Quiet revolutions, risk and uncertainty

12 February 2015

Thirty years ago pensioners were much more likely to be poor than any other population group and had income well below the average. Since then, year after year pensioner incomes have grown faster than those of non pensioners. Pensioners are now less likely to be poor than are those of working age and, on some measures, average pensioner incomes are higher than average incomes among the working age population.

That represents a quiet revolution in policy and outcomes. Over that period all elements of income for pensioners have been rising – state pensions, means-tested benefits, private pensions, and earnings. At the same time longevity has risen dramatically. So all this has come at a cost, both in terms of public spending and lower earnings for those of working age. Why the latter? Because so much money has had to be ploughed into occupational pension schemes to pay for promises for today’s pensioners which turned out to be vastly more expensive than expected.

Government and private sector have, belatedly, responded. Defined benefit occupational schemes are essentially dead outside the public sector. Auto-enrolment will bring millions more into some form of pension saving. State pension ages are set to rise. State pensions for future generations will be less generous than planned as a result of the new single tier reforms. Increasingly retirees will be dependent on defined contribution pensions which, given recent reforms, need not be turned into a stream of income via an annuity. Individuals are also responding by working longer, a trend which has gradually been reversing the sharp drop in average retirement ages which occurred in the 1970s and 1980s.

These trends are set to continue. By 2030 average retirement ages will be higher than now, state pensions beginning to fall, occupational pensions becoming gradually less important for former private sector workers, and savings in DC schemes, including through autoenrolment, more important.

Will the rise in pensioner incomes continue? Recent work at IFS, based on known characteristics of those currently in their 50s, suggests that over the next decade or so incomes will continue to rise. A significant part of this will be driven by increases in incomes from earnings. Many of those in their 50s, especially in their late 50s, still have substantial occupational pension rights. State pension rights will remain relatively high.

The longer term outlook is more uncertain. Lower occupational pension provision is sure to affect many. The high point of state provision will fade further into the past. And younger cohorts are actually seeing their earnings drop below those of older cohorts at the same age. This is a very unusual pattern. In addition home ownership levels among those born in the 1970s and after are substantially lower than was the case for their parents’ generation.

Beyond uncertainty over levels of future provision these trends create one big additional challenge – how to share risk. Increasing dependence on defined contribution pensions means that all the risk sits in the hands of the individual – not the employer, not the government, not future generations. A system of pension provision without more risk sharing is unlikely to be robust into the long term.

Blog taken from Beyond April 2015: the long view on UK pension reform conference brochure

Paul Johnson, Director, Institute for Fiscal Studies

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