In the UK the issues are quite different to those faced by a lot of other countries that have more generous state pensions than we do. Without reform, those countries are looking at spending an increasing proportion of GDP on pensions in the future. Now that isn’t the case in the UK. Due to reforms going back more than 20 years, state spending on pensions is not likely to increase that substantially as a percentage of GDP, in spite of increasing longevity.
But the system is creaking under a number of different pressures. One of the problems with a less generous state pension is that a lot of pensioners end up living in poverty. New Labour has targeted extra resources at the very poorest of pensioners through increasing means-tested benefits, but that was at the cost of increased complexity and reduced incentives for people to make their own provisions. Currently, around 40 per cent of pensioners receive some form of means-tested benefit; without reform that is set to increase to more than three quarters of pensioners by 2050.
Another problem is what’s happening to private pensions. In the UK, many people have enjoyed quite generous occupational pensions linked to final salaries. But for a number of reasons many companies have been closing these schemes and a lot of people haven’t been taking out individual personal and stakeholder pensions to replace them. So we have both a declining state pension and fewer people making any additional private provision.
What solutions is the Government proposing?
The Government’s recent proposals have three main elements. The basic state pension is going to be more generous and, in the future, linked to earnings, not prices. Partly this is going to be funded out of higher taxes, but partly it is going to be funded by the second main change, which is raising the state pension age from 65 to 68 by 2050. The third element is an attempt to increase the level of private provision via a National Pension Savings Scheme. The Government rejected compulsory additional saving – instead, you will be automatically enrolled in the scheme and will have to make a conscious decision to opt out. The aim with auto-enrolment is to overcome the inertia that often acts as a barrier to saving. Evidence shows that where firms have introduced auto-enrolment into their firm-based schemes, it does have a positive effect. If you are in the scheme, you will have to contribute four per cent of your earnings but, as an additional incentive, the equivalent of three per cent of your earnings will be paid in by your employer and a further one per cent by the government. If you stick with the scheme throughout your working life, that should give you enough for a decent additional pension on top of the basic state pension.
So assuming these proposals are implemented, who would be the winners from the changed system and who would be the losers? For those at the bottom in terms of pension income, the set of proposals doesn’t really help very much, it just changes the form of help they get. Currently, they get money in the form of means-tested benefit; in the future, they will get it as a basic state pension. However, because benefits don’t get through to everyone who needs them – some people don’t claim through stigma or ignorance – the shift to higher state pension will help. But generally, if you are claiming the full amount of means-tested benefits, you won’t gain in terms of the amount per week that you get. In fact, if you take into account the fact that those on lower incomes tend to have a shorter life expectancy, the increase in the state pension age will be a bigger hit out of their total pension income. Those who are better off will lose relatively less from the increase in state pension age and will tend to gain from having income in the form of a basic state pension, rather than means-tested benefits.
And finally, do you think the Government has come up with proposals that will work?
The proposals go some way to addressing the problems in the current system but there is a possibility that this is not the final set of proposals we will see in the next few years. The future growth of means-tested benefits will be less, but still around one third of pensioners are predicted to receive some money from means-tested benefit by 2050. I think auto-enrolment and the National Pension Savings Scheme will give some people the push through the door they need to start saving, but I am not sure it will achieve the same kind of results as it has in individual firms. Where auto-enrolment has been introduced by individual firms, it has been the employer driving the process. That’s completely different to introducing a scheme nationally, when many employers are going to be quite resistant to something they have to contribute three per cent to. And if people don’t have additional savings, they are going to have to rely on a fairly low basic state pension in retirement.
Finally, raising the state pension age from 65 to 68 may not be enough to encourage people to work longer. Many people are retiring in their 50s and 60s, well before the current state pension age; those who are less well qualified may face barriers to getting employment, others may leave work on health grounds. These people aren’t necessarily going to work longer because the state pension age has increased, and they may find themselves facing real hardship if they don’t qualify for a state pension until they are 68.