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 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

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
: Retirement age for women to 65

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

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
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)
: £750m of £5.5 billion
: £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!