pension reform in the uk - university of...

Alison O’ConnellPensions Policy InstituteRetirement Commission, Wellington2 February 2006

PPIPENSIONS POLICY INSTITUTE

www.pensionspolicyinstitute.org.uk

Pension reform in the UK

http://www.pensionspolicyinstitute.org.uk/



• Why is reform needed?• What reforms are being

considered?• Some key points that may be

relevant to New Zealand


The backdrop

•People are living longer•The state pension is declining•Savings are flat

“If nothing else changes, tomorrow’s pensioners will be relatively poorer, on average, than today’s pensioners”


The structural arguments for reform

1. Complexity2. Unequal outcomes3. Too high expectations of

saving4. State pensions unsustainable


The UK pension systemTier 1State

Tier 2State

UnfundedContributory

or (different) credits

Compulsory for most

employees

Tier 3Private, tax incentivised

FundedContributory

Voluntary

BSP: Basic State

PensionS2P: State

Second Pension Previously

SERPS

Occupational and personal

pensions

Pension Credit = Guarantee Credit + Savings Credit

StateMeans-tested

Contracting-out


or credits

Compulsory for most workers


Complexity of state pensions means uncertainty in future benefit

• Over 100 parameters define an individual’s future state pension income

• Over a lifetime, parameters may change:• Individual circumstances • Government policy• Annual Budget decisions

PPIPENSIONS POLICY INSTITUTEMore older people

will be means tested

63%46%

64% 71%82%

40%

Today 2025 2050

IFS estimate PPI estimate

Estimated proportion of older people eligible for Pension Credit

Pension Credit take up:50% - 80%

PPIPENSIONS POLICY INSTITUTERetirement income

varies greatlyPre-tax income of single pensionersby quintile2003/4, £ per week

Bottomfifth

Next fifth Middlefifth

Next fifth Top fifth

£102£145

£175£217

£405

State pension & benefits

Occupational pension

InvestmentsEarnings

Personal pensionOther

PPIPENSIONS POLICY INSTITUTEMany reasons for

unequal outcomes

State pension & benefits

BSP & S2P: gaps and unequal entitlement for women and carersLegacy of SERPS: higher pensions for higher earnersSome benefits not taken upMore £s saved and more tax relief per £55% of tax relief goes to 2.5m higher rate taxpayers

Occupational & personal pension

PPIPENSIONS POLICY INSTITUTEWhy is private

pensions saving not growing?• Some employers limiting expenditure on

employee pensions; increasing regulation cited as an influence

• Means-tested state benefits a barrier to selling and buying pensions

• High living costs, especially at young ages• Low trust in pension products• Low interest in savings and pensions;

people prefer to spend money now


0%1%2%3%4%5%6%7%8%9%

2010 2020 2030 2040 205002468101214161820

State spend on pensions planned not to keep pace with pensioner population

People over state pension age, RHS, millions

Cost of state pension system, LHS, % GDP (as at November 2005)


UK’s spending on state

0%

5%

10%

15%

Aus US NZ Spain Sweden UK

2005

2050

Illustrative government spending on state pensions as a percentage of GDP, as at November 2005

pensions looked out of line


The UK pension systemTier 1State

Tier 2State


or (different) credits

Compulsory for most

employees


FundedContributory

Voluntary

BSP: Basic State

PensionS2P: State

Second Pension Previously

SERPS


pensions


StateMeans-tested

Contracting-out


or credits

Compulsory for most workers

PPIPENSIONS POLICY INSTITUTEThe shape of the

consensus solutionTier 1State


FundedContributory

VoluntaryBSP: Basic

State Pension


pensions

StateMeans-tested Smaller

Bigger and wider

PPIPENSIONS POLICY INSTITUTEThe Pensions

Commission’s options for reform1. Unify BSP and S2P into a

flat-rate Citizen’s Pension: immediately or by 2045

2. Let the gradual flattening of S2P play out to 2055

3. Accelerate the gradual flattening of S2P to 2030

Pension Commission’s preferred approach

PPIPENSIONS POLICY INSTITUTEThe Pensions Commission

preferred approachTier 1State

Tier 2State

UnfundedContributory or (revised) creditsCompulsory for most employees

and self employed


FundedContributory

Voluntary

BSP: Basic State Pension

S2P: State Second Pension


pensions


StateMeans-tested

DB only

UnfundedFuture accruals: residency-basedUniversal over

age 75Compulsory for

most workers

Tier 2½State/Private partnership

FundedContributory

Compulsory for employer if

employee does not opt out

NPSS: National Pension Savings Scheme


Hutton’s 5 key tests of pension reform1. Affordable? ...long-term stability of public finances…

2. Fair? ...never again see pension poverty...fair to women and carers, correcting past inequalities…fair to those who have saved…

3. Promotes personal responsibility?...welfare state provides a floor…but its primary role must be to enable people to provide for themselves…

4. Simple? …people need to know what Government will do for them…

5. Sustainable? ...people can make decisions about their retirement planning with confidence that it won’t be pulled apart by successive Governments fiddling with the system…

PPIPENSIONS POLICY INSTITUTEHow does the Pensions

Commission’s preferred approach measure up?1. Affordable? Probably…but need for

increase in spending not fully appreciated

2. Fair? Better but not as good as it could be?

3. Promotes personal responsibility? To some extent, as means-testing restrained, but NPSS too prescriptive?

4. Simple? No

5. Sustainable? Unlikely


Some key points for NZ

1. NZS is a world-class model2. Is KiwiSaver a better design for

the UK than NPSS?3. Expenditure on state pensions has

to increase as the population ages4. Working at later ages has to be a

key part of policy


KiwiSaver vs. NPSS (1)

NPSS KiwiSaverScope Auto-enrol employees,

employer must contribute if employee stays in

Auto-enrol new job starters

Contri-butions

As a % of pre-tax earnings between £4,888 to £32,760:4% employee 3% employer1% tax relief

4% of all earnings, employee only, plus $1,000 one-off incentive


KiwiSaver vs. NPSS (2)

NPSS KiwiSaverInvest-ment

6-10 funds0.5% AUM max chargeOne lifestyle default fundOther funds allowed

Few default providersFee subsidy from GovernmentOther providers allowed

Benefit Available at age 65 only; have to annuitiseor drawdown by age 75

Early withdrawal available and partial withdrawal allowed for (incentivised) first house purchase


KiwiSaver vs. NPSSNPSS KiwiSaver

Policy aim

It is a reasonable aim of public policy to seek to ensure that the median earner achieves an income replacement rate [in retirement] of at least 45%.Pensions Commission

…help New Zealanders to save, giving them greater security and choice and strengthening the economy.

Minister of Finance


0%1%2%3%4%5%6%7%8%9%

2010 2020 2030 2040 205002468101214161820

Planned state spend on pensions has increasedDecember 2005 revision

People over state pension age, RHS, millions

Cost of state pension system, LHS, % GDP

Previous plans

PPIPENSIONS POLICY INSTITUTEThe impact of the

Commission’s proposals

4.8%2.6%

1.6%

0.6%

Newsaving in

NPSS

Improvedstate

pensions

Laterretirement

Total

Increase in the percentage of GDP transferred to people aged above SPA, due to each element of reform proposal by 2050


Further information


Pension reform in the UK: Timeline• 1998: Government adopts “40:60” state:private policy, proposes

stakeholder pensions, S2P and Pension Credit

• To 2005: Concern grows among pensions stakeholders about statepensions…consensus on the objective of reform and shape of the solution emerges, but important differences in how to get there (see PPI publications)

• End 2002: Government tasks Pension Commission to look at the future of long-term private savings (compulsory?)

• 2003/4: Legislation for new Pension Regulator and Pensions Protection Fund developed

• October 2004: Analysis in Pensions Commission First Report confirms stakeholder concerns

• February 2005: Government commits to reform of state pensions• November 2005: Pensions Commission Second Report with 3

options for reform• Spring 2006: Government proposals expected in White Paper

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