One thing I hear regularly from people of a certain age is that “there will be no state pension by the time I retire…”. The Second Pension Commission report came out a couple of weeks ago and that’s not what they think.
Over the last 16 years the UK state pension has risen relative to earnings. Before 2010 it only increased in line with price inflation. The Triple Lock was introduced in 2010 and increases the state pension by the highest of overall wage inflation, price inflation or 2.5%. It now represents about 30% of median UK earnings, up from around 20% in the pre-Triple Lock days. However, this in turn had been a sharp decline from when it had been up around 30% in the late 1970s and the policy was designed to reverse this decline. 2010 was the David Cameron / Nick Clegg coalition government, still very much in the wake of the GFC and austerity.
The total replacement rate number (the percentage of your working age salary you receive as a pension) in the UK is about 54%. This is fairly unremarkable – the OECD average is 63% but is a result of several factors. Many of the higher replacement rate countries are relatively lower earners – I see Turkey, Mexico, Colombia near the top for example, but Mexican median earnings are about £4,000 per year with a replacement rate of about 80%. Germany, the US, Australia and Norway are all at a similar level to the UK in percentage terms.
This leaves private pensions needing to take up a lot of slack and Automatic Enrolment (AE) has been one of the more successful government policy interventions of recent times. Workplace pension participation was just 47% in 2012 before the introduction of AE and is now 79%. Participation among those eligible is higher still at 89%. The freedom to opt out is considered an important part of the policy but neither the report nor I know why 11% of people actually do this.
One consequence of AE has been a dramatic rise in the number of people in Defined Contribution (DC) versus Defined Benefit (DB) pension schemes. Before reading the report, I had perceived DB schemes to have all but disappeared, but more people had a DB pension than DC as recently as 2013. DC is not forecast to overtake DB by size of assets until 2030. These are all private sector numbers and doesn’t include the public sector.
One consequence of this is a higher dependency on market returns for future outcomes. Over the last ten years to the end of May, the annualised UK equity market return has been 9.3% vs 13.9% for global equities in GBP. Recent calls to mandate more investment by pension funds into the UK market would have a large impact on pension outcomes if these trends continued in the future. On my maths £1 invested for 40 years at 9.3% gets you £35.10, while 13.9% will get you to £181.70 – 5x the amount.
Will the state pension still be there when today’s middle-aged cohort retires? It is true that the UK is caught in several well-known long-term trends. We are living longer while birth rates are slowing. Older people are becoming a bigger percentage of the population.
Even recently life expectancy from 65 has increased. For men it was 18.2 years in 2004 compared to 19.9 years in 2024. There is a similar relative increase for women going from 20.9 years to 22.6. These increases are either side of 9% in 20 years – a significant amount at a national level.
The UK population replacement rate is around 2.1 children per female. In 2012 we were producing 1.88 children per female, and it is now down to 1.42. This reduces the size of the future work force as well as future tax and pension contributions.
Also part of all this – reappearing continually in the UK – is our relatively low productivity, leading to stagnant wage growth. Please don’t forget productivity in the economic sense is not about rolling your sleeves up – the UK is not some kind of workshy outlier. In the economic sense it is education, training, investment, infrastructure, resources, technology. Much of this is in the government remit and is bipartisan. We could argue about where it is going to come from, but nobody is against higher productivity.
Pensioner poverty is also hopefully a bipartisan issue. At the turn of the century 28% of pensioners were in relative poverty after housing costs. This is defined as more than 60% below the median income. In other words, if you are living solely off the state pension you would meet the definition of poverty even at today’s 30% of median income. Following large scale pension reform, the number of pensioners living in poverty has fallen to about 16%. This is now lower than working age parents at 25%.
The first Pension Commission had identified the state pension level of 30% of median income as a good starting point for a healthy overall replacement rate. They then thought 15%-18% each would come from AE and further voluntary savings to get a replacement rate somewhere around the mid-60s and up around the OECD average.
There are likely to be continued adjustments to retirement age. The Triple Lock is contentious. The argument around it resurfaces at regular intervals and it may also be tweaked and adjusted at some point. There is a debate to be had about the balance between competing demands on the state and intergenerational fairness. But there is significant long-term planning and policy around these well-known population trends and their impact on pension economics, which have been implemented and endorsed by several governments of different parties. Scrapping the state pension would be a particularly shameless U-turn that would be hard to explain in the context of recent policy. I highly doubt any government of any party will entirely cancel or even significantly devalue the state pension in any foreseeable future.
Robert Fullerton – Senior Research Analyst
FPC26712
All charts and data sourced from FactSet
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