The UK needs a new renewed pensions settlement. Professor Nick Pearce, Director of the Institute for Policy Research and one of the three members of the Pensions Commission, explains why.
The work of the first Turner Pensions Commission twenty years ago led to the creation of a new settlement for the state and private pensions system that has proved remarkably resilient. It recommended a comprehensive set of reforms to ensure that the UK could meet the challenge of funding decent pensions in an ageing society and achieved a political consensus that has endured through major economic shocks and changes in government.
The building blocks of these reforms – a more generous, less means-tested state pension system, gradual increases in the state pension age, auto-enrolment into workplace pensions saving and the creation of NEST – continue to provide the foundation for the pensions system today. Our task in the Second Pensions Commission is therefore not to start again, but to finish the job.
The Second Pensions Commission has been asked to report on the long-term future of the pensions system in the UK, out to 2050 and beyond. Since the first Commission reported, the socioeconomic context had shifted. Productivity and real earnings growth have stagnated since the financial crisis, putting pressure on pensions savings and the fiscal sustainability of the pensions system. There has been a rise in self-employment and insecure, low-wage work, accompanied by falling rates of pensions saving by the self-employed – a topic on which Bright Blue is set to publish a major report soon.
The decline in home ownership since the financial crisis likewise means that, by 2050, renters are likely to make up around half of all pensioners in poverty, though they will only constitute around a quarter of the total pensioner population.
On the positive side of the ledger, auto-enrolment has been a public policy success that has reversed the trajectory of decline in workplace pension saving. Around nine-in-ten eligible employees are saving into a workplace pension, up from 55% in 2012. That has meant an increase of around 11 million more pension savers. Opt-out rates have stayed below 11%, far lower than the 30% predicted – demonstrating the power of inertia. The latest data suggests that median earners are achieving 50% of their pre-retirement earnings when they retire.
Yet one-third of eligible private sector employees have contributions that only follow auto-enrolment minima – currently 8% of earnings between a lower threshold of £6,240 and a ceiling of £50,270 – and this rises to half of the lowest-paid eligible employees. The relative value of the lower and upper thresholds has also drifted significantly over time.
In particular, many people are not reaping the full benefit from compound investment returns on the value of their pensions. Our interim report shows that compound investment returns can be worth up to two-thirds of the final value of a pension pot. Put simply, every £1 you save into a pension can provide over £4 in retirement income, even after taxes, charges and inflation are considered.
Low minimum contributions are not the only challenge we face in this area. Alarmingly, around 18 million people (45% of the working age population) are not currently saving into a pension at all, despite nearly half of them being in work. Some ethnic minorities, too, have significantly lower pension participation, as do carers, women, the self-employed and lower earners. One of the main tasks of the second Pensions Commission is to ensure that the auto-enrolment framework works to bring as many people as can afford to save for their retirement into workplace pension saving, and at rates that will ensure adequate incomes in retirement.
That, of course, will not work for the self-employed, who lack the convenient mechanism of an employer and monthly payroll from which to trigger default pension contributions. Self-employed pension saving has decreased from 50% in the 1990s to less than 20% today, and for the self-employed whose sole source of income is their self-employed work, rates of pension saving are as low as 4% – and for the younger self-employed it is lower still. Ensuring the self-employed have access to a viable and affordable mechanism for pension saving is a major challenge facing our Commission.
Another key development since the 2000s is in how pensions are accessed. This has become significantly more complicated since the first Pensions Commission, when the assumption was that defined contribution pots would generally be used to buy annuities to deliver a regular pension income for life. But, the 2014 pension access reforms leading to the introduction of Pension Freedoms in 2015 changed the settlement of what a pension pot is for. This gave UK retirees far greater pension flexibility than their peers in most countries, but also far greater responsibility for managing pension wealth and the range of risks this involves. Since these changes, we have seen high levels of full cash withdrawals that risk running down savers’ pension wealth too quickly.
As defined contribution pension wealth becomes increasingly important, so too do the challenge and impacts of making decumulation decisions while retaining the advantages of flexibility. As with the principles underlying auto-enrolment, the pensions system needs to work in the interests of savers as they enter retirement and protect those who do not, or cannot, engage. Decumulation cannot always require detailed financial knowledge or expensive advice, yet must be robust to potential cognitive decline in later retirement.
Alongside the FCA’s introduction of ‘Targeted Support’ and the expansion of collective defined contribution schemes, the Government is introducing ‘Guided Retirement’ through the Pension Schemes Act 2026. This offers opportunities to help address decumulation challenges if framed and delivered effectively but must, as far as possible, represent a true default for pension savers.
The UK needs a renewed pensions settlement, one that delivers an adequate, fair and sustainable pension system, protects the most vulnerable, bolsters and incentivises private saving and ultimately ensures that today’s workers can look forward to financial security in their later years. My fellow commissioners and I are committed to delivering on this mandate. In early 2027 we will present our recommendations to government to build a stronger, fairer and more sustainable pension system that is truly fit for the 2050s and beyond.
This article was originally published on the Centre Write website. Read the original article.
All articles posted on this blog give the views of the author(s), and not the position of the IPR, nor of the University of Bath.
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