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Pensions and Savings in the UK

Pensions and Savings in the UK. Matthew Wakefield The Institute for Fiscal Studies January 2004. Outline. Why an economic policy issue? Responding to the ageing population Pressures on UK pensions system Conceptual framework What this suggests about UK policies

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Pensions and Savings in the UK

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  1. Pensions and Savings in the UK Matthew Wakefield The Institute for Fiscal Studies January 2004

  2. Outline • Why an economic policy issue? • Responding to the ageing population • Pressures on UK pensions system • Conceptual framework • What this suggests about UK policies • Reform as natural experiment: what economists can learn and contribute • Conclusions

  3. Why an economic policy issue? Allocation of scarce resources • Between consumers in population • Across an individual’s lifetime Reasons for policy intervention? • Equity • Efficiency/market failures • Paternalism

  4. Why ‘hot’ policy issue now? Ageing population • Financial pressure on (state) provision • Ensure elderly get adequate resources

  5. Ageing Population

  6. Projected spending

  7. Pressures: Responses • Increase pension age • Reduce generosity of indexation • Reduce generosity of benefit calculation • Increased private (funded) provision

  8. Pensions Green Paper, December 2002 Why more reforms? • Under-‘saving’: 3million + 5 or 10 million What reforms? • Simpler pensions & tax treatment • Better information • More flexible retirement Not overhaul of ‘voluntarist’ system nor of incentives currently provided

  9. The UK Pension system, 2003/4 Additional voluntary contributions (AVCs) Other saving ‘Free-standing’ AVCs Third tier (voluntary) Approved occupational pensions (DB & DC form) Personal pensions (individual) State 2nd Pension (S2P)), formerly SERPS Stakeholder pension Secondtier (mandatory) Contracted out Contracted in First tier (mandatory) Basic state (flat) pension Pension Credit, formerly MIG

  10. Reforms • 1981: Price index BSP • 1988: Personal Pensions • 2000: SERPs generosity reduced (1986/1990 legislation, both halved SERPs generosity, reforms to be phased in) • 2001: Formal introd. of Stakeholder pensions • 2002: State Second Pension (S2P) • 2003: Pension Credit • ?2007? S2P made into flat-rate benefit • 2010-20: Retirement age for women to 65

  11. What’s the issue? Policy question • Are people saving enough? Academic question • Are people saving enough?

  12. Conceptual Framework • Lifecycle model • Consumption (& saving) depend on: • total resources; prices (interest rate); preferences • Save to facilitate consumption smoothing • Also smooth through labour supply

  13. The Taxation of Saving Three points at which savings could be taxed: • Initial deposits (tax on earnings) • Returns on investment (tax on interest/ capital gains) • Withdrawals (tax on withdrawals) Regimes • “Comprehensive income tax”: TTE (or ETT) • “Comprehensive expend. tax”: EET or TEE

  14. The Taxation of Savings in UK • Interest bearing accounts: Taxed, Taxed, Exempt (TTE) • Private Pensions (EET(E)) • ISAs (TESSAs & PEPS) (TEE) • A tax perk for the rich? • More help for the poor: a Saving Gateway?

  15. A Saving Gateway? Matched savings vehicle to lower-income adults • Correct disincentives from benefit withdrawal • Correct low savings due to lack of knowledge/ habit Problems • Targeting: those who already save • Targeting: those with good reasons not to save • Borrow to ‘save’

  16. Reform as a natural experiment Personal Pensions and Saving • 1988: New route for opting out of SERPs • First form of tax relieved retirement saving for those not covered by occ. Schemes • Normal Contracted Out Rebates (5.8% of earnings between UEL & LEL) plus 2% bung for years before 1993 • Reduced SERPs generosity also announced

  17. Effects of personal pensions Effects: • How many savers? • Characteristics of savers • How much will people save? • How much of the saving is new saving? • Effect on public finances of reform to national insurance and SERPS

  18. Effects of personal pensions:OP saving across the income distribution

  19. Effects of personal pensions:PP saving across the income distribution

  20. Effects of personal pensions:Amounts of contributions by source

  21. Lessons from Personal Pensions People will respond to incentives: • No. of optants under-predicted by fact of 8 (Disney and Whitehouse, 1992) • Relevance to saving gateway?

  22. Lessons from Personal Pensions Impact on Household saving rate • Substitution effect: new vehicle good value (+) • Offsetting from existing assets • Wealth effect of COR investment (-) (occ pen holders and mis-selling) • 1989-90: £750m of £5.5 billion • 2001-02: £3 billion of £9 billion (0.3% of GDP)

  23. Lessons from Personal Pensions Opting out and the public finances • “One-way bet” and opting out voluntary implies future SERPs reduction won’t recoup all of CORs paid. Case study of PPs gives us economic analysis of substitution and wealth effects on savings, and also public finance analysis

  24. Conclusions • Ageing population, pressure on pensions • UK system: complex and ongoing reforms • Will people have adequate resources? • Reforms as useful case study for analysis • But number of reforms and their interactions can complicate analysis • More importantly: difficult for families to plan their saving (stakeholder, PC, SG, ISA) • Plea for simplification then stability!

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