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 Reform as natural experiment: what economists can learn and contribute Conclusions

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

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

Ageing Population

Projected spending

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

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

The UK Pension system, 2003/4 First tier (mandatory) Third tier 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 Second tier (mandatory) Contracted out Contracted in First tier (mandatory) Basic state (flat) pension Pension Credit, formerly MIG

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

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

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

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

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?

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’

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

Effects of personal pensions 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

Effects of personal pensions: OP saving across the income distribution

Effects of personal pensions: PP saving across the income distribution

Effects of personal pensions: Amounts of contributions by source

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?

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)

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

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!