27 July 2017
Live long and prosper
Countering the Catch-22 of the state pension
By Frank O’Nomics
Naomi Campbell may have cause to be a bit upset. As someone in the UK born just after 5th April 1970, she may just miss out on being able to claim a state pension when she is 67, having to wait at least another year.
There is a strange irony in having an announcement that the government is contemplating raising the age at which we can receive pensions at almost the same time as news that the growth in life expectancy in the UK has started to tail off. Surely this suggests that the state can be more relaxed about funding shorter retirements? Sadly, the recent State Pension age review by John Cridland really just acknowledges a much longer-term increase in longevity, and the report on life expectancy is somewhat questionable.
The Cridland Report starts reassuringly by recommending that the State Pension age should continue to be universal across the UK but, in bringing forward the rise to 68 from between 2044 and 2046 to between 2037 and 2039, it leaves us wondering whether further changes will be made before those born after 1970 hit the critical age. The report argues that the pension age should increase over time to reflect life expectancy, which for many raises the Catch-22 prospect of never quite getting old enough. If that is the case what do we need to do to address the potential retirement income shortfall?
The State Pension age is increasing because there is no pot of money to provide the pension, and it is clear that future generations will not be able to afford to pay for an ever-increasing retired population from tax receipts. Every year that the pensions age is increased saves the government 0.3% of GDP. It also leads to increased employment rates. If everyone worked one year longer it would add 1% to GDP. By bringing forward the increase to 68 by 7 years the government can save £74 billion. Given that there will be growing demands on the healthcare system, such savings are likely to be badly needed.
If the increase is inevitable, just what will the likes of Naomi miss out on? The current state pension is £159.55 a week or £8,296 per year so the victims of the delay will need to save sufficient to cover this shortfall if they had previously expected to rely on it. For Naomi this may be just take one day of “getting out of bed for less than £10,000”, but for the majority it will be a more difficult task. If we then look at the Catch-22 scenario, where we never quite catch-up with a rising State Pension age, we will need to save a great deal more. Generating a sum equivalent to the current State Pension would require a pension pot of £161,850, and if you wanted to ensure that the income generated kept pace with inflation, that pot would have to be £276,900. This would involve a lot more trips down the catwalk.
You might suggest that this gloomy scenario does not fit with the moderation of increases in life expectancy. A recent review by Sir Michael Marmot showed that the rate at which lifespans were increasing had halved since 2010, to around one year longer every 10 years for women and every six years for men. Commentators have extrapolated this trend to suggest that life expectancy will start to fall – but this seems very speculative. Looked at over the longer term, there have been similar slowdowns in increases in life expectancy, with considerable volatility over any three-year period. Future advances in healthcare, and particularly any improvement in treating diseases such as dementia (where the death rate has been rising) could prompt a fresh spurt in expected lifespans.
Are fears of never getting a State Pension justified? Given the increase in the proportion of the population that will be made up by the elderly, it seems eminently possible that, at the very least, the State Pension could become means tested. This may seem entirely reasonable for retired super models, but for many it would mean a fundamental review of their saving plans. Anyone currently aged 40, who needs to make up a £8297 income shortfall when they are 68, would need to start saving into a pension an additional sum close to £700 per month. Clearly, if they wanted to retire earlier this sum would be higher, just shifting your target age to 67 involves saving another £60 per month.
There are ways of mitigating the increase in the pension age to 68. One is to allow those who are poor, or ill, to take a pension earlier. The latter would make sense given the longevity issues, but the former raises some moral hazard issues – what is the point of saving for a pension if the state will cover me if I don’t? The other alternative would be to allow people to take a reduced pension at an earlier age. This would seem to be a much fairer basis, both in helping those who cannot find employment, or find work too demanding, and in incentivising others to carry on working by offering a greater pension when they stop. Hopefully such alternatives will be reviewed before the government finally legislates to bring forward the increase to 68. The Cridland Report argues that the pension age should not change by more than one year over any 10-year period, and that individuals get 10 years notice of any change. This does at least mean that we will have some time to adjust our saving patterns – but that adjustment can only be up.
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