The Institute for Fiscal Studies (IFS), in partnership with abrdn Financial Fairness Trust, today publishes the final report of its Pensions Review. Drawing on extensive research conducted over the past 2½ years, the report sets out a comprehensive roadmap for reform, aimed at addressing serious challenges facing the UK pension system and substantial risks to the finances of future generations of pensioners. The proposals are timely, with the government set to announce its own review of retirement income adequacy soon.
Together, the proposed reforms aim to help move the UK’s pension system towards one that will: provide a secure state pension; increase the number of workers saving into a private pension and help many others save more; provide increased and targeted support to many hit hardest by state pension age rises and others particularly at risk of poverty at older ages; and offer solutions to help people manage their pension wealth through retirement.
Policy recommendations
There have been major improvements to the UK pensions system in recent decades. But serious problems remain for the next generation of pensioners. Fewer will benefit from the advantages of generous ‘defined benefit’ pensions, high levels of homeownership, and rising house prices enjoyed by the current generation. The review has identified a number of issues that need addressing including: pressure on public finances from an ageing population; many workers failing to save enough to have an adequate income through retirement – including most of the self-employed; complex decisions over how to draw on and manage pensions through retirement; and increasing numbers of older people living in more expensive, insecure, private rented accommodation. To address these challenges, the review makes a set of specific recommendations, as follows:
1. Delivering a secure state pension
The ageing population is putting strain on the state pension system and there is low confidence in how much the state pension will provide in the future. To address this, we propose a four-point pension guarantee with the following points:
- The government should choose a target level of the new state pension as a fraction of economy-wide average earnings (currently it is worth 30% of median full-time earnings). The government could use the current ‘triple lock’ to reach that target. But once that target is met, over the longer run the state pension would rise in line with average earnings growth.
- The state pension should always grow at least as fast as inflation. When earnings growth is below inflation, the state pension should therefore rise in line with inflation. This would temporarily cause the state pension to be above target. As is done in Australia, the state pension would then continue to rise in line with inflation until it returns to target.
- The government should commit to never means-testing the state pension.
- The state pension age should only rise as longevity at older ages rises. But it should rise by less than those increases in longevity, meaning the average time spent receiving the state pension would still increase.
2. Boosting private pension saving in a targeted way
Around 20% of private sector employees, and 80% of self-employed workers, are not saving in a private pension. Of those employees who are saving in a ‘defined contribution’ arrangement, almost 40% are set to miss a standard benchmark for an adequate retirement income. But many working-age individuals are struggling with low incomes now, so it is important that any changes minimise the potential for lower take-home pay for those already on a low income. The Review therefore does not support proposals for across-the-board increases in default minimum automatic enrolment contributions but instead recommends:
- Ending the practice where employer pension contributions only have to be made if the employee also contributes. All employees (aged 16–74) should receive at least an employer pension contribution worth 3% of their total pay.
- Increasing minimum default total pension contributions under automatic enrolment in particular for those on average earnings and above. This boosts private pension saving, but protects take-home pay in periods when individuals have low earnings.
- Introducing new mechanisms to facilitate pension saving by the self-employed, such as integrating pension contributions into Self Assessment tax returns.
The proposals boosting pension contributions from employers and employees would generate an additional £11 billion per year of private pension saving (£5 billion from employer contributions and £6 billion from employee contributions). Those on course for low-to-middle retirement incomes would see the biggest boost to their incomes – by an average of 13–14% – from these reforms.
3. Improving means-tested support
There have been significant rises in income poverty for people in their early 60s. Additional targeted financial support should be introduced to support those who are most harmed by increases in the state pension age. As well as helping those most in need, this should help build broader support for future necessary increases in state pension age. The Review recommends:
- Enhancing universal credit for people within one year of their state pension age, either for all on low incomes and assets (costing £600 million per year) or targeted towards those with health conditions (costing £200 million per year). These costs are less than one-tenth of the exchequer gain of around £6 billion per year from raising the state pension age by a year.
- For pensioners, the government should continue to focus on ways of boosting take-up rates of means-tested support. Housing benefit should be increased for pensioners living in the private rented sector, so that they are provided with support based on the local rents of (at least) a two-bedroom property (initially costing £150 million per year).
4. Helping people manage pension wealth in retirement
People managing ‘defined contribution’ pension pots face too many complex decisions over their (often numerous) pension pots. They risk either running out of private pension wealth later in life or being overly conservative and not enjoying the fruits of their savings. This is a huge problem and an immensely difficult one. The Review proposes:
- Expanding the automatic consolidation of small deferred pension pots, especially for those approaching (or above) the state pension age.
- Facilitating and encouraging flexible but protective default retirement income products, such as ‘flex then fix’ approaches combining the flexibility of ‘drawdown’ earlier in retirement with the security of annuities (which provide a regular income for life) at older ages.
- Ensuring people can access high-quality information and support without having to pay for expensive and ongoing financial advice, along the lines of the Financial Conduct Authority’s recent proposals for targeted support.
David Gauke, former Secretary of State for Work and Pensions and Chair of the Steering Group of the Pensions Review, said:
‘The final report from the IFS’s review comes at the perfect time with the government’s own review expected to commence imminently. Pensions need long-term planning and, ideally, a broad consensus. The proposals put forward maintain an important balance between the state, employers and workers. The government should provide a secure pension income, further increases in the state pension age should be accompanied by more support for those hardest hit, and both employees and employers should gradually contribute more to help achieve greater financial security in retirement.’
Paul Johnson, Director of IFS and co-Director of the Pensions Review, said:
‘There is much to celebrate about the current UK pensions system. The current generation of retirees is, on average, doing much better than any previous generation. Pensioner poverty is way down on the very high levels in the 1970s and 1980s, and is indeed below that for other demographic groups. The state pension has been simplified and is now much more generous to many women than in the past. Many more employees have been brought into workplace pensions by the successful roll-out of automatic enrolment.
‘But there is a risk that policymakers have become complacent when it comes to pensions. Without decisive action, too many of today’s working-age population face lower living standards and greater financial insecurity through their retirement. Our recommendations give government a clear and affordable roadmap: shore up the state pension, help workers save more – but only in periods when they are better placed to do so – and help individuals to make the most of their pension pots through retirement. Taken together, they would create a pension system fit for the next generation.’
abrdn Financial Fairness Trust, funder of the Pensions Review, said:
‘Many low earners are set to face financial difficulties when they retire, with one-in-three low earners currently saving into defined contribution pensions not on track to achieve a standard benchmark for an adequate retirement income. Many are not saving at all, especially the self-employed. This poses serious problems for individuals as well as the state, and action is needed sooner rather than later to avoid problems growing and to future-proof pensions. Our recommendations would bring an additional 5 million employees into pension saving and would significantly boost retirement incomes for those on low-to-middle incomes.’
Mike Ambery, Retirement Savings Director at Standard Life, has shared his comments on the Institute for Fiscal Studies’ Pension Review as follows: “Pensions are firmly in the spotlight at the moment. In recent weeks we’ve had series of major policy announcements that have set a clear direction of travel on the investment aspect of the system and a drive for fewer, larger schemes. The broader question of how we ensure people have enough to live on in retirement and receive the help they need requires further focus and the IFS paper, alongside the expected adequacy review from the government, will move this conversation on.
“The report correctly identifies widespread under-saving and gaps in pension provision. We are supportive of their conclusion that there is not a one size fits all solution to these problems but there is a need to be more inclusive, particularly for the self-employed, as well as for younger workers who are not yet included. The risk of over saving for those on low incomes is significant but so too is the need for most of those on average or higher earnings to save more. Striking the right balance will be a key challenge of the adequacy review, and any change would need to be carefully considered and in consultation, especially with employers.
“With the state pension accounting for a significant proportion of all welfare spending, the report highlights the risk that the state pension age could be pushed back further to maintain affordability. We agree that there are issues here and people’s ability to keep working haven’t necessarily kept pace with increases in state pension age, as evidenced by the rise in poverty levels among those in their early 60s.
“The report recognises that many aspects of the pension system design are moving in the right direction, with plans afoot to help consolidate small pension pots and reduce the complexity of decisions people face at retirement in particular. We see the need for a joined up approach between Targeted Support and default retirement income options as particularly important, as together they have the potential to reduce the anxiety that many people experience around making the wrong decision at the point of retirement. Targeted Support will also give individuals support in recognising that they might not be saving enough.
“The discussion on how default retirement income solutions will be designed is just getting going but we agree that these need to meet people’s twin need for a degree of income certainty and flexibility. This also recognises that decisions when not supported can sometimes have life-changing implications. We look forward to a long-awaited review of retirement provision, aligning with ensuring decisions in saving and spending provide support and guidance for both secure and better retirements through an integrated public and private retirement system.”
