Pension policy – where have we been, where are we going? · – We can model incomes really quite well that far ahead given what we know about pensions, health, working patterns

© Institute for Fiscal Studies

Pension policy – where have we been, where are we going? Paul Johnson


Introduction

• People living longer and incomes in retirement rising

– Incomes higher than non-pensioners on average

– Next decade likely to see continued rise in pensioner incomes

• Longer term future looks less certain

– Lower state pensions

– Collapse of private sector DB schemes

– Falling home ownership

• Policy on state pensions looks stable

– Subject to sorting out the triple lock

• We have got ourselves into a difficult place on private pensions

– No risk sharing

– Tax treatment

Good news

• Life expectancy has been rising

– unexpectedly


Rapid, unexpected change in life expectancy Predicted life expectancy at birth


65

67

69

71

73

75

77

79

81

83 19

71

1974

19

77

1980

19

83

1986

19

89

1992

19

95

1998

20

01

2004

20

07

2010

20

13

2016

20

19

Pro

ject

ed li

fe e

xpec

tanc

y

1971



65

67

69

71

73

75

77

79

81

83 19

71

1974

19

77

1980

19

83

1986

19

89

1992

19

95

1998

20

01

2004

20

07

2010

20

13

2016

20

19

Pro

ject

ed li

fe e

xpec

tanc

y

1979

1975

1971



65

67

69

71

73

75

77

79

81

83 19

71

1974

19

77

1980

19

83

1986

19

89

1992

19

95

1998

20

01

2004

20

07

2010

20

13

2016

20

19

Pro

ject

ed li

fe e

xpec

tanc

y 2006

2002

1998

1994

1991

1987

1983

1979

1975

1971

Good news


– Unexpectedly

• Incomes in retirement have been rising fast

– And much more than for working age population


The remarkable catch-up in pensioner incomes


60%

65%

70%

75%

80%

85%

90%

95%

100%

105%

110%

chart shows median after housing costs incomes of pensioner households as % of median for non-pensioners (HBAI income definitions)

Income by age 1978-80 to 2012-13


60%

80%

100%

120%

140%

Perc

enta

ge

of

ove

rall

med

ian

inco

me

(mea

sure

d A

HC

)

Age

1978–80 2007–08 2012–13

Median income by age compared to overall median income (measured AHC)

Source: Figure 3.7b of Living Standards, Poverty and Inequality: 2014 http://www.ifs.org.uk/publications/7274 Notes: Household income is equivalised and measured after housing costs are deducted

http://www.ifs.org.uk/publications/7274


Poverty rates by age


0%

5%

10%

15%

20%

25%

30%

35%

40%

1978-80

Source: Figure 6.3a of Living Standards, Poverty and Inequality: 2013





Poverty rates by age


0%

5%

10%

15%

20%

25%

30%

35%

40%

1978-80 2011-12

Source: Figure 6.3a of Living Standards, Poverty and Inequality: 2013




Pensioners doing better before the recession


-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

0s 10s 20s 30s 40s 50s 60s 70s

2001-02 to 2007-08

Annual real income change by age

...and after


-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

0s 10s 20s 30s 40s 50s 60s 70s

2001-02 to 2007-08

2007-08 to 2013-14

Annual real income change by age

Good news


– Unexpectedly



• Reflecting rising state and private pensions

– And also later retirement and increased earnings


Male employment rates slumped but have been rising for some time


0

10

20

30

40

50

60

70

80

90

100 1

97

4

19

76

19

78

19

80

19

82

19

84

19

86

19

88

19

90

19

92

19

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20

00

20

02

20

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20

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20

10

20

12

20

14

Em

plo

ymen

t ra

te

65-69 (LFS)



0

10

20

30

40

50

60

70

80

90

100 1

97

4

19

76

19

78

19

80

19

82

19

84

19

86

19

88

19

90

19

92

19

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00

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20

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20

14

Em

plo

ymen

t ra

te

60-64 (LFS)

65-69 (LFS)



0

10

20

30

40

50

60

70

80

90

100 1

97

4

19

76

19

78

19

80

19

82

19

84

19

86

19

88

19

90

19

92

19

94

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00

20

02

20

04

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06

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08

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20

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Em

plo

ymen

t ra

te

50-54 (LFS)

55-59 (LFS)

60-64 (LFS)

65-69 (LFS)

Chandler and Tetlow (2014) http://www.ifs.org.uk/publications/7384



Good news


– Unexpectedly



• Reflecting rising state and private pensions

– And also later retirement and increased earnings

• And our projections suggest continued improvements over the next decade

– http://www.ifs.org.uk/publications/7251




Equivalised family income projections: 65+ population


£0

£10,000

£20,000

£30,000

£40,000

£50,000

£60,000

2010 2012 2014 2016 2018 2020 2022

Rea

l fam

ily in

com

e (

£p

a, 2

01

4–1

5 p

rice

s)

Median 10th percentile 90th percentile

Source: Figure 5.1, Emmerson, Heald and Hood (2014) http://www.ifs.org.uk/publications/7251


But are we doing too well?

• One way of thinking about that is to ask how well off people are in retirement relative to during their working life

• Traditionally looked at how much of gross final earnings are replaced by pensions

– This was the basis for much of the Pension Commission’s work

• But is this a good measure?

– Should be interested in net, not gross incomes

– Why just consider pensions and not other wealth?

– And aren’t we interested in incomes compared to average over a working life, not just final earnings?


Replacement of average lifetime earnings

• For couple households born in the 1940s we define:

50-20ageearningsrealdequivaliseAverage65ageatincomerealEstimated ratet Replacemen =

Consider several definitions of income

Taking into account household size

Adjusting for inflation; considering average purchasing power

Source: Table 6.2, Crawford & O’Dea (2014): Retirement sorted? The adequacy and optimality of wealth among the near-retired? http://www.ifs.org.uk/publications/7358



Percentage of couple with:

Total pension income

<=67% replacement 20%








Percentage of couple with:

Total pension income

... plus annuitised non-housing wealth

<=67% replacement 20% 10%







Comparing ‘optimal’ and actual (private) wealth


For the current generation of pensioners

• A remarkable triumph

– Despite longer lives and earlier retirement incomes are higher than they were during working life for most

• Down to a combination of

– Increasing state pensions

– More generous means tested benefits

– Occupational pensions

– House prices


What about the future?

• For the next decade at least things still look quite positive

• Further ahead things may look less rosy

– Earnings have fallen and savings rates were lower


Incomes are dipping


100

200

300

400

500

600

700

800

20 25 30 35 40 45 50 55 60 65 70

Rea

l ho

useh

old

inco

me

(£

per

wee

k, 2

01

1-1

2 p

rice

s)

Age

1940s 1950s 1960s 1970s

Source : Authors’ calculations using FES/EFS/LCF, various years

As are savings rates


-80

-60

-40

-20

0

20

40

60

20 25 30 35 40 45 50 55 60 65 70

Rea

l ho

useh

old

sav

ing

(£

per

wee

k, 2

01

1-1

2 p

rice

s)

Age

1940s 1950s 1960s 1970s

Source : Authors’ calculations using FES/EFS/LCF, various years



– We can model incomes really quite well that far ahead given what we know about pensions, health, working patterns etc



• The state pension is becoming less generous for many

– The single tier is worth less than basic pension plus SERPS/S2P


Male median earner who works continuously up to his state pension age


0%

10%

20%

30%

40%

50%

60%

70%

80%

1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980

Perc

enta

ge

of

age-

50

ear

nin

gs

Year of birth

Basic state pension Single-tier pension

Second-tier pension Excess (single-tier transition)

Source : Authors’ calculations using earnings profiles from FES/EFS/LCF, various years







• The single tier is worth less than basic pension plus SERPS/S2P

– Home ownership rates are declining


Recent cohorts are also less likely to own a home


0%

10%

20%

30%

40%

50%

60%

70%

80%

20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40

Ho

meo

wn

ersh

ip r

ate

(%)

Age

Born 1963–67 Born 1973–77 Born 1983–87







• The single tier is worth less than basic pension plus SERPS/S2P

– Home ownership rates are declining

• The collapse in DB scheme membership outside the public sector is huge

– A double whammy on earnings


Declining private sector DB coverage

0

1

2

3

4

5

6 19

95

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Mill

ions

Closed

Open

© Institute for Fiscal Studies Source: Occupational Pension Scheme Survey.

Active members of private sector defined benefit schemes

Employer contributions to pension funds – in constant prices terms

Source: Office for National Statistics

Pension costs have played a big role in average wages rising less quickly than productivity


http://www.resolutionfoundation.org/wp-content/uploads/2015/09/Productivity-briefing.pdf






To recap...

• The current generation at and near retirement are doing very well

• To some extent at the expense of younger generations

– Who can expect lower retirement incomes

• What about policy?


The recent history of state pensions

• SERPS was introduced in 1978

• Governments have spent the whole period since un-introducing it

– A long and tortuous path given the complexities around contracting out

• Any link between contributions and entitlement has effectively ended

• The single tier is the logical final step

– Very close to a flat rate “citizens’ pension” based on history of residence

– Note that it reduces expected future generosity for almost everyone


Remaining policy issues

• Pension age

– Rising over coming decades

– We know that increasing female SPA is increasing employment • http://www.ifs.org.uk/publications/7323

– Commitment to raise with life expectancy so people live a third of adult life (over 20) in retirement


Legislation to increase pension age


Age Legislated

66 2020

67 2028

68 2046

69

70

71

72

73

74

75



Age Legislated Population variant

central

66 2020 2020

67 2028 2028

68 2046 2036

69 2049

70 2063

71

72

73

74

75



Age Legislated Population variant

central high

66 2020 2020 2020

67 2028 2028 2028

68 2046 2036 2031

69 2049 2034

70 2063 2037

71 2040

72 2045

73 2051

74 2057

75 2064

Remaining policy issues

• Pension age

– Rising over coming decades

– We know that increasing female SPA is increasing employment • http://www.ifs.org.uk/publications/7323

– Commitment to raise with life expectancy so people live a third of adult life (over 20) in retirement

• Level and indexation

– Triple lock adds £15bn to costs by 2050 relative to earnings indexation

– Introduces an element of pure randomness into pension level

– Makes no sense as a policy


Effects of triple lock and pension age on spending


Recent history of private pensions

• Regulation and demise of private sector DB schemes

– This looks irreversible

• Spread of DC

• Introduction of auto-enrolment

– Successful so far (but minimum default contributions very low)

• Ending of compulsory annuitisation

– Effects unknown

• Chaotic changes to tax treatment

– And continual change to tax treatment of other forms of savings


Policy priorities for private pensions

• Risk sharing

– No risk sharing in DC schemes

– None now in retirement without annuitisation

– This CANNOT be optimal

• In my view the overwhelming priority must be to find some way of achieving more risk sharing

– Defined ambition?

• Also to limit the windfall to those with accrued rights

– Move from RPI to CPI indexation

– (note this was easily the biggest change to public service pensions) • http://www.ifs.org.uk/budgets/gb2012/12chap5.pdf


http://www.ifs.org.uk/budgets/gb2012/12chap5.pdf

The formula effect


[http://www.ifs.org.uk/publications/7513]


Urgent need to sort out tax regime

• Annual allowance cut in stages to £40,000 and lifetime allowance cut to £1 million

– Raising c. £5 billion a year

• From April 2016 annual allowance phased down once income exceeds £150,000 reaching just £10,000 when at £210,000

– Introducing very high effective marginal rate

• No attempt to tackle the genuinely generous parts of the system

– The tax free lump sum

– NI treatment

• And now consultation on the whole structure

• This is no way to make policy in an area where stability and certainty matter a lot


What should be done?

• Unambiguous conclusion about what an efficient, neutral tax treatment of pensions should be

– Contributions exempt from tax, returns free of tax, tax paid on withdrawal (EET)


Cost of tax relief

• HMRC says £35 billion =

– Tax relief on contributions, +

– tax relief on investment returns, +

– NI relief on employer contributions, -

– Tax paid on pensions in payment

• “True cost” against an expenditure tax benchmark is closer to £16-17 billion

– £14 billion of NI relief, +

– Cost of tax free lump sum • perhaps £2.5 billion but, bizarrely, not published by HMRC


What should be done?

• Unambiguous conclusion about what an efficient, neutral tax treatment of pensions should be

– Contributions exempt from tax, returns free of tax, tax paid on withdrawal (EET)

• From current situation that means:

– income tax treatment makes sense (other than lump sum)

– NI treatment much too generous

• Treatment at death bizarrely generous and distorting

• Focus of consultation elsewhere entirely

– Move to TEE (unlikely to happen)

– Move to flat rate relief • Which would be redistributive but move away from rational tax system


Policy conclusions

• State pensions

– Stick with single tier but move away from contributory fiction and make dependent on, say, 30 years residence

– Get rid of triple lock: link to earnings, raising in line with prices when they rise more but claw back later

– Raise pension age at least in line with longevity

• Private pensions

– Focus on finding a way to reintroduce some risk sharing

– Consider reducing DB benefits by enforcing CPI indexation

– Move to rational, stable EET tax system

– Over time increase employee auto enrolment contribution rates


Documents

Pension policy – where have we been, where are we going? · – We can model incomes really quite well that far ahead given what we know about pensions, health, working patterns