THE UNITED KINGDOM 1. MAIN CHARACTERISTICS OF THE PENSION SYSTEM In the UK, the statutory State Pension system consists of a flat-rate basic pension and an earnings-related additional pension, the State Second Pension that reformed the previous State Earnings-Related Pension Scheme (SERPS) (survivor's and disability pensions are also statutory). These two tiers of the first pillar are financed through earnings-related National Insurance contributions. In addition, earningsrelated pensions of government sector employees are covered in part by State budgets. State Pension age is 65 for men and 60 for women but legislation is in place to equalise State Pension age at 65 by April 2020. A full flat-rate basic State Pension normally requires 44 qualifying years of National Insurance Contributions (which may include some National Insurance credits) for men and 39 qualifying years for women. State Pensions cannot be taken up before State Pension age, but may be deferred in return for a higher State Pension (10.4% increase per year of deferral) or a one-off lump sum with interest instead (annually at least 2% above the Bank of England base rate). A unique feature of the UK pension system is the possibility to contract out of the additional State Pension. This requires coverage by an occupational or personal pension scheme providing equivalent or better benefits than the earnings-related component of the statutory scheme. 60% of the employed are in such contracted-out schemes and are entitled to a National Insurance contribution rebate. The introduction of the State Second Pension (in 2002) enables people on lower earnings to build up their pension entitlements. People earning between the lower earnings limit (about 4,264 for 2005/6) and 12,100 (for 2005/6) will accrue pension rights as if they had earned 12,100. In addition, individuals are credited second pension rights for periods when they cannot work due to caring responsibilities or disability. Pension Credit introduced in 2003 is an income-related benefit for people aged 60 or over. It is targeted at the least well off pensioners and the income test is more generous than for previous income-related benefits. Pension Credit provides, or contributes to, a minimum level of income of 109.45 for a single person or 167.05 for a couple. These amounts may be more for people who have caring responsibilities, are severely disabled or have certain housing costs. Occupational pension schemes tend to be established by a single employer and were generally of the defined-benefit type, providing pensions based on years of service and final pay. However, the coverage of defined-benefit schemes is declining and most new schemes have taken the form of DC schemes.- 1 Personal pensions were introduced in 1988 to offer a private second pension to people without access to an occupational scheme or who change jobs frequently (although Retirement Annuity Contracts, similar to personal provisions, were available prior to 1988). About 14% of the working age population have personal pensions (44% for self employed). To make private second pensions more 1 Occupational Pension Schemes 2004: The twelfth survey by the Government Actuary, published June 2005.
attractive, Stakeholder Pensions were introduced in April 2001. This form of personal pension account was designed to provide an option for people with moderate incomes who do not have access to a company pension scheme. Stakeholder pensions must meet a number of minimum standards and in particular have low charges (maximum 1.5% of fund value per annum, reducing to 1% after 10 year s membership), and have the flexibility for participants to vary contributions or move between schemes without any financial penalty. About 1.37 million people contributed to stakeholder pensions in 2003/4. 2 Around 40% of the working age population is contributing to an occupational or personal pension about 60% of employees of working age - and over 2 thirds of pensioner households had income from a private pension scheme (72% had investment income from non-pension sources). 2. Situation and perspectives in light of common objectives 2.1 Current situation Concerning adequacy, the median income of people aged 65 or more stands at about 74% of the income of those aged 0-64. The gross replacement rates for a worker at the average wage retiring at 65 after 40 years of contributions currently lies at 66% (82% net), 17% from the statutory scheme and 50% from the occupational scheme. This is based on the assumption that the person remains in the scheme for three quarters of their career and is contracted out of the State Second Pension for that time. For people with no private pension at all (only with a public State Second Pension) the gross replacement rate is 35% (47% net). The poverty rate among elderly people in UK has declined in recent years, but remains above EU average. According to latest national figures, in 2003 the relative poverty rate (at the 60% of median income threshold) for people aged 65 and more was lying at 24% (30% for oldest people, aged 75 or more), at an higher level than the poverty risk for the 0-64 population of 17%. According to national figures, the poverty risk among persons aged 65 and more declined by about 5 percentage points from 1996/97 to 2002/2003. 3 However, these figures do not show the full effect of Pension Credit, introduced in October 2003, and which is expected to lead to a further fall in pension poverty in 2004-2005 at a time when earnings of the working age population have increased rapidly. Concerning sustainability, the employment rate of people aged 55-64 was 56% in 2004, which is significantly above the Lisbon targets, while the average age of effective labour market withdrawal is 62.9 for men and 61.4 for women in 2004. Among persons 50 to 69 year olds who retire before State Pension age, 49% give illhealth as a reason, 18% were offered financial terms to retire early or take voluntary 2 HMRC data 2003/4. 3 This decline is higher if one refers to the absolute poverty ceiling of 1996/97: the decline from 1996/97 to 2002/2003 amounts then to about 15 percentage points, corresponding to a reduction of the poverty risk of two thirds. According to other national sources, with incomes measured After Housing Costs, the relative poverty risk among elderly people above State Pension age declined by about 8% from 1996/97 to 2003/2004.
redundancy and a further 18% were made redundant, dismissed or had no choice. 4 Moreover, those in receipt of private pension income were more likely to retire early. Some measures were introduced to encourage the participation of older workers both before and after State Pension age, (in particular by providing back-to-work help through the New Deal 50 Plus) and tackling age discrimination. Incentives for continued or more flexible working have been strengthened and people may delay claiming their pension or even de-retire when they have claimed, and earn an increase pension later, or a generous lump sum payment. In parallel, the simplification of tax incentives for pensions will introduce a single universal regime for tax-privileged pension savings. 5 In view of the importance of private provision, the current diversity and complexity of private pension schemes poses particular challenges. Individuals are faced with a range of choices when they start or change employment. The large number of schemes raises issues of the feasibility of close supervision. A further notable development over the last decade has been the closure of employer sponsored defined benefit (DB) provision (The pensions Commission estimates 60% of DB schemes are closed to new members) which have been replaced with defined-contribution (DC) schemes. While the trend in total scheme membership is uncertain, average contributions to occupational DC schemes are lower than for DB schemes (according to the National Strategy Report, total contributions to DB schemes are broadly in the 17-20% range, whereas DC schemes are usually in the 7-9% range. The difference in contribution levels would suggest less generous occupational pensions for workers in the future. The challenges posed for private pension provision by longer life expectancy, economic uncertainties and risk of inadequate management are currently being put on the political agenda. The establishment of a Pension Protection Fund (PPF) will provide increased security for the members of occupational pension schemes. The PPF started operating in April 2005 and will pay compensation (up to certain limits) to members of defined benefit schemes and the defined benefit part of hybrid schemes, where the employer becomes insolvent and the scheme is underfunded. For those scheme members who lost part of their defined benefit occupational pension prior to April 2005, who are within three years or above of their scheme pension age, the Government has introduced the Financial Assistance Scheme (FAS) with funding of 400 million, which will top up to a level broadly equivalent to 80% of the core pension benefits (to a maximum of 12,000 per year). Additionally, the new Pensions Regulator, established in April 2005 will take a pro-active approach to pension scheme management focussing on fraud, poor administration and underfunding. It can impose civil penalties and, where appropriate, prosecute those responsible through the criminal courts and contributes to providing information and assistance to some operators. Concerning modernisation, the legislation is in place to equalise State Pension age at 65 by 2020. Relative living standards are on average slightly higher for men (76% for 65+ relative to 0-64) than for women (73%), and poverty risk remains higher for women (28% at the 60% threshold for 65+) than for men (23%). 4 Factors affecting the labour market participation of older workers, Department of Work and Pensions Research Report 200. 5 There will be two key thresholds in the new regime - the lifetime allowance, set initially at 1.5 million, rising to 1.8 million by 2009/10; and the annual allowance, set initially at 215,000, rising to 255,000 by 2009/10.
The portability of pension rights will also be improved from April 2006 onwards by giving early leavers a right to a cash transfer to a new scheme after three months. Adults (up to State Pension age) are being provided with individual State Pension forecasts, and employers are being encouraged to provide information to their workers on pension options and entitlements. The UK Government is developing a web-based retirement planner and an interactive website, covering work, savings and retirement planning, and is working with financial services to improve the range of information and guidance materials available, to the entire population, including those of school age. 2.2 Outlook, reform measures and policy debates The United Kingdom is expected to face similar demographic trends to most EU Member States, but the currently favourable situation protects it from the most urgent risks. The old-age dependency ratio, even if growing from 24% in 2003 to 45% in 2050, is still projected to be among the lowest in the EU. Recent reforms should translate into improvements of adequacy of pensions, and in particular of the situation of the poorest pensioners. Continued increases in the take up rate of the Pension Credit should translate into further decreases of poverty rates among people aged 60 or more. Replacement rates at a given age are expected to remain constant for the coming decades for people contracting out, under the assumption of a contribution rate of 23.7% (18.7% employer and 5% employee), which is significantly higher than the current average contribution rates to occupational schemes. Currently, around 60% of employees contract out into occupational/private schemes For people who don't contract out of the State Second Pension the gross replacement rate is projected to decline from the current levels of 35% (47% net) to 25% in 2050 (41% net). A major challenge will then be to ensure that more people have access to, and make use of, opportunities to provide for a higher living standard after retirement. Although the UK already meets the Lisbon and Stockholm employment targets (the employment rate of people aged 55-64 was 56% in 2004), there is still room for improvement. The UK Government has announced that it will make compulsory retirement ages in companies below age 65 unlawful, except where an employer can justify a lower age. Employers will also give due consideration to individuals who request the right to stay in employment beyond any state retirement age. The need for a 65 default retirement age in legislation will be reviewed in 2011. The Incapacity Benefit (IB) Green Paper Pathways to Work (2002) set out a long-term strategy for encouraging and assisting people with health problems and disabilities to return to work. This strategy is critical to support older people, as 1.3 million of the 2.7 million people claiming IB in the UK are over 50. The UK Government recently announced proposals for reforming Incapacity Benefits. Pathways to Work pilots have been introduced, bringing together employment and health support for the first time and by October 2006 a third of all claimants will be able to receive the help available through Pathways. Whereas adequacy of the basic State Pension had developed into a major challenge over the 1980s and 90s, future financial sustainability of the public pension system appears less challenging. The strategy for ensuring the financial sustainability of the whole pension system is to focus public pension expenditure on lower income groups
and to encourage more pension provision to be funded by private savings. UK State Pension spending is around 5% of GDP and according to national sources is projected to remain broadly stable over the next 50 years. 6 Expenditure on State Pensions is expected to increase from 47 billion in 2001/2 to 54 billion in 2007/08 (real terms, 05/06 prices). According to the AWG projections of 2005, spending on public pensions, including public employees pensions, will increase by 2 p.p. of GDP from 6.6 % of GDP in 2004 to reach 8.6% in 2050. On the basis of the current budgetary situation, the budgetary projections imply gross debt to increase from current 41% to 90% of GDP in 2050. Finally, financial sustainability of public pensions appears to be well under control, but depends to a larger extent than in other countries on the performance of private pension providers. If private pensions decline from their current and anticipated levels, future governments may face increased claims of income-tested benefits. In October 2004, a government-commissioned report on the future adequacy of pensions was released. The 'Independent Pensions Commission' chaired by Adair Turner indicated that "unless new government initiatives can make a major difference to behaviour, it is unlikely that the present voluntary private system combined with the present state system will solve the problem of inadequate pension saving." (Pension s Commission Press release on 12/10/2004). According to this report total spending amounts to 9.9% of GDP, out of which 6.1% is public and 0.8% of GDP corresponds to public sector pensions. Spending for the later group seems to be dynamic and a reform process has been put in place, including a rise of the normal retirement age to 65. The UK government is seeking to address the issue of undersaving through its Informed Choice programme, which aims to maximise the take-up of work-based pensions and support people through education and information in making decisions about saving for their future. 3 CONCLUSION Recent reforms of the State Second Pension and 'Pension Credit', the UK has improved state pension adequacy. Poverty rates have been declining in recent years and are expected to decline further once the full effect of Pension Credit appears. While financial sustainability of state pensions appears to be under control and employment rate among older workers is already high, employment opportunities full-time, part-time and flexible working hours to help older people to stay in work as long as they wish can contribute to increase old age income. A unique feature of the UK pension system is the possibility to contract out of the State Second Pension. Subsequently, the adequacy, as well as sustainability of pensions depends to a larger extent than in other countries on the coverage and performance of private pensions. In this respect, the UK should continue to address the major challenge of ensuring that people have access to, and make use of the provisions for a higher living standard after retirement. Extending the coverage and depth of pensions saving will be important to ensure adequate income replacement in the future. The precise form of reform will be based on Pensions Commission's recommendations out of its second report at the end of 2005, advising in particular on 6 Source: Annex A, HM Treasury s Budget Report published alongside the Pre-Budget Report 2005.
whether there is a need of "moving beyond a voluntary approach". In this respect at lease three issues arise concerning future adequacy. The first is the impact of the shift to DC pension plans on the level of contributions to occupational schemes, secondly, how to ensure that people accommodate the rate of the basic State Pension through increases in other sources of retirement income, and thirdly how to continue to improve incentives to work later and save adequately.
4. BACKGROUND STATISTICS UK EU25 Adequacy Current situation Total Men Women Total Men Women At-risk-of-poverty rate 1 18 17 19 16 15 17 0-64 17 16 17 16 16 17 65+ 24 21 27 18 15 20 75+ 30 28 32 Nd Nd Nd Income inequality 1 0-64 5,9 65+ 4,0 Income of people aged 65+ as a ratio of income of people 0,74 0,76 0,73 aged 0-64 1 Median pensions relative to 2 median earnings Nd Nd Nd Long-term projections Theoretical replacement 3 2005 2030 2050 rates Total net replacement rate 82 84 85 Total gross replacement rate 66 68 69 Gross repl. rate 1 st pillar 17 18 19 Gross repl. rate 2 nd /3 rd pillar 50 50 50 Financial sustainability Current situation ESSPROS Pension 1995 2000 2003 1995 2000 2003 expenditure 4, % of GDP 11,9 12,2 11,0 12,5 12,6 Employment (2004) 5 Total Men Women Total Men Women Employment rate (25-54) 80,8 87,7 74,2 76,8 85,2 68,5 Employment rate (55-64) 56,2 65,7 47,0 41,0 50,7 31,7 Effective labour market 6 exit age (2004) 62,1 60,7p Public finances (2003) 7 Public debt, % of GDP 39,8 63,3 Budget balance, % of GDP -3,3-2,8 Long-term projections (EPC 2006) Level increase Level increase 2004 2030 2050 2004-50 2004 2030 2050 2004-50 Old-age dependency ratio 8 24,3 41,3 45 +85% 25 40 52 +108% Public pensions expenditure, 9 % of GDP 6.6 7.9 8.6 +2.0 10,6 11,9 12,8 +2,2 Factors determining the Contribution to change in percentage points Contribution to change in percentage points evolution of public pensions expenditure (2000-2050) 10 of GDP of GDP Demographic dependency 4,7 8,6 Employment -0,1-1,1 Eligibility Nd -2,1 Level of benefits Nd -2,7 Total (including residual) 1,9 2,2
Notes: 1. Source: Eurostat data collection 2005. Poverty line: 60% of median equivalised income; inequality measure: income share ratio S80/S20. During the transition towards EU-SILC European harmonised income and living conditions data, it has been agreed to use indicators derived from national sources according to a common agreed methodology. While such indicators cannot be considered completely comparable due to the use of different surveys or reference year for income, every effort has been made to ensure the maximum comparability. It can be noted that 12 Member States already use EU-SILC surveys (BE, DK, EL, ES, FR, IE, IT, LU, AT, PT, FI, SE; SILC 2004, Income data 2003), while other Member States rely on national sources (income data 2003), apart MT (2000), CZ, DE and SK (2002). 2. Source: Eurostat. Median individual pension income of retirees aged 65-74 in relation to median earnings of employed persons aged 50-59 excluding social benefits other than pensions. 3. Source: national calculations according to the method determined by the Indicators Sub-Group of the Social Protection Committee. Theoretical replacement rate of a male worker with a career length of 40 years full-time work at average earnings with contributions to first and second pillar pension schemes, retiring at the age of 65 years in 2005. 4. Source: ESSPROS, EUROSTAT. Includes expenditure by certain private social protection schemes. 5. Source: European Labour Force Survey, 2004. 6. Source: European Labour Force Survey, 2004. 7. Source: European Commission, DG ECFIN. 8. Source: EUROSTAT (2005), demographic projections. Number of people aged 65 and over as a percentage of people aged 15-64. 9. Source: Economic Policy Committee 2006. Public pension expenditure (including most public replacement incomes to people aged 55 or over, also including pension expenditures from the funded tier of statutory schemes), before taxes. 10. Source: Economic Policy Committee 2006. Public pension expenditure (including most public replacement incomes to people aged 55 or over, but not including pension expenditures from the funded tier of statutory schemes), before taxes. * proportion negligible