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Pensions and Savings in the UK. Matthew Wakefield The Institute for Fiscal Studies January 2004. Outline. Why an economic policy issue? Responding to the ageing population Pressures on UK pensions system Conceptual framework What this suggests about UK policies

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pensions and savings in the uk

Pensions and Savings in the UK

Matthew Wakefield

The Institute for Fiscal Studies

January 2004

  • Why an economic policy issue?
  • Responding to the ageing population
  • Pressures on UK pensions system
  • Conceptual framework
  • What this suggests about UK policies
  • Reform as natural experiment: what economists can learn and contribute
  • Conclusions
why an economic policy issue
Why an economic policy issue?

Allocation of scarce resources

  • Between consumers in population
  • Across an individual’s lifetime

Reasons for policy intervention?

  • Equity
  • Efficiency/market failures
  • Paternalism
why hot policy issue now
Why ‘hot’ policy issue now?

Ageing population

  • Financial pressure on (state) provision
  • Ensure elderly get adequate resources
pressures responses
Pressures: Responses
  • Increase pension age
  • Reduce generosity of indexation
  • Reduce generosity of benefit calculation
  • Increased private (funded) provision
pensions green paper december 2002
Pensions Green Paper, December 2002

Why more reforms?

  • Under-‘saving’: 3million + 5 or 10 million

What reforms?

  • Simpler pensions & tax treatment
  • Better information
  • More flexible retirement

Not overhaul of ‘voluntarist’ system nor of incentives currently provided

the uk pension system 2003 4
The UK Pension system, 2003/4

Additional voluntary

contributions (AVCs)



‘Free-standing’ AVCs

Third tier



occupational pensions

(DB & DC form)

Personal pensions


State 2nd Pension (S2P)), formerly SERPS

Stakeholder pension



Contracted out

Contracted in

First tier (mandatory)

Basic state

(flat) pension

Pension Credit, formerly MIG

  • 1981: Price index BSP
  • 1988: Personal Pensions
  • 2000: SERPs generosity reduced (1986/1990 legislation, both halved SERPs generosity, reforms to be phased in)
  • 2001: Formal introd. of Stakeholder pensions
  • 2002: State Second Pension (S2P)
  • 2003: Pension Credit
  • ?2007? S2P made into flat-rate benefit
  • 2010-20: Retirement age for women to 65
what s the issue
What’s the issue?

Policy question

  • Are people saving enough?

Academic question

  • Are people saving enough?
conceptual framework
Conceptual Framework
  • Lifecycle model
  • Consumption (& saving) depend on:
    • total resources; prices (interest rate); preferences
  • Save to facilitate consumption smoothing
  • Also smooth through labour supply
the taxation of saving
The Taxation of Saving

Three points at which savings could be taxed:

  • Initial deposits (tax on earnings)
  • Returns on investment (tax on interest/ capital gains)
  • Withdrawals (tax on withdrawals)


  • “Comprehensive income tax”: TTE (or ETT)
  • “Comprehensive expend. tax”: EET or TEE
the taxation of savings in uk
The Taxation of Savings in UK
  • Interest bearing accounts: Taxed, Taxed, Exempt (TTE)
  • Private Pensions (EET(E))
  • ISAs (TESSAs & PEPS) (TEE)
  • A tax perk for the rich?
  • More help for the poor: a Saving Gateway?
a saving gateway
A Saving Gateway?

Matched savings vehicle to lower-income adults

  • Correct disincentives from benefit withdrawal
  • Correct low savings due to lack of knowledge/ habit


  • Targeting: those who already save
  • Targeting: those with good reasons not to save
  • Borrow to ‘save’
reform as a natural experiment
Reform as a natural experiment

Personal Pensions and Saving

  • 1988: New route for opting out of SERPs
  • First form of tax relieved retirement saving for those not covered by occ. Schemes
  • Normal Contracted Out Rebates (5.8% of earnings between UEL & LEL) plus 2% bung for years before 1993
  • Reduced SERPs generosity also announced
effects of personal pensions
Effects of personal pensions


  • How many savers?
  • Characteristics of savers
  • How much will people save?
  • How much of the saving is new saving?
  • Effect on public finances of reform to national insurance and SERPS
lessons from personal pensions
Lessons from Personal Pensions

People will respond to incentives:

  • No. of optants under-predicted by fact of 8 (Disney and Whitehouse, 1992)
  • Relevance to saving gateway?
lessons from personal pensions1
Lessons from Personal Pensions

Impact on Household saving rate

  • Substitution effect: new vehicle good value (+)
  • Offsetting from existing assets
  • Wealth effect of COR investment (-)

(occ pen holders and mis-selling)

  • 1989-90: £750m of £5.5 billion
  • 2001-02: £3 billion of £9 billion (0.3% of GDP)
lessons from personal pensions2
Lessons from Personal Pensions

Opting out and the public finances

  • “One-way bet” and opting out voluntary implies future SERPs reduction won’t recoup all of CORs paid.

Case study of PPs gives us economic analysis of substitution and wealth effects on savings, and also public finance analysis

  • Ageing population, pressure on pensions
  • UK system: complex and ongoing reforms
  • Will people have adequate resources?
  • Reforms as useful case study for analysis
  • But number of reforms and their interactions can complicate analysis
  • More importantly: difficult for families to plan their saving (stakeholder, PC, SG, ISA)
  • Plea for simplification then stability!