UK public pension reform: what effect on the finances of pensioners?

1. UK public pension reform: what effect on the finances of pensioners? Richard Disney Carl Emmerson BA festival of science, 7th September 2004

2. Introduction • Frequent and substantial pension reform over last 30 years • These reforms affect future pensioners • Circumstances of today’s pensioners likely to be a poor guide to the future

3. Main findings • On average state retirement income set to become less generous • As a result of reforms since 1997 this is not true of those with lifetime lower earnings • Increasing role of income-tested support likely to reduce private saving for retirement

4. Key UK pension reforms • Flat rate element: • Basic State Pension introduced in 1948 • Earnings-related element: • SERPS introduced (1975 legislation) • subsequently cut (1986 and 1995 legislation) • replaced by State Second Pension (2000 legislation) • Income-tested element • much more generous since April 1999 • set to be relatively more generous in the future

5. 1998 Green Paper “[the minimum income guarantee] will be increased year by year as resources allow. Over the longer term our aim is that it should rise in line with earnings so that all pensioners can share in the rising prosperity of the nation” “anyone who works throughout their working life (including spells as a carer or off work through long-term illness or disability) will receive a total state pension above the rate of the minimum income guarantee.”

6. Projected state spending (1) Source: Department for Work and Pensions

7. Projected state spending (2) Source: Department for Work and Pensions

8. never married man median male earnings full contribution history never married women median female earnings full contribution history never married man median male earnings leaving the labour market at age 60 never married women median female earnings out of labour market 26 to 40 (inclusive) leaves the labour market at age 60 Modelling future entitlements (1) Four example individuals:

9. Modelling future entitlements (2) • Flat rate element: • Assume full entitlement to the basic state pension • Earnings-related element • Assume not contracted-out of SERPS / S2P • Earnings profile taken from those born 1921–1925

10. Earnings profile Median earnings among those born in 1921 to 1925 Source: Family Expenditure Survey

11. Modelling future entitlements (2) • Flat rate element: • Assume full entitlement to the basic state pension • Earnings-related element • Assume not contracted-out of SERPS / S2P • Earnings profile taken from those born 1921–1925 • 2% a year real earnings growth assumed • Income-tested element • Modelled under (extreme) assumption of no private retirement income

12. Findings • Structural reforms to the system cause • large (non-linear) changes over time • long time lag before reforms have full impact • Differential indexation of different components of the system also important

13. State income – person 1 Estimated state income at age 65, by year reaches age 65

14. Impact of reforms – person 1 Estimated state income at age 65, by year reaches age 65

15. State income – person 2 Estimated state income at age 65, by year reaches age 65

16. State income – person 3 Estimated state income at age 65, by year reaches age 65

17. State income – person 4 Estimated state income at age 65, by year reaches age 65

18. Impact of reforms – person 4 Estimated state income at age 65, by year reaches age 65

19. Income-related benefits • Higher entitlement in future among our example individuals at age 65 • What impact might this have on incentives to work or save? • How might coverage of income-related benefits change over time?

20. Basic State Pension Pension credit reform

21. Current eligibility for benefits Note: Age corresponds to the oldest member of a couple

22. Pension credit and incentives • Increased eligibility among today’s pensioners • increased support for lower income pensioners • increased reward for having saved • little disincentive to work or save • But for today’s working age population it is expectations of the future that matter

23. How might the system evolve?

24. B C Pension credit and incentives Ambiguous Reduced?

25. Future eligibility for benefits • Generosity of system • uprating of Pension Credit • future rents for Housing Benefit • local tax bills for Council Tax Benefit • Other retirement income • generosity of state pensions • individual saving decisions

26. Future eligibility for benefits?

27. Comparison with Canada • Flat rate component (OAS) • oldest part of system • indexed to prices • Income-related component (GIS) • introduced in 1967 • withdrawn at 50% on income above OAS • now indexed to prices • Earnings-related component (CPP/QPP) • introduced in 1976 – time lag on reaching maturity • indexed to prices

28. Comparison with Australia • Income-related component • introduced in 1909 • 25% of male average earnings • withdrawn at 50% above threshold • Mandatory private saving • introduced in 1992 • 9% contribution rate • No mandatory annuitisation • eligibility for full income-tested component very high

29. Conclusions • We show how current (and past) reforms will affect future pensioners, and future eligibility for income-related benefits • State retirement income has peaked for those on median male earnings • But, projected path of income-related benefits will increase state retirement income of those on lower earnings • Despite lower withdrawal rate on income-related benefits, reduced incentive for many to save privately for retirement

30. UK public pension reform: what effect on the finances of pensioners? Richard Disney Carl Emmerson BA festival of science, 7th September 2004