The Institute for Fiscal Studies (IFS) has made four recommendations for improving pensions adequacy that it believes would improve the state pension and boost private pension savings by around £11bn a year.
The recommendations are the result of a two-and-a-half-year research project exploring how to improve retirement outcomes, and come as the government has promised to begin its own pension adequacy review in the coming months.
The report calls for changes that take into account the needs of low earners who may be adversely affected by increases in contribution rates. It also argues for measures to make it easier for self-employed people to save for a pension.
“Without decisive action, too many of today’s working-age population face lower living standards and greater financial insecurity through their retirement.”
Paul Johnson, IFS
Paul Johnson, director at the IFS and co-director of the Pensions Review, warned that there was “a risk that policymakers have become complacent when it comes to pensions”, following the success of policies such as auto-enrolment.
“Without decisive action, too many of today’s working-age population face lower living standards and greater financial insecurity through their retirement,” Johnson said.
“Our recommendations give the government a clear and affordable roadmap: shore up the state pension, help workers save more – but only in periods when they are better placed to do so – and help individuals to make the most of their pension pots through retirement. Taken together, they would create a pension system fit for the next generation.”
A four-point ‘guarantee’ for the state pension scheme
The four recommendations relate to the state pension, boosting private savings, means-tested support for low-income retirees, and improved management of pensions through retirement.
On the state pension, the IFS has proposed a “four-point guarantee” to “increase confidence in the state pension as a stable and secure basis of the pension system”.
The report recommended that the government gradually move away from the triple lock towards a dual system linked to earnings growth and inflation, which would “improve predictability and… make sure that pensioner incomes keep up with increases in living standards”.
The IFS argued that the government should categorically rule out means testing of the state pension.
It also called for the state pension age to continue to rise as longevity increases, but said increases should be lower than longevity increases to ensure people typically spend longer in retirement.
To alleviate concerns about a rise in pensioner poverty as the state pension age increases, the IFS said universal credit should be extended through means-testing for those approaching retirement age.
This would help ensure that, as the state pension age rises, low-income retirees do not lose out.
“Means-tested support for pensioners should be streamlined to boost take-up, and housing benefit should be made more generous for the growing number of pensioners residing in the private rental sector,” the IFS said.
Boosting pension savings
The report made several recommendations to boost private pension savings levels to improve incomes in retirement.
While there have been calls from across the pensions industry for minimum auto-enrolment contributions to rise to 12% of salary, the IFS called for a more nuanced approach designed to boost savings for low earners without dramatically reducing take-home pay.
The report states that the auto-enrolment system “should help people save at points of life when it is easier for them to do so”. To aid this, employer contributions should start from the first pound of earnings and apply regardless of whether the employee is contributing.
Default-level contributions should then be increased for employees on or above average earnings, which the IFS said meant that “the government can protect take-home pay when individuals are on low earnings, but still deliver a boost to many people’s retirement incomes”.
It also called for self-employed people to be given greater access to pensions by facilitating saving through the self-assessment tax regime.
Innovative approaches to income in retirement
The IFS supported the government’s proposal for the automatic consolidation of small pension pots, set out in April following a report from the Small Pots Working Group. The proposal states that deferred pots with less than £1,000 would be automatically consolidated into a designated provider to reduce costs and potentially improve outcomes for members.
However, the IFS’s report said this £1,000 level should be gradually increased following its successful implementation, as fragmentation needed to be “reduced dramatically”.
The report also called for more innovation in the decumulation stage, with savers “guided towards sensible ways of drawing on their pensions that reduce the risk of them running out of private resources”.
This includes “flex then fix” approaches such as that currently being developed by Nest and other defined contribution providers.
“However, even very well-designed default solutions will not be right for all, and people should be able to get high-quality information to make sensible decisions without having to take expensive financial advice,” the IFS added.
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Industry reaction
Zoe Alexander, director of policy and advocacy at Pensions UK, said the IFS’s report was “a timely and welcome contribution to the policy debate about how to secure adequate retirement income for the UK population”.
“The state pension affords too little protection from poverty, the scope of auto-enrolment is too narrow, and contributions are too low for most workers,” Alexander said.
“If policymakers plan now and set out a roadmap for reforms, over the next 10 to 15 years, a new framework could be implemented to substantially improve the prospects of the majority of savers.”
Zoe Alexander, Pensions UK
The trade body is currently working on research to explore how to prevent low earners from “over-saving” into pensions and further reducing their take-home pay.
“If policymakers plan now and set out a roadmap for reforms, over the next 10 to 15 years, a new framework could be implemented to substantially improve the prospects of the majority of savers,” Alexander said.
Patrick Heath-Lay, chief executive officer at People’s Partnership, provider of the People’s Pension master trust, said: “The IFS… analysis highlights a central dilemma for pension reformers: how to raise overall pension saving to address the savings adequacy gap without forcing lower earners into saving too much, potentially reducing their standard of living.
“This issue – alongside the need to balance higher savings rates with the impact on employers – must be addressed in the second phase of the government’s pensions review.”
