Ready for Ageing? - Select Committee on Public Service and Demographic Change Contents

Annex 8: Pensions and savings (see paragraphs 8 and 12 to 15 of the report)

Reforming pensions and savings

160.  The resources that older people use to sustain themselves after they cease earning come from the state (about half)[203], individuals' savings (largely in private pensions), and other income. As the average lifespan has grown, the proportion of life spent in retirement has grown with it.[204] But in future it will not be realistic or desirable to expect the state—and younger taxpayers in particular—to pay for this (see Annex 7). We agree with the Turner Commission) that people will need to choose whether to work for longer, save more, or have a lower income in retirement.[205] They will need to make informed decisions to do so.

161.  Our society will have to make difficult decisions about pensions and savings. There is already a major problem with individuals not saving enough for retirement, which demographic change will exacerbate.[206] Indeed, recent research suggests that UK residents are the "worst in the world" at saving for retirement.[207] Longer lives mean that many people are at risk of having insufficient income to pay for older age. Many people underestimate how long they will live and misunderstand what they will have to pay for, and so do not feel motivated to save (see Annex 6).[208] Where people do appreciate the need to save for later life, they are often bewildered by the complexity of the products available.[209]

162.  The Government might consider developing a resource that will help people understand how much they need to save for older age, and the risks and benefits associated with investing in pensions and other savings vehicles. We were informed that in Finland a central Pensions Institute provides government and individuals with regular comprehensive information about pension trends and likely pension benefits; the US Department of Labor provides a 'Top 10 Ways to Prepare for Retirement' webpage.[210]

163.  The Government are moving to incorporate the existing earnings-related state pension scheme into the new single-tier pension and are not seeking to make membership of private schemes compulsory. Instead, they plan to incentivise individuals to join a regulated pattern of private schemes. We welcome the progress in pension reform that the Government have made, but consider that without urgent additional action to encourage saving more for retirement, demographic change will cause significant problems for many people's level of income in later life.[211] According to OBR projections cited by the Confederation of British Industry (CBI), pensions expenditure will rise from 5.7% of GDP in 2011-12 to 8.2% of GDP in 2060-61.[212]

Pension problems

164.  Our pensions system is beset by major problems, many of which were identified by the Turner Commission[213]:

·  Defined contribution (DC) pensions now dominate private pension provision. Since the Commission reported, the proportion of people with defined benefit (DB) pension schemes has continued to fall, and "by and large the private sector has become a DB desert".[214] Recent figures from the National Association of Pension Funds (NAPF) announced that 13% of final salary pensions were open to new joiners in 2012, a drop of a third from 2011, and the steepest fall since comparable data began in 2005, when 43% were open.[215] While the defined benefit pensions system has proved to be unsustainable, we consider that for many savers defined contribution pensions are seriously inadequate. They shift longevity and investment risks from employers to employees, who are the least able to bear those risks (see Annex 6).[216] The link between the sacrifices that a person makes in order to put money into a pension scheme, and the rewards from their saving that they can look forward to receiving when they retire, effectively has been broken.[217] Savers cannot know the scale of pension that they might end up with in a DC plan, and many employees are ill-equipped to understand or bear the risks that accompany this uncertainty.[218] When even a sizeable pension pot might buy only a small pension, it is less likely that people will feel that it is worth the sacrifice to pay into it. The big shift to DC pensions therefore carries risks and uncertainties largely unappreciated by the public, and sharply differentiates those who are able to look forward to the outputs of DB schemes from those who are not.

·  Although our society has done better than some other countries at providing a safety net to keep older people out of poverty, the uncertainty over future pension income from DC schemes means that many of those on middle and lower incomes have uncertain or inadequate incentives to save.[219] For these and other reasons, the Government have estimated that 10.7 million people in Great Britain (excluding Northern Ireland) can expect inadequate retirement incomes.[220]

·  People who are still in DB schemes (mostly public sector workers), and high earners who can use savings vehicles for defined contribution schemes, are likely to be reasonably well-served by the current system.[221] But while public sector DB pensions offer certainty to savers, they shunt substantial costs to later taxpayers.[222] It is likely that both public and private sector DB pensions in the future will pay out less than they have in the past.[223]

·  The current pensions framework also creates gender-based disadvantages. Women who have fluctuating work records due to maternity and childcare responsibilities, and those who have periods as carers of children or elderly people (of which a disproportionate amount are women) stand to do worse than men in the new defined contribution world. In particular, women face disadvantages in the annuities market.[224]

165.  The result of this framework and the incentives that it engrains is that replacement rates in older age—the percentage of a worker's pre-retirement income that is paid out by a pension programme upon retirement—are lower in the UK than in most other advanced economies.[225]

Policy responses

166.  For many years the basic state pension was allowed to fall in relation to median incomes, though topped up for a while by the state second pension. Then DB schemes went into decline and, as the Turner Commission pointed out, most people had to rely on means-tested state support in retirement.[226] The Commission's report stimulated a period of reform under different governments, with cross-party support. Later retirement, the first part of the implicit bargain that the Commission proposed, is now being implemented.[227] The Government are taking positive steps in pension reform, and when complete, the current reforms to the pensions system will represent progress, which the Committee welcomes. State pensions will be linked to earnings (at a minimum), preventing further erosion; the National Employment Savings Trust (NEST) and auto-enrolment have now been established, extending private pension coverage to many who were not covered previously; and the single-tier state pension, which will rationalise state provision and make it more generous for those with intermittent employment histories, is under consultation.[228]

167.  With auto-enrolment, the Government are attempting to incentivise people to take out DC pensions by requiring employers to offer and automatically enrol employees in a scheme, to which the Government then contributes. NEST provides a default for employees if they decide not to save with one of the other schemes on offer. The flat-rate state pension seeks to replace means-testing for certain state pension entitlements with a single state pension for all recipients.[229] Joanne Segars, Chief Executive of the National Association of Pension Funds (NAPF), told us that this reform would give people "a very clear indication of how much they will get and how much they need to save on top of that. Importantly, it means their private savings will not be means tested away, which currently does act as a disincentive".[230]

168.  The Government also intend to introduce cost-stabilisers for public sector DB pensions[231], and have begun to reform rules on the requirement to annuitise pensions.[232] This means that the state will now have more understanding of the risk to which taxpayers are exposed in paying for public sector pensions, and DC pension investors will have a better understanding of their final settlement.

169.  But further action will be required. The most recent pensions White Paper departed from the Turner Commission recommendations in laying out how the new full state pension age would not be linked automatically to increases in life expectancy: the Government told us that this is because the rate at which life expectancy is increasing has accelerated.[233] We consider that, due to rising healthy life expectancy, it will only be a matter of time before the Government will have to revisit this decision.

170.  Moreover, it is not yet clear whether auto-enrolment will ensure pension coverage for employees who currently do not have pensions. The likely take-up and drop-out rates under this scheme are uncertain.[234] Even if take-up is high, it does not follow that the resulting pension income will be sufficient for all participants.[235] We consider that although it would be a major advance if those paying into pension schemes (employers, employees and tax relief) eventually contribute 8% of earnings into auto-enrolment schemes, as the Government have proposed, this will not represent enough for a decent pension income, even on top of the Government's newly suggested flat-rate pension.[236] Since the Turner Commission recommended a combined default contribution rate of 8%, life expectancy has risen and is very likely to rise further (see Annex 2). Moreover, returns on savings and annuities have fallen. Well-managed defined benefit schemes that offer half pay or better on retirement usually require much higher rates of contribution (on average, 20% to 25%), whereas DC contribution rates tend to be, on average, between 5% and 15%.[237] People may also need to assume that they will have some periods of interrupted earnings with no or low pension contributions because of caring responsibilities and uncertainty in the job market. In the not too distant future, therefore, the 8% default rate will need to be reassessed. Though Joanne Segars welcomed auto-enrolment because it will give six to nine million people—many of them women, low-paid workers and part-time workers who have been excluded from pensions in the past—the opportunity to save in a pension for the first time with an employer contribution, she outlined how individuals also needed a "decent foundation for that private saving" in the form of a flat-rate state pension.[238] Professor Hills considered that the flat-rate state pension and auto-enrolment would help with offsetting the recent decline in pension accumulation, but they would "get only part of the way to what people would regard as being an adequate income in later life".[239]

171.  The capacity of individuals to access additional sources of income is restricted if they are "old, disabled and poor".[240] In general, people have varying opportunities to build on the platform that the Turner Commission proposed by working in later life. Those with caring responsibilities (often women), as well as people with interrupted job histories, may find it very difficult either to retire later or to supplement their retirement by doing extra work (see Annex 5).[241] Public policy responses to encourage older people to save should therefore focus more strongly on these groups. Furthermore, pensions should not be considered in a vacuum. Wider policy choices include the provision of more employment opportunities, support for independent living, and flexible retirement. At present, the Government do not seem to be paying sufficient attention to these important policy areas (see Annex 5).

172.  The Committee concludes that despite significant progress, the current system of state and private pension provision is still not adequate for a large proportion of the future elderly population. Many people, young and old, expect far more than they will get: society is behind where it needs to be.[242] The savings crisis for older age is exacerbated by a lack of clarity about what DC pensions will deliver, and concerningly weak pensions for many women and for many on middle and lower incomes. While the poorest will be protected at a basic level by state provision, and the richest can afford to save enough in private schemes, there is a substantial gap for much of the rest of the population. While progress is being made on state pensions, we conclude that the current DC pensions system is not fit for purpose for anyone who is not rich, or who moves in and out of work due to bad health or the need to care for others.

Policy proposals

173.  The Government should review how to strengthen incentives for saving.

174.  The Government should persist with the implementation of reforms set out by the Turner Commission. State pension reform must continue, ensuring the provision of a decent basic pension, although there will need to be further work on finding cross-party agreement on the basis for determining what a decent minimum level should be. The Government should continue to support auto-enrolment. But implementing the Turner Commission proposals alone will not be enough—as the Turner Commission report made clear. Many of the assumptions made in the report, for example those on expected longevity, have already changed (see Annex 2).[243]

175.  Because of the cost to future taxpayers of public sector DB schemes, the Government must keep the Independent Public Service Pensions Commission reforms under review. This would enable the Government to track longevity changes, and assess if over time public sector pensions are fair and sustainable.

176.  We urge the pensions industry, employers and the Government to tackle the lack of certainty in DC pensions and address their serious defects, and to work together to re-design DC schemes to create better options so that people are clearer about how much they can expect to get from their pension as a result of the savings that they make. The pensions industry needs quickly to find ways of improving the outcomes from DC schemes. The industry should more effectively align retirement income expectations with actual outcomes from DC plans, and seek better to manage the risk that these income goals are not realised. The industry needs to think more creatively about the basic architecture of DC schemes to avoid the risk that auto-enrolment fails to produce a greater take-up of retirement income planning. This is the whole point of auto-enrolment; we suggest that the inadequate performance of DC schemes to date poses the greatest risk to our savings culture and the move towards re-invigorating pensions saving.

177.  The Committee welcomes the Government's recent proposal to consider a 'defined ambition' pensions regime which would "seek to give greater certainty for members than a DC pension about the final value of their pension pot and less cost volatility for employers than a DB pension".[244] Through such proposals, the Government are moving away from a focus on reforming DB pensions towards a more pressing issue for many taxpayers—how to make the DC market work. We consider that the 'defined ambition' proposal represents a positive step forward. More active Government intervention in this market is likely to be necessary to secure better outcomes for savers. Unless such an innovation comes about, there is a risk of fundamental and permanent damage to NEST and the settlement laid out by the Turner Commission. We urge the Government to make their plans concrete as soon as possible.

178.  Unless these actions are taken, incentives for saving will continue to be inadequate. People cannot adapt their life plans unless the Government help to make pensions and savings choices and their implications much clearer.

179.  Given present longevity trends, the Government need to do much more to communicate to the public the importance of planning for an adequate income in older age.

180.  People need to consider using a variety of sources of funds and ways of saving for later life.[245] More people working for longer will be part of the solution (see Annex 5), as will be unlocking the value in our homes. Many older people have seen the value of their homes increase considerably, but have not seen this rise as offering even a partial solution to the challenges of paying for longer life, or have been unable to gain easy access to the increased value (see Annex 7). The Government should make it easier for people to use a variety of routes to save for their retirement, including equity build-up and release.

203   Pensions: Challenges and Choices - The First Report of the Pensions Commission, 2004, figure 4.1. Back

204   A New Pension Settlement for the Twenty-First Century: The Second Report of the Pensions Commission, November 2005, p.96. Back

205   A New Pension Settlement for the Twenty-First Century: The Second Report of the Pensions Commission, November 2005. Back

206   Central Government (DoH, DWP and DCLG), written evidence: "current estimates suggest that 11 million people are not saving enough into a pension to meet their expectations of pension income in retirement". Back

207   HSBC, The Future of Retirement: A new reality, 2013. Back

208   Ipsos MORI. See also Dr Joan Costa-Font, LSE; Q 592; Home Instead Senior Care. Back

209   Dr Joan Costa-Font, LSE. Back

210 Back

211   Central Government (DoH, DWP and DCLG), written evidence. Back

212   CBI. Back

213   A New Pension Settlement for the Twenty-First Century: The Second Report of the Pensions Commission, November 2005. Back

214   A New Pension Settlement for the Twenty-First Century: The Second Report of the Pensions Commission, November 2005, p.122; Q 603 (Rt Hon Lord Warner, Commissioner, Commission on Funding of Care and Support, Dilnot Commission). Back

215   NAPF, Final salary pensions shut at record rate in private sector, 28 January 2013. Back

216   Age UK. Back

217   Q 585 Back

218   Q 465; Q 466 (Dr Ros Altmann). Back

219   OECD, Pensions at a glance 2011: retirement-income systems in OECD and G20 Countries, 2011, p.149; Q 465; Q 471; QQ 482-483 (Dr Altmann); QQ 466-467 (Joanne Segars, Chief Executive, National Association of Pension Funds (NAPF)). Back

220   Department for Work and Pensions (DWP), Estimates of the number of people facing inadequate retirement incomes, July 2012.  Back

221   See Andrew Warwick-Thompson, High earners new models, Pensions World, March 2010. Back

222   Q 602 (Paul Johnson). Back

223   Q 545 Back

224   Professor Noel Whiteside, University of Warwick. Back

225   Department for Work and Pensions, Older people and employment. Back

226   IFS briefing note 105, The history of state pensions in the UK from 1948 to 2010, A Bozio, R Crawford and G. Tetlow, Institute for Fiscal Studies, 2010, figure 7.1. Pensions: Challenges and Choices - The First Report of the Pensions Commission, 2004, figure 4.1. Back

227   Department for Work and Pensions, Older people and employment.  Back

228   Central Government (DoH, DWP and DCLG), written evidence. Back

229   DWP White Paper: The single-tier pension: a simple foundation for saving, January 2012 Back

230   Q 468 Back

231   Public Service Pensions Bill, introduced 13 September 2012.  Back

232   The Government announced in their June 2010 Budget that the requirement to purchase an annuity by age 75 would end from April 2011. Back

233   DWP, The single-tier pension: a simple foundation for saving, Cm 8528, January 2013, p.66; Central Government (DoH, DWP and DCLG), written evidence. Back

234   Q 466 (Professor Whiteside); Q 472 (Joanne Segars); Central Government (DoH, DWP and DCLG), written evidence. Back

235   Q 464 (Joanne Segars); Q465 (Dr Altmann).  Back

236   Q 685: Steve Webb MP, Minister of State for Pensions, outlined how auto-enrolment should mean a minimum 8%savings rate for employees paying into their pensions, "The minimum contribution for the employee will end up at 4 per cent, but it turns into 8 per cent overnight with the mandatory employer contribution plus tax relief ... I accept that 8 per cent is volatile and unpredictable and you do not know what pension it will buy you, but you have a damn good start if your four has become eight".  Back

237   DWP, Defined Contribution Pension Provision, Research Report No. 608, C. Dobson and S. Horsfield, 2009, see figure 5.3. A very crude 'rule of thumb' is that individuals should save at a rate of half their age-i.e. a 44 year old should save 22% of gross income including tax relief, employers' contributions etc. See also Back

238   Q 466 Back

239   Q 545 Back

240   Q 472 Back

241   Professor Noel Whiteside; Q 538. Back

242   Central Government (DoH, DWP and DCLG), written evidence. Back

243   Central Government (DoH, DWP and DCLG), written evidence. Back

244   DWP, Reinvigorating workplace pensions, Cm 8478, November 2012, p.4; Q 685. Back

245   Q 464 (Dr Altmann); Q 210-211, Q 212; Q 478 (Richard Humphries); Equity Release Council; McCarthy & Stone. Back

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