Heidi Karjalainen: Securing a stronger, sustainable pension system fit for the future
The government is expected to announce the second phase of its pensions review this summer, focussing on adequacy of pension saving – a topic that the pensions industry has been calling for action on for a long time.
As we wait for the government's review to begin, we at the Institute for Fiscal Studies (IFS) have just published a final set of recommendations from our own IFS Pensions Review, which began at the start of 2023.
A huge amount of analysis and stakeholder engagement has gone into this set of recommendations over the last two and a half years. Our review considered not just how much people are saving for retirement, but how that fits with the state pension system, means-tested benefit available at older age, and the system for drawing down on pension wealth in retirement.
Our final recommendations provide a clear and credible blueprint for the UK's pension system – and useful insights for the government during their review. They can be split into four areas of focus.
First, the government needs to use the current automatic enrolment framework to help increase retirement incomes. More private pension saving is needed, but this needs to be balanced with the fact that many working-age people struggle with low take-home pay today. We propose two key changes to the current system.
Pension participation should be extended by providing employer contributions to almost all employees (anyone with earnings above £4,000 per year), even to those who do not contribute themselves.
In addition, the default minimum pension contributions should be increased particularly for on middle and higher-earners. One way to achieve this, which we model in our report, would be to increase the total minimum contribution rate to 10% to apply to a new qualifying earnings band of £9,000 to £90,000. Together, this package of reforms would increase the retirement incomes of low-to-middle-income people by almost 15%, but would also protect the take-home pay of low earners.
Second, more support is needed for those who are deciding how to spend their defined contribution pension wealth. DC pension pots are growing in importance over time, and policy should help people to view them, and use them, as a pension, not just a savings pot. We agree with the government's current direction of travel here – while freedom to choose should remain, default products should steer people towards solutions that provide flexibility earlier in retirement, and protection against living longer than expected at older ages.
Third, the state pension needs to provide a secure and sustainable foundation of income in retirement. The government should set a target level for the state pension relative to average earnings, and commit to that target. For indexation of the state pension, we propose an Australian-style "smoothed earnings link" which would ensure increases in line with average earnings growth in the long run, with inflation protection in place in periods where inflation exceeds average earnings growth.
Finally, the state pension age should continue to rise when life expectancy rises, although not as fast as life expectancy itself. And to protect those hardest hit by the increases, enhanced means-tested support should be provided through Universal Credit to people in the run-up to state pension age.
We understand that these recommendations cannot all happen immediately. Reforms can, and should, be phased in. Employers should get several years' notice of increases in minimum contributions to allow them to adjust. The government could set a target level for the state pension but commit to keeping the triple lock until that target level is reached, most likely after the end of the parliament.
We hope to see the government's adequacy review announced soon. However, that announcement will be just the starting point – it is important that the government uses the findings from that review to help bring about decisive policy action as soon as possible.
The sooner we do this, the more generations of workers will benefit from these policies that will improve their outcomes in retirement. The government needs to act swiftly to secure a stronger, sustainable pension system fit for the future. Our IFS Pensions Review provides a set of policy proposals that would help achieve those goals.
Heidi Karjalainen is a senior research economist at the IFS
