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The state pension reforms currently before Parliament will provide a firm foundation on which people can build through their private saving to reach the standard of living they would like in retirement:
- Increased coverage of State Pensions – in the past, women and carers have not had the same access to State Pensions as men. After reform, around 75 per cent of women reaching State Pension age in 2010 will be entitled to a full basic State Pension and this will reach over 90 per cent of women (and men) by 2025.
- Reduced reliance on Pension Credit – restoring the link between earnings and the basic element of the State Pension, and changes to how Savings Credit is calculated, will ensure that Pension Credit remains targeted at the groups who need it. We estimate that without change and assuming continued uprating policy, by 2050 around 80 per cent of pensioner households would have been entitled to Pension Credit. With the reform package, that will fall to around 30 per cent in 2050. This will mean that there will be greater benefits of saving for more people.
The state reforms will ensure that Pension Credit is targeted at those who need it – namely, groups who have not been able to contribute for enough years to build up rights to a sufficient State Pension.
As a result of the reforms, anyone who contributes for 24 years or more will be lifted above Guarantee Credit only. The Government will be able to give workers a reasonable expectation that if they work and/or care, and save, for most of their career they will not be on Pension Credit on retirement. Without reform, that would not have been possible.
Pension Credit will continue to be an important safety net for those who are not able to make such provision – but there will still be good incentives to save.
Lower charges and the presence of an employer contribution will directly enhance the value of pension funds. Payback will clearly depend on a range of factors such as investment performance40. However, in the reformed system, in real terms, a median earner aged 25 in 2012 might expect payback of £2.55 for each £1 saved, compared with £1.13 for every £1 saved without reform, as illustrated in Figures 6a and 6b41. Someone receiving Savings Credit in 2050 could still get a return of £2 for every £1 saved.
The result of the reforms, bearing in mind the difficulty of all long-term predictions, is that there will only be a small group of people – less than 10 per cent of pensioner households in 2050 – who may not see any benefit from saving. To fall within this group, people would have to have a severely deficient state pension record and not have earned above £5,000 in many years of their working life. They are thus unlikely to have been automatically enrolled into a personal account or alternative pension scheme for long, and will have accumulated relatively small pension funds. Even this group may benefit as they will be able to take their pension as a lump sum if the total is less than the trivial commutation limit (£15,000 in 2005/06).
The reforms to State Pensions combined with the employer contributions mean that the incentives to save are better for all age groups compared to the system prior to reform. Very few people will see little or no benefit from saving. The majority will see significant returns.
Some people will rightly decide not to save for a pension. They could include those on persistent very low incomes or those struggling with high unsecured debt. But the large majority of people can expect to benefit from saving. Ultimately, it should be for the individual to decide whether and how much to save based on their particular circumstances.
Figure 6a: Potential payback from £1 contribution for a male median earner aged 25 in 2012, without proposed reforms
Figure 6b: Potential payback from £1 contribution for a male median earner aged 25 in 2012, with proposed reforms
Source: DWP modelling
Notes: Median earnings in 2006/07 are £23,000.
This figure is for illustrative purposes only. It should not be used as the basis for individual decisions as specific circumstances or variation from the underlying assumptions will lead to different results.
- Financial incentives to save for retirement, November 2006, www.dwp.gov.uk/pensionsreform/pdfs/financialincentives.pdf
- These savings are reinforced by Sefton J, van de Ven J and Weale M, December 2005, The Effects of Means-Testing Pensions on Savings and Retirement.
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