- Thinktank the Tony Blair Institute (TBI) sets out plan for radical overhaul of the state pension
- Scrapping the triple-lock should be the first step toward keeping government spending on pensions under control, the report argues
- Plans are set out for a ‘Lifespan fund’ that would let people take state pension income earlier at a discounted rate…
- …this could even include withdrawals to cover a period out of work pre-retirement, with higher National Insurance (NI) rate when returning to employment
- Complex overhaul of the state pension system is unlikely in the near future, but report raises key debate over sustainability of the current system
AJ Bell director of public policy, Tom Selby, says:
“The triple-lock has become a totemic symbol of support for older workers and pensioners, with no political party yet prepared to tackle the question of how we fund the subsequent growth in state pension spending over the long term. Inevitably, a state pension which rises faster than wages and inflation over time can’t be sustained indefinitely without massive cutbacks elsewhere.
“The only levers government has on offer at the moment to control state pension spending are how much and when – the amount the state pension pays and when people can start claiming.
“That’s why the UK state pension age is already on-track to rise to 68 and could in the future increase further or faster – or both. Naturally, many people look at healthy life expectancy data and worry they’ll be too unwell to enjoy their retirement, if they reach state pension age at all.
“Against that backdrop, a radical plan to overhaul the state pension and replace it with a more flexible system that allows people to take a lower income but start claiming earlier might seem sensible.
“But the proposals are complex and the prospect of the government calculating an ‘actuarially fair’ retirement income for each individual based on key details like their personal health records feels somewhat dystopian, and would clearly be vulnerable to people gaming the system by over-stating ill-health and habits like drinking and smoking.”
Today’s state pension
“The state pension we have today is relatively simple, at least in comparison to the TBI’s proposals.
“To qualify for the full state pension you need a 35-year NI record. If you’re short of a few years – perhaps because you worked abroad for a period of time – you can top up. If you’re not paying NI because you’re caring for children, for example, you can get a credit so you’re not left with a gap in your record.
“A universal state pension age applies to everyone and, while you can choose to delay taking a state pension in order to boost the income slightly, you don’t have the option to take it early. That means those in poor health who may prefer to receive a lesser amount sooner don’t have that option, and recent analysis of life expectancy data highlighted that in large swathes of the UK healthy life expectancy is now below state pension age.
“Once you claim your state pension you benefit from a watertight guarantee that it will pay out until you die and, at the very least, the spending power will be protected. But the triple-lock inevitably ratchets up government spending on pensions over time as a result, a big factor behind the cost as a share of GDP steadily increasing.
“In short, the current state pension is fairly straightforward and provides people with certainty, but it is increasingly expensive and pretty inflexible.”
TBI’s Lifespan Fund
“The TBI’s blueprint for a complete overhaul of the system centres on a new ‘Lifespan Fund’.
“For the public the main selling point is increased flexibility, with the ability to take a discounted income earlier provided you can show your total income meets a minimum floor. There would also be an option to receive some income during working life to help manage periods of financial strife, reviving your contribution record with a higher NI contribution rate when you go back to work.
“The income you get from the state would be ‘personalised’, providing a guaranteed income for life that reflects your age and health status – much like an annuity, this means the younger and healthier you are the less you get and the older and sicker you are the more you get.
“The option of flexibility is likely to appeal. But the prospect of an income being determined by the state depending not only on age, but health as well, would prove hugely controversial. Although it attempts to address the issue of those in poor health receiving little or no benefit from the state pension system today, it would surely give way to new fairness concerns. The approach comes with serious moral hazard, and many people would inevitably feel aggrieved that their neighbour received a higher income due to poor health. There would clearly be an incentive for people to try and game the system by over-reporting health concerns too.
“From the government’s perspective, the big appeal would be moderating long-term costs. The state pension is funded on a rolling basis – tax generated today pays pensions today, rather than being paid forward to fund your own retirement income in the future.
“An ageing population means state pension costs as a share of GDP are set to rise sharply, with more pensioners and fewer working taxpayers to keep the system afloat.
“The TBI proposals rip up the current system and save money in the process. Most of the cost reduction comes from moving away from the triple-lock toward a smoothed link with earnings growth.
“The other big cost saving, which represents a radical departure from the current system, is the proposed plan to effectively limit entitlement. Under today’s system everyone is entitled to the same pension until they die, effectively meaning entitlement is only limited by your own longevity. The TBI plans flip that on its head. Notionally everyone would be able to get 20 years of income at today’s state pension level, but that income would be adjusted according to life expectancy. So someone age 65 in good health expected to live for thirty years to age 95 would get around half the income of someone in mediocre health with a projected life expectancy of 80.
“These proposals really would represent a radical departure from how the state pension in the UK works today. Being able to access your state pension earlier at a reduced rate could benefit some, particularly those with lower life expectancy. But most people simply have no idea how long they might live for and if large numbers of people go down that road, it could exacerbate retirement income challenges later in life.
“Moreover, moving from a single tier benefit to a flexible benefit would create fiendish complexity, both for people engaging with the new system and in transitioning from the current framework.”
Could these proposals work?
“It’s worth bearing in mind that the state pension was radically reformed a decade ago and those reforms will still take decades to work through – another massive overhaul could create even more uncertainty as well as complexity.
“The report is absolutely right that the triple-lock will need to be scrapped at some point, but it also opens up a debate on whether the state pension itself should be a stable foundation or a more flexible income people can tailor to their needs.
“Some aspects of the report could be a decent guide to future policy thinking. For example, moving to a smoothed earnings link to uprate incomes in retirement feels a reasonable compromise.
“Likewise, it isn’t completely inconceivable that people could be permitted to take state pension income more flexibly at a younger age in exchange for accepting a discount.
“Even the idea of allowing people to access their ‘Lifespan Fund’ during periods out of work, topping up their entitlement with higher NI costs later on may also have some appeal as a means of smoothing the impact of financial shocks and incentivising people to start contributing to the system again in future.
“However, the most radical ideas, like setting incomes based on personalised life expectancy and health data, will surely never get off the ground.”
