that's what makes it effective.
Paul Johnson: People aren’t necessarily engaging with it, and then suddenly they get to 60 or 65 or 70 or whenever they decide to take it, and they've got this huge range of choices open to them. And with the best will in the world, actually, if you continue to have to make those choices in your eighties and nineties, we know that people's capacity to make those choices actually declines in in later old age and the scale of help and so on that's available.
Paul Johnson: And the complexity is such that we're potentially storing up trouble ahead.
Sangita Chawla: I think that's a very big subject that we don't understand fully, isn't it? The sort of cognitive load for individuals. And when that starts to sort of really impact on your ability to make those difficult decisions. Changing the sort of angle a little bit, one of the questions I get asked about all the time from friends is, should I have a pension, should I have should I buy a property?
Sangita Chawla: And then for the younger people, they're coming to me and going, do I actually need to buy a property, or should I be renting? Actually, I can't afford to get onto the property ladder. So are you exploring that as part of your review?
Paul Johnson: Absolutely. I think it’s one of the big changes that we're living through. Twenty-five years ago, the vast majority of people in their thirties were already owner occupiers and private renting was relatively unusual, certainly beyond your early thirties. That's changed almost completely. We've had an almost halving of the fraction of people in their thirties who are owner occupiers, and we've already seen something like a doubling of the number of people in their fifties who are private renters.
Paul Johnson: And so this is coming at us quite soon. So, of course, if you hit retirement and you're still paying private rents, then you'll either have a lot less money available for other things or you are going to fall back on the state to pay your housing benefit, to cover your rent. And that's one of these big intergenerational changes where until 20 years ago, every sort of cohort, as we move through time, is more like to be an owner occupier, and a really important part of security in retirement and keeping costs down in retirement is to minimize those housing costs.
Paul Johnson: That may well change and it is changing for the later cohorts. And I think that's going to be really tough for some. Now, again, this is clearly very unequal. There are some people who will own their own homes and, actually, they're often the people who will also inherit homes. So we may actually see a sort of bifurcation of some people who end up with if you've bought a home during their life and then they inherit as well, and then some people who don't get either of those benefits.
Sangita Chawla: And the fact that the UK market is still very owner occupied is quite different to the rest of the world, isn't it? I mean, in Europe there's a lot of people that rent, and around the world. So it's interesting to see how we play out as a market. The bank of Mum and Dad is probably what's funding and supporting money.
Sangita Chawla: How long can that run for?
Paul Johnson: I mean there are billions flowing between older generations and younger at the moment. I mean gifts during life normally to help people onto the housing ladder and, of course, then there's a lot of inheritance that's going to come down. But that's very unequally spread. And if your parents aren't owner occupiers or own a home, that's not worth very much…
Paul Johnson: You're in a much worse position than those who are, who have got parents who have done well, who may have a property in London or the south east. So that has all sorts of social and economic effects. It makes it hard for people to move from other parts of the country, for example, down to London if they don't have the support for those housing costs.
Paul Johnson: So this isn't just a sort of individual savings and pensions issue. It's actually a sort of social and economic issue much more generally.
Sangita Chawla: Well, I'll be fascinated to see what comes out of the next part of your research on that. So also, for most people, the State Pension still plays a very important role. So is that something that's sustainable for the Government going forward, in your opinion?
Paul Johnson: Yeah, and it's important to be clear that it really does play an important role. The State Pension is around about £10,000 a year now. For a lot of pensioners, still, for a majority, it’s still at least half of that. So we shouldn't at all ignore that and we're not going to. It's also very important to recognise that the State Pension is much more generous than anything that's available to people under State Pension age.
Paul Johnson: So, is it sustainable? Yes. You know, we can make the choice to keep it at that kind of level over time, but it will cost us. So, if we stick with the sorts of policies we have at the moment with triple lock and actually with State Pension age rising in line with what is intended, we'll still be devoting something like 4% of national income, about £100 billion, a lot of additional money to pensions in 40- or 50-years’ time.
Paul Johnson: And that obviously implies that we'll need to raise taxes by quite a lot to pay for that. And then in addition, there will be additional costs associated with health care and additional costs associated with social care. And actually, they’re bigger than the additional costs associated with pensions. And I think it's something that politicians really don't want to talk about because these are big choices ahead of us.
Paul Johnson: They're big choices about how much we're going to essentially maintain the welfare state we've got used to, maintain the NHS, maintain pensions at their current levels, and therefore inevitably have to raise taxes or make some other choices, such as stop some higher earners using the health service or stop some higher earners getting the State Pension. I'm not suggesting that we do that, but those are the choices that are ahead of us.
Paul Johnson: And, of course, there are other choices about how quickly we increase the pension and how quickly we increase the State Pension age.
Sangita Chawla: There's an awful lot there to cover. And so when you're thinking about the pensions review, what comes next? How are you prioritising what's on the list?
Paul Johnson: Well, we'll be covering state and private pensions. I think the next element will be focusing on issues around state pensions, lots of issues there. So, yes, it makes sense to increase the State Pension age, for example. But we know that when you do that, you really increase poverty rates among people who are just taken below the State Pension age.
Paul Johnson: So, poverty rates among 65-year-old men more than doubled when the pension age rose from 65 to 66. So, we'll be looking at how that might pan out in the future as pension age rises further, we'll be doing some projections as to what future pensioner incomes might look like, given what we know about the population at the moment.
Paul Johnson: We'll be looking at the choices Government has over their own pension provision, and then we'll be looking at a whole series of issues around the relative roles of owner-occupied housing, saving in a pension, saving in other forms. A lot of people in their fifties and sixties actually have a second property, and the role they play. And we'll also be looking at these intergenerational issues.
Paul Johnson: How important is inheritance going to be and gifts from parents going to be, going forward, as well as these bigger issues around risk sharing. So there's an awful lot of work to do, but it's going to be a good two years before we come out with the final report, hopefully with some recommendations, certainly with some options. But there'll be a number of reports along the way.
Sangita Chawla: So it could be a Johnson Commission? One day we may be having talking to you as Lord Johnson?! That's the same as the Turner Commission.
Paul Johnson: I doubt that very much! Adair Turner, he was commissioned by the Government. This is an entirely independent piece of work, that we're carrying out with vastly less resources.
Sangita Chawla: Well promise me you will come back and talk to us about it.
Paul Johnson: Absolutely happy to.
Sangita Chawla: Thank you so much anyway. And we look forward to having you back again to talk through the next part of your research and what comes out of the review. It's a really important subject for the whole industry and I know it affects the lives of everybody. So well done. Thank you very much for being here.
Paul Johnson: Thank you.
Sangita Chawla: That brings us to the end of the episode. If you enjoyed our discussion today, you can find more interviews and podcasts on our website. Just search Standard Life Thinking forward. Thanks again and see you soon.