What should the UK’s pension system look like in 2050?

IF Senior Researcher Conor Nakkan puts forward a vision for the future of the UK’s pension system, drawing on IF’s response to the Second Pensions Commission.

What did the Commission find?

In May, the Second Pensions Commission published its interim report. The Commission is tasked with considering the long-term future of the UK’s pension system, with the final report and recommendations due in 2027. Its overarching objective is to lay the groundwork for a pensions system that is “adequate, fair, and sustainable” by 2050.

At the outset, the interim report recognises the progress made since the first Pensions Commission in the early-2000s. Nine in ten eligible employees now participate in workplace pensions. The new State Pension has created a better foundation for retirement incomes. And pensioner poverty has also fallen significantly over recent decades.

But significant challenges remain. Around 15 million working-age people, or 43 per cent of the total, are projected to fall short of the Commission’s target retirement income replacement rates. In other words, almost half of all workers are not saving enough to provide them with a comfortable retirement.

Moreover, almost half of working-age people are not saving into a pension in a typical month. Four million employees fall outside automatic enrolment because of its age limits and £10,000 earnings trigger. Only 17 per cent of the self-employed currently save into a pension.

Falling homeownership also means that more future pensioners will enter retirement while still paying rent.

The fiscal backdrop: An ageing population

Alongside these concerns about adequacy, the interim report also acknowledges the fiscal pressures that are facing the country, driven in part by an ageing population. The share of the population aged over 65 is projected to rise from 19 per cent today to 28 per cent by 2075.

This matters because the State Pension operates on a pay-as-you-go basis. This means that the pensions received by today’s retirees are funded by today’s workers. As the number of pensioners grows relative to the working-age population, the cost per worker will rise.

Spending on the State Pension is already set to increase significantly over the coming decades. The latest long-term forecasts from the Office for Budget Responsibility (OBR) show State Pension spending rising from around 5 per cent of GDP today to around 9 per cent by 2075–76. Health spending is also projected to rise from 8 to 13 per cent of GDP. Over the same period, public debt rises from around 100 per cent of GDP to almost 300 per cent.

The OBR is clear that unless there are significant improvements in economic growth or productivity, current policy settings will result in debt moving onto an “unsustainable and ever-rising path.”

Rethinking state support

Following publication of the interim report, organisations were invited to share their views on what the UK’s pensions system should look like in 2050.

In our response, we argued that the State Pension should continue to provide a secure foundation for retirement and protect pensioners from poverty. However, given the scale of the fiscal and demographic challenges facing the country, we think that state support needs to become more sustainable and better targeted.

The triple lock

The most immediate priority should be replacing the triple lock. This increases the State Pension each year by the highest of earnings growth, inflation or 2.5 per cent. It now increases spending faster than either prices or wages over the long term. And it also gives the same increase to the wealthiest retirees as to the poorest pensioners.

As we argued in Time to Unlock, the State Pension should only rise with inflation until 2030–31 and by the average of inflation and earnings thereafter. As the OECD also argued earlier this month, this approach would generate substantial long-term savings and reduce the volatility associated with the triple lock. But it would also preserve a link between pension uprating and broader improvements in living standards. We estimate that it would save £19 billion a year by 2035–36 and £38 billion by 2045–46.

Some of these savings should be redirected to the poorer pensioners. A new Low-Income Pension Supplement for households receiving Pension Credit could be worth £30 a week. By the mid-2030s, it would only cost around 10 per cent of the savings from our proposed reform.

Introducing means-testing

Over the longer term, the UK should consider a more targeted and means-tested State Pension. Australia’s Age Pension is reduced or withdrawn from retirees with high incomes or substantial assets. Combined with compulsory private saving, this helps contain Age Pension spending, which is projected to fall from 2.3 per cent of GDP in 2022–23 to 2 per cent by 2062–63.

State pension age

The State Pension age must also form part of the discussion. We have argued that the government should consider raising it to 70 by 2035. Thereafter, for every three years added to life expectancy, the pension age would rise by two. This would need to be accompanied by better support for disabled people, carers, manual workers and people in poor health.

Strengthening private pension saving

A more targeted State Pension will only be credible if future pensioners build larger private pension pots. The UK should therefore build on automatic enrolment and move towards a stronger mandatory system.

The current statutory minimum contribution is 8 per cent of qualifying earnings, including only 3 per cent from employers. For many workers, this legal minimum has become the standard contribution rate. Australia, by comparison, requires employers to contribute 12 per cent of ordinary earnings as part of its superannuation guarantee.

The UK should gradually raise minimum contributions, with employers carrying a larger share of the increase. The automatic enrolment age should fall from 22 to 18, while the earnings trigger should be reduced so that more lower-paid workers and people with multiple jobs are included.

People who remain in paid work above State Pension age should also lose their exemption from employee National Insurance contributions and contribute on the same basis as younger workers.

A new pensions settlement for 2050

The UK needs a pensions system that is fit for the future. The Commission’s Interim Report identifies the central pressures: population ageing, inadequate private saving, falling home ownership, and growing fiscal constraints.

These pressures will only intensify over the coming decades. Maintaining the triple lock will push up State Pension spending in an arbitrary and unpredictable way. Delaying State Pension age reform will increase the burden on future taxpayers. Failing to strengthen private pension saving will leave millions of future retirees with inadequate incomes. Avoiding means-testing will protect wealthy retirees at the expense of poorer pensioners and younger workers.

A fair pensions settlement must protect people in old age. But it must also be affordable for those who fund it. Younger and future generations should not be expected to absorb the full cost of demographic change through higher taxes, weaker public services and lower living standards.

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Photo by Sasun Bughdaryan on Unsplash.