IFS

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

Richard Disney

Carl Emmerson

BA festival of science, 7th September 2004

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

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

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

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.”

Projected state spending (1)

6.9%6.8%6.9%

6.1%6.4%

6.1%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

2003

/04

2013

/14

2023

/24

2033

/34

2043

/44

2053

/54

Per

cent

age

of n

atio

nal i

ncom

e

Source: Department for Work and Pensions

Projected state spending (2)

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

2003

/04

2013

/14

2023

/24

2033

/34

2043

/44

2053

/54

Per

cent

age

of n

atio

nal i

ncom

e

Housing-related benefits

Pension Credit

Attendance Allowance andDisability Living Allowance

Other Pension Benefits

State Second Pension / StateEarnings-Related Pension

Basic State Pension

Source: Department for Work and Pensions

Modelling future entitlements (1)

• 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

Four example individuals:

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

£0

£2,000

£4,000

£6,000

£8,000

£10,000

£12,000

£14,000

£16,000

16 20 25 30 35 40 45 50 55 60 64Age

£ p

er

yea

r, 2

00

4 p

rice

s

Men

Women

Source: Family Expenditure Survey

Earnings profile

Median earnings among those born in 1921 to 1925

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

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

State income – person 1

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

Year reaches age 65

% o

f ea

rnin

gs a

t ag

e 50

Pension CreditSERPS / S2PBasic State Pension

Estimated state income at age 65, by year reaches age 65

Impact of reforms – person 1

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

50.0%

Year reaches age 65

% o

f ea

rnin

gs

at a

ge

50

SERPS - 1975 ActSERPS - 1986 ActSERPS - 1995 ActS2P - 2000 Act

Estimated state income at age 65, by year reaches age 65

State income – person 2

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

Year reaches age 65

% o

f ea

rnin

gs a

t ag

e 50

Pension CreditSERPS / S2PBasic State Pension

Estimated state income at age 65, by year reaches age 65

State income – person 3

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

Year reaches age 65

% o

f ea

rnin

gs a

t ag

e 50

Pension CreditSERPS / S2PBasic State Pension

Estimated state income at age 65, by year reaches age 65

State income – person 4

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

Year reaches age 65

% o

f ea

rnin

gs a

t ag

e 50

Pension CreditSERPS / S2PBasic State Pension

Estimated state income at age 65, by year reaches age 65

Impact of reforms – person 4

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

50.0%

Year reaches age 65

% o

f ea

rnin

gs a

t ag

e 50

SERPS - 1975 ActSERPS - 1986 ActSERPS - 1995 ActS2P - 2000 Act

Estimated state income at age 65, by year reaches age 65

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?

Pension credit reform

£0

£50

£100

£150

£200

£0 £25 £50 £75 £100 £125 £150 £175Income other than means-tested benefits

Fin

al i

nco

me

Original non-means tested income

Final income with MIG

Final income after Pension Credit reform

Basic State Pension

Current eligibility for benefits

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

90.0

100.0

60-64 65-74 75+ 60-64 65-74 75+ 60-64 65-74 75+

Per

cent

age

elig

ible

for

mea

ns-t

este

d be

nefit

s

After Pension Credit reform

Before Pension Credit reform

Single men Single women Couples

Note: Age corresponds to the oldest member of a couple

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

How might the system evolve?

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

Financial year

% o

f m

ea

n f

ull

time

ma

le e

arn

ing

s

Pension Credit GuaranteeBasic State PensionTotal income required for no PC at state pension ageTotal income required for no PC, 15 years after state pension age

Pension credit and incentives

£0

£50

£100

£150

£200

£60 £80 £100 £120 £140 £160Income other than means-tested benefits

Fin

al i

nco

me

Final income with MIG

Final income after Pension Credit reform

B C

Ambiguous Reduced?

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

Future eligibility for benefits?

45.8 45.8 45.8 45.845.8 46.8

63.6

13.5

45.8 45.8

71.1

3.8

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

90.0

100.0

BSP = earnings, PC = earnings

BSP = prices, PC = prices

BSP = prices, PC = earnings

BSP = earnings, PC = prices

Pe

rce

nta

ge

elig

ible

fo

r th

e P

en

sio

n C

red

it

2004-05 2025-26 2050-51

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

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

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

IFS

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

Richard Disney

Carl Emmerson

BA festival of science, 7th September 2004