Pensions Commission says “private pensions need to do more”

The Pensions Commission that the Government established last year has published its interim report and backing evidence. Policy recommendations aimed at delivering a sustainable pension system for 2050 and beyond are planned for spring 2027, though the report contains some hints about the direction of travel. In the Government’s accompanying press release, the Minister for Pensions reiterates that there will not be changes to automatic enrolment contributions this Parliament.

Key themes and analytical conclusions include:

“Private pensions need to do more”

Although the precise balance of responsibility between State, employers and individuals will be considered in the next report, the Commission is clear that “private pensions need to do more”.

It says there is “good reason to be concerned about the level of the legal floor for automatic enrolment contributions, which has become more of a norm than a minimum”. Minimum contribution rates were never intended to produce adequate retirement incomes for most people but the “third pillar” of voluntary savings has “not materialised for many”: one third of eligible DC private sector employees have contributions at statutory minimum levels, and half of median earners have contributions within 2% of pay of the statutory floor. The Commission suggests that “some of the lack of additional saving could be driven” by people assuming that minimum rates are the “correct” amount to save.

“An adequate future pensions system must include a solution for those self employed who are not saving elsewhere”, including “for younger, lower earning self employed people, who are especially likely not to have private pension savings”.

“Higher rates of private pension saving and higher coverage” will be required, especially when more people are now expected to be renting in retirement. The Commission will therefore “consider how the eligibility criteria, income thresholds, and minimum contribution rates for automatic enrolment will need to be adjusted in the future”.

Distributional focus

Pensions policy must define what “adequate” means and how it is measured. The Commission recognises there are two different adequacy challenges – an “absolute” minimum income, of most importance to low income groups, and the “relative” replacement ratios needed for other income groups to avoid significant drops in their living standards after retirement. The importance of renting/home-ownership to retirees’ living standards is also a focus, noting renters are particularly at risk of poverty (“For a single pensioner, covering the cost of private renting throughout retirement can easily require over £200,000 of extra pension saving”).

There is a strong focus on low and middle-earners. Although higher earners are less likely to be on course for their target replacement rates (because they have more income to replace), the Commission says the current system is “working well” for many of them (and notes that the “cost” of upfront tax relief on their contributions has grown) and that some could improve retirement incomes by accessing housing wealth.

The Commission argues that many part-time workers excluded from automatic enrolment by the £10,000 earnings trigger may be able to save and would benefit from saving in pensions; 55% are in above-median-income households.

After noting that State Pension outcomes between men and women are now much more equal, the Commission says that “efforts must now turn to the private pension savings gap that women face relative to men”. (A report published by DWP yesterday and quoted in the Commission’s evidence pack emphasises that divergence of contributions from men and women after birth of a first child are driven by labour market participation/hours rather than employees’ decisions.) Challenges for other groups (carers, disabled people, some ethnic minorities) are also noted but the Commission says that “these disparities cannot necessarily be resolved through the pensions system”.

Reducing early retirement

The Commission calls the age at which people leave the labour markets “a critical but often under-recognised determinant of pension adequacy”.

It says that “although the UK’s State Pension Age is not low by international standards, we have a low average labour market exit age” and points to OECD analysis suggesting that “even small increases in employment rates among those in their 50s and 60s could generate substantial gains for the wider economy”. The Commission promises “a particular focus on reducing early, permanent exit from the labour market well before State Pension Age”.

Decumulation

Relatedly, the report expresses concern about high levels of “encashments”, high drawdown rates, pension withdrawals while people are still working, and early access to tax-free lump sums becoming decoupled from retirement income in DC schemes. It says “the confusion caused by the 2014 reforms needs to be resolved”, with pension freedoms meaning that people “are expected to understand tax policy and investment projections and how long they will live and what their life will look like”.

It calls for “pre-emptive action”, saying a “strong approach to turning pension savings into incomes to last throughout retirement should be in place by default”, “support must operate as a genuine default”, and implies that a cap on charges in decumulation might also be needed.

Investment and charges

Higher contributions are “by no means the only or even the primary method of improving pot size”, with the Commission noting how much DC schemes’ investment returns vary.

Current deductions through charges are hailed as “a significant policy success” but the Commission says it is “difficult to see a justification” for the range of charges that providers may apply to different employers.

State Pensions and means-tested benefits

The Commission calls State Pensions “the backbone of retirement income for almost every pensioner”; its analysis shows that, even in the eighth decile of pensioner incomes, State Pensions provide more than a third of total income. It suggests that State Pensions themselves must remain “as universal as possible” but that the system of supplementary means-tested benefits may need to be renewed.

How much private pensions need to provide depends on the future value of State Pensions. This, in turn, depends on the uprating mechanism applied over the coming decades. Some commentators had suggested that the Commission could help different political parties simultaneously drop support for the Triple Lock, in the same way that its predecessor shifted debate on State Pension Age.

The Commission notes that the full New State Pension, as a proportion of median full-time pay, is already at around the level envisaged by the first Pensions Commission. Its analysis assumes that the Triple Lock – which increases State Pensions relative to earnings over the long term – will stay in place. How much State Pensions rise relative to earnings would then depend on the volatility of prices and earnings growth. The Commission says that policy will need to be “robust” to the risk that lower-than-expected State Pensions worsen the adequacy challenge.

Consultation

The Commission has asked for input to the next stage of its work to be submitted by 14 July.