October pensions supplement: Neglected costs

The current government has delivered or is planning radical changes to the delivery of education, health and, through its planned “universal credit,” working-age social security. On pensions, that other great pillar of the welfare state, it has shown less short term radicalism but perhaps just as much appetite for long term change.

That short-term conservatism is in fact one reason why the scale of fiscal austerity faced by most elements of public spending has been quite so severe. The section of the population that is aged 65 and over is currently growing very fast. There will be two million more people in that age group in 2020 than in 2010. Population ageing is well and truly with us.

That swift rise in the number of pensioners has been accompanied by almost complete protection of their benefits. The state pension is triple locked--—rising by the fastest of CPI inflation, earnings growth, or 2.5 per cent. Other benefits for pensioners have been largely protected, while benefits and tax credits for those of working age have already been cut by £18bn, with more to come.

This protection of current pensioners, expensive though it is, is no doubt electorally savvy. It protects a group with legitimate expectations and less chance than younger people to replace lost income through additional work. But it may also reflect a slightly outdated notion of the economic position of pensioners.

Just 30 years ago rates of income-poverty among pensioners were much higher than those among the working-age population. So successful have we been in turning that round that today, for the first time, average pensioner incomes (after housing costs are taken into account) are higher than the average for the population as a whole. And poverty rates among pensioners are lower than those for working-age people. Recent work at the Institute for Fiscal Studies suggests that the majority of those reaching state pension age at the moment will be better off in retirement than they were on average during their working lives.

This astonishing turnaround has been made possible by a combination of more generous state provision and an occupational pension system from which many retirees have been substantial beneficiaries. This generation has also benefited from high levels of home ownership and swiftly growing property values.

The future, though, may look less rosy. Future generations will not benefit from the same generous occupational pension schemes. And it is on future generations that this government’s radicalism towards state provision will bite. For the centrepiece of reform has been the replacement of the current combination of flat rate and earnings related state pensions with a new single tier pension. This looks like the end point of the long march away from earnings related state provision which began almost the moment the State Earnings Related Pension Scheme was introduced in 1978. But it has been designed in a way once again to protect those retiring in the next decade or so. Indeed, among this group, there will be some substantial beneficiaries from the change. But it will result in significantly smaller state pensions for many of those retiring from the 2030s on, particularly those with higher earnings.

The combination of this reform with increases in state pension age should mean that government spending on state pensions grows less quickly than it otherwise would have done over the coming decades, though the Office for Budget Responsibility still forecasts pension spending to rise from 5.5 per cent of GDP in 2018/19 to 7.9 per cent by 2063/64. But coming alongside the dismantling of generous occupational schemes (at least outside the public sector) and lower rates of home ownership among younger cohorts it does look like the onward march of pensioner prosperity will begin to come to an end.

The one countervailing force will come from that other radical pension reform which, quietly, is currently underway: the introduction of auto-enrolment into private pensions. We are now nearly two years into the roll out of this policy, which will see millions of private sector workers enrolled into private pensions for the first time. All the indications thus far are that this is working relatively smoothly, with very high levels of participation. That should help support the retirement incomes of many modest earners—to some extent taking the place of state provided earnings related pensions.

But there are two important, and surprisingly neglected, costs to this change.

First, it will surely play a continuing role in keeping wage growth down. The money for the extra contributions has to come from somewhere. For many it will most likely come from wages. As employers also continue to shovel huge amounts of cash into underfunded occupational schemes, to the benefit of older workers and pensioners, and we continue to pay for current state pension provision, the overall effect will be to dampen the living standards of current workers for some time.

Second, the balance of risk in pension provision has moved decisively onto the shoulders of those least able to bear it: the individual savers. State provision involves risks being borne collectively. In defined benefit occupational schemes the risks can be shared between employees, across generations of employees and with shareholders. For most current workers, auto enrolled into defined contribution schemes—where what comes out depends only on what goes in and on investment returns—all the risk is held by the individual worker.

Perhaps more than in any other area of the welfare state, the quiet revolution in pension provision is moving risk and responsibility from the state onto the individual. And maybe it seems so quiet because its effects are not yet clear. It is largely those still more than a decade from retirement who are and will be paying the price in terms of their future pensions, their current wages and the risks they are bearing.