Heidi Karjalainen, a senior research economist at the Institute for Fiscal Studies, explores the imminent state pension age increase as the latest review continues.
From the start of April, the state pension age will start rising from 66, reaching 67 in early 2028. This upcoming change was announced in 2011 and legislated in 2014, in response to higher life expectancy projections and as a wider package of spending cuts made after the 2010 general election.
The main rationale for an increase in the state pension age is straightforward, as it is a key policy lever for controlling the rising costs of the state pension system as the population ages. The Office for Budget Responsibility estimates that the move to 67 will save about £10bn by the end of the decade, compared with keeping the age at 66.
But beyond the public finance effects, what might this change mean for individuals and households? This is what is going to matter for most people. And although prediction is difficult, evidence from previous increases in the state pension age gives a useful guide.
Employment impacts
Past increases pushed up the employment rate among affected groups as some people delayed their retirements and therefore stayed in work for longer. For example, the employment rate of 65-year-olds rose by about 10 percentage points when the state pension age increased from 65 to 66.
In other words, about one in 10 people respond to an increase in the state pension by working more, but most do not. Research also shows that the extra employment largely comes from people staying in existing jobs longer, rather than finding new roles or re-entering work after time out of the labour force.
Because this increase in employment is concentrated among a minority of people, for most of those affected, the main impact is simply a delay in receiving their state pension, pushing down their disposable incomes. For some people, this feeds into higher rates of income poverty; the increase in the state pension age from 65 to 66 more than doubled the relative income poverty rate among the affected group from 10% to 24% after the reform.
While we may expect the effects of the upcoming change to be similar, there are reasons why they may differ in scale.
Although we still expect some people to work for longer as a response to the state pension age rising to 67, the employment rate among those in their mid-60s falls rapidly with age. That may mean that there is less scope for employment to rise in response to the policy. This is reinforced by the fact that the prevalence of ill health and disability rises with age, which may limit some people’s ability to stay in their jobs.
A smaller employment response would mean the reform is slightly less beneficial for the public finances, and would mean slightly larger falls in average household incomes.
Political difficulties
Perhaps the most important thing in terms of the future is not exactly how much the rise in the state pension age affects the public finances, or how it affects household incomes, but how it goes down politically.
There is an independent review of the state pension age underway into the timing of further increases. Once that is published, the government will have to respond and potentially legislate for some future increases.
If the increase to 67 is proving to be difficult or controversial, that may make it harder for the government to legislate for further increases to 68 – and beyond.
Heidi Karjalainen is a senior research economist at the Institute for Fiscal Studies.
