Almost four in 10 private sector workers face a ‘financial cliff edge’ when they retire if the pensions system remains as it is, according to a new report.
The Institute for Fiscal Studies’ Pensions Review concluded that “decisive action” is required to create a pension system fit for the next generation.
Over the past two-and-a-half years, the think tank and abrdn’s Financial Fairness Trust have looked at the challenges facing the UK pension system and the risks to future generations of retirees.
Fewer workers will benefit from the advantages of defined benefit (or final salary) pensions in the future, or will have the security of home ownership and rising house prices enjoyed by the current generation.
Pension savings
Around half of middle- and high-earning employees will fail to reach their “target replacement rate” that will maintain their current living standards, while 13% of all earners are not on track for the Pension and Lifetime Savings Association’s recommended minimum standard of £13,400 a year after tax when they retire.
A higher proportion of self-employed people are not saving enough into private pension pots for their retirement, it added.
In terms of the state pension, the IFS warned that keeping the “triple lock” in place would disproportionately force poorer households to work for longer, and potentially push the state pension age up to 74.
It said: “Increases in the state pension age required to keep spending on the state pension below a certain level of national income would have to be substantial.
“[Official] modelling shows that to keep public spending on the state pension below six per cent of national income while retaining the triple lock, the state pension age would have to rise to 69 by 2049 and 74 by 2069.”
It argued that the government should make a number of guarantees on the state pension, including that the state pension should always grow at least as fast as inflation, and committing never to means-test it.
The IFS also made a number of recommendations for reforming both state and private pension provision, including that employers’ pension contributions are set at at least 3% of pay, regardless of the employee’s contribution.
The think tank would also like to see eligibility for auto-enrolment shift from the current age range of 22 to 66 to 16 to 74, while also lowering the earnings threshold from £10,000 to just £4,000 annually.
Further recommendations include:
- Increasing the minimum default pension contributions under auto-enrolment, particularly for higher-than-average earners, to boost private pension saving;
- Introducing new mechanisms that facilitate pension saving for the self-employed, such as integrating pension contributions into their tax returns;
- Expanding the automatic consolidation of small deferred pension pots to reduce complexity as workers approach retirement age;
- Encouraging more flexible retirement products that could combine early drawdowns with security at an older age;
- Enhancing Universal Credit for people within one year of their state pension age;
- Boosting take-up rates of means-tested support so pensioners can make their money go further.
The IFS also stressed that employees need better access to “high-quality information and support [on pensions] without having to pay for expensive and ongoing financial advice”.
Around 20% of private sector employees, and 80% of self-employed workers, are not saving in a private pension, it is estimated.
Paul Johnson, IFS director and co-director of the Pensions Review, said there was much to celebrate: “The current generation of retirees is, on average, doing much better than any previous generation. Pensioner poverty is way down on the very high levels in the 1970s and 1980s, and is indeed below that for other demographic groups.
“But there is a risk that policymakers have become complacent when it comes to pensions. Without decisive action, too many of today’s working-age population face lower living standards and greater financial insecurity through their retirement.”
Former work and pensions secretary and chair of the review’s steering group, David Gauke, added: “Pensions need long-term planning and, ideally, a broad consensus. The proposals put forward maintain an important balance between the state, employers and workers.
“The government should provide a secure pension income, further increases in the state pension age should be accompanied by more support for those hardest hit, and both employees and employers should gradually contribute more to help achieve greater financial security in retirement.”
Last month, the government introduced the Pension Schemes Bill, which is designed to make pensions easier to understand and manage.
Work and pensions secretary Liz Kendall claimed the reforms would secure “better value for savers’ pensions and drive long-term investment in British businesses”.
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