UK pensions are increasingly unequal. Seven million UK workers and millions of pensioners enjoy generous defined benefits (DB), whilst the defined contribution (DC) pensions of those who follow are unlikely to deliver the incomes needed to maintain their standard of living.
UK pensions are increasingly unequal. Seven million UK workers and millions of pensioners enjoy generous defined benefits (DB), whilst the defined contribution (DC) pensions of those who follow are unlikely to deliver the incomes needed to maintain their standard of living. The Resolution Foundation has carried out research which says that pensioner incomes now outstrip those of working age families. These working age families also must save more towards their own retirement as employers’ contributions are now less generous.
The real Living Wage has been important for low paid workers. A real living wage employer aims to pay a socially acceptable level of income. The pensions system should also aim to deliver a socially acceptable standard of living – a “Living Pension”. The Centre for Research in Social Policy (sponsored by the Joseph Rowntree Foundation) carries out research into “Minimum Income Standards” (MIS) which is used to calculate the real Living Wage. The MIS for a single pensioner in 2016 was £13,575 pa. This could be the proxy for the Living Pension.
We have worked with the Joseph Rowntree Foundation to develop this idea further. We were asked to design a benefit structure which distributed pension costs more evenly across the workforce. The Single Tier State Pension (STSP) gives a base line and nearly all workers are eligible. Therefore to achieve this socially acceptable level of pension, a scheme needs to provide an income of around £5,500 per annum. So, does the minimum level of contributions under automatic enrolment provide this level of pension? This is more likely to be achieved the more risk is taken, but because DC delivers different outcomes for people depending on the investment choices made and the time period concerned, it is not clear that DC auto-enrolment delivers what is required. But, DC outcomes can be improved. For example, the level of risk and contribution levels in the fund could be set based on the likelihood of achieving the Living Pension including the STSP.
The Local Government Pension Scheme (LGPS) provides a certain income, but the target benefit is too high for a low paid worker. LGPS benefits can be very generous for low paid workers, particularly when taking into account the STSP as well. These individuals are paying for a pension they do not need, to the detriment of their standard of living during their working life. The basket of goods which is used to calculate the real Living Wage does not include an allowance for making provisions for retirement, so even workers who are paid the real Living Wage may be taking home less than they need for a socially acceptable standard of living in practice.
Therefore the answer must provide more certainty than DC, but does not need to be as generous as the usual defined benefit options. Our solution was a defined benefit scheme which targets about £5,500 pa, accrued over the working life and with limited increases and dependants’ benefits.
Companies which provide defined benefits often face large concentration risks within their pension schemes, with a large proportion of the risks associated with a small number of highly paid employees. A Living Pension design removes much of this concentration of risk, because the risks and spend are more equitably distributed across the workforce.
With high levels of intergenerational unfairness and unaffordable contributions for many, the current system is not fit for purpose and so new models for sustainable benefit provision are needed. Companies should revisit their benefit offerings considering member outcomes (i.e. a socially acceptable standard of living in retirement) and explore alternative methods of delivery. In many cases, this could mean an adequate benefit could be provided at an affordable cost, with lower risks to companies than traditional defined benefits and a lower risk to the employees who can least afford inadequate standards of living in old age.