As good as it gets? The adequacy of retirement income for current and future generations of pensioners

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Executive Summary

Concerns about the future retirement incomes of today’s working age generations abound. The future living standards of today’s working age adults when they retire from work are at the forefront of debates on fairness between the generations. The public ranks this as its second-highest area of concern in terms of the chances of young adults having a better life than their parents’ generation – only home ownership attracts stronger pessimism. The opinion that young people today will ‘never be able to retire’ is one frequently volunteered when people are asked about their concerns for each generation’s quality of life.

These public perceptions are a reflection of the economic backdrop. Over the course of the 21st Century, household incomes for pensioners have performed extremely well and pensioner poverty has fallen by one-third. These outcomes are welcome, but they are set against the stagnation of working age incomes. As a result, households of working age now typically have slightly lower incomes than pensioners. In the context of future pensions adequacy this is concerning, because weak incomes – and the very poor earnings performance that is the main driver of these – reduce people’s ability to set money aside for later. Indeed, successive younger cohorts are currently accumulating less wealth at each age than their predecessors did.

Sitting alongside worrying income and wealth trends are cost pressures and a later retirement age due to rising longevity, and the long-term decline in generous ‘defined benefit’ (DB) pension provision. On this basis, it is no surprise that the mood on future retirement incomes is downbeat.

A range of reforms to both state and private pensions is underway, set in motion by the Pensions Commission 15 years ago

With concerns about the demographic outlook and declining private pension coverage apparent at the turn of the century, 15 years ago the government established the Pensions Commission to conduct a wholesale review of systems for both state and private provision. In 2006 the Commission’s final report made a range of recommendations, the key pillars of which were:

  • A flat-rate State Pension – uprated in line with earnings – with wide coverage to provide an easy-to-communicate base income in retirement that would incentivise private saving; and,
  • A national private pension saving scheme (or company alternatives) targeted at low to middle earners via a system of automatic enrolment – with a right to opt-out and modest compulsion on employers to match contributions.

Reforms since 2006 have largely built on these recommendations. The new State Pension was introduced from 2016, and auto-enrolment into private pensions has been steadily rolled out and ramped up over the course of this decade. While not without areas of concern – particularly the effect of rising contributions on current living standards at a time of weak income growth – this latter policy looks set to drastically improve private pension coverage, especially for women and low earners. For millennials (born 1981-2000), the policy has meant that almost two-thirds of private sector employees aged 30 are contributing to an occupational pension, compared to only half of baby boomers (born 1946-1965) at the same age. However, millennials are more likely to be contributing to less generous ‘defined contribution’ (DC) schemes, rather than the defined benefit pensions of old.

A detailed assessment of past and future retirement income adequacy is essential for informing current intergenerational debates

With deep public pessimism regarding incomes for future pensioners, divergent outcomes in current living standards across the age range, and a policy system currently undergoing huge change, the case for an in-depth look at the adequacy of retirement incomes is clear. This is especially important for the Intergenerational Commission, which is considering what further policy changes – in a range of areas including but not limited to pensions – may be needed to renew the intergenerational contract and restart generational living standards progress.

That is the subject of this report, the 12th for the Intergenerational Commission hosted by the Resolution Foundation. It presents detailed findings on the adequacy of retirement incomes for recent cohorts of retirees in Great Britain, along with projections of future adequacy both across and within generations for all of today’s working age adults. When considering adequacy we focus on both:

  • Retirement income levels, and the extent to which they fall below minimum acceptable standards; and,
  • Earnings replacement rates (the extent to which post-retirement income replaces pre-retirement earnings) assessed against the benchmarks established by the Pensions Commission.
  • Recent cohorts of retirees have experienced improving income levels, but earnings replacement rates have fallen short of adequacy benchmarks.

Our analysis of retirement income adequacy for recent cohorts of retirees covers those retiring from work over the decade-and-a-half up to 2012, mainly younger members of the silent generation (born 1926-1945) and the oldest baby boomers. This group reached retirement before the full weight of current State Pension reforms had been felt, and missed out entirely on auto-enrolment. In this sense, this ‘backward-looking’ analysis provides a baseline against which to consider recent policy changes and allows us to review the justification for reforms.

Income levels at retirement have performed well across the distribution for recent retirees. Overall, individual gross state benefit and private pension income in the years immediately following retirement increased by 24 per cent in constant-earnings terms between the 1927-29 and 1945-47 cohorts. This has been driven by growing private pension income, although increasing state benefit income in relation to earnings has played more of a role for women. Despite these welcome trends, there remains a stubborn core of around one-fifth of recent retirees who fall short of the Minimum Income Standard.

The typical earnings replacement rate in the years immediately following retirement for those retiring from the turn of the century to 2012 was 54 per cent. The figure varied across the pre-retirement earnings distribution though, with higher replacement rates at the bottom of the pre-retirement distribution and lower replacement rates at the top. Such a shape mirrors the one targeted by Pensions Commission benchmarks, but it is worth noting that typical replacement rates fell short of benchmark adequacy levels (for example, a target of around 67 per cent for those in the middle of the pre-retirement earnings distribution) for all but the lowest pre-retirement earners. Overall, nearly three-quarters (73 per cent) of those retiring between 2000 and 2012 (mainly the tail-end of the silent generation and the oldest baby boomers) fell short of Pensions Commission adequacy benchmarks.

These findings must be contextualised by the fact that certain circumstances and choices – like early retirement and the option of taking a lump sum – have reduced replacement rates relative to those for adults following the typical trajectory assumed in projections, or when setting benchmarks. But the strong conclusion remains that despite improving income levels, the old system has not delivered adequate earnings replacement upon retirement for current pensioners, providing a clear case for the changes to private saving currently underway.

Overall, future pensioners look set to experience similar levels of earnings replacement adequacy to recent retirees

Like our assessment for recent retirees, our projections of future retirement incomes are produced on an individual basis. We assume that beyond this parliament the new State Pension is uprated in line with average earnings growth, and account for the further roll-out of auto-enrolment.

At retirement age (assumed to be State Pension age) our modelling suggests that individual pension incomes for millennial men retiring in the 2050s (born largely in the 1980s) will on average be at similar levels to incomes for younger baby boomer men retiring in the 2020s (born 1955-1965), when expressed in constant-earnings terms. However, we find that constant-earnings terms pension incomes dip by around £25 a week for men in the younger half of generation X (the overall generation spans 1966-1980) retiring in the mid-2040s. Following a modest improvement in individual pension incomes for baby boomers retiring in the 2020s, our modelling suggests incomes among women will remain broadly flat for successive cohorts of generation X and millennials to 2060.

Consistent with our findings for current pensioners, we expect around one-fifth of new retirees to continue to enter retirement with an income below the level of the individual pensioner Minimum Income Standard. The risk is higher for women (around 30 per cent) than for men (around 10 per cent). Other than for baby boomer men retiring after 2020 who do slightly better, this pattern is consistent across generations.

Over the full duration of retirement, we expect a greater share of pensioners to fall below the individual pensioner Minimum Income Standard. That’s because pension income – a mix of state and private pensions – increases by less than earnings each year. By 23 years into retirement, we could expect over half of pensioners to have fallen below the Minimum Income Standard.

Turning to replacement rates for both sexes combined, we project that around three-quarters (77 per cent) of all cohorts retiring from 2020 will fall below adequacy benchmarks at their point in the pre-retirement earnings distribution, with the figure for generation X slightly worse. In all cohorts, those at the bottom of the pre-retirement earnings distribution are most likely to meet benchmark replacement rates. Including those close to meeting the adequacy measure (within 5 percentage points) improves the picture, reducing the share of ‘at risk’ adults to 60 per cent for younger baby boomers and millennials, and two-thirds for generation X.

While falling short of the Pensions Commission targets in the main, our findings suggest that typical replacement rates across the distribution for future generations will be broadly in line with those of current pensioners. Of course, caution should be taken when comparing actual outcomes in recent years to projections, given the inevitable simplification underpinning our input assumptions. But the common perception that future retirement income adequacy will be substantially worse than the current position appears wide of mark.

Within this overall picture, different patterns emerge for men and women. For women, replacement rates are broadly flat across generation X and millennials and within all pre-retirement income quintiles. But these outcomes represent a step-change upwards from the replacement rates experienced by recent female retirees – of around 10 percentage points in quintile 2, falling to around 5 percentage points in the top two quintiles of pre-retirement earnings. Again, caution should be taken when comparing actual outcomes to projections, but this step-change finding is consistent with the growth in private and state pension provision for women that has occurred in recent years.

Replacement rates fall for men across the pre-retirement earnings distribution between the younger baby boomers and generation X. They then rise through to the millennials, increasing by around 5 percentage points in quintiles 2 and 3 between the older members of generation X and the millennials. This pattern of change will partly reflect the fact that auto-enrolment arrived too late to offset falling DB provision among older members of generation X (who are due to retire in the 2030s). However, it will also be driven by the fact that generation X is likely to record stronger wage performance in its pre-retirement years than those who came before.

The evolution of policy – and the performance of the economy – demonstrate the sensitivity of these outcomes

Of course, our projections are much too uncertain to be considered predictions of what will come. Instead we take them to provide an indication of the likely relative differentials in retirement income adequacy for future generations of pensioners. By way of considering how these differentials might react to alternative assumptions, we have also modelled the impact of other scenarios reflecting possible changes to either policy or the economy:

  • A more generous State Pension: The continuation of the ‘triple lock’ (as opposed to our central assumption of a State Pension uprated with earnings) would have a significant upward effect on typical replacement rates. The effect is broadly consistent across sexes, boosting replacement rates of the lowest-earning millennials by around 7 percentage points, and by around 2 percentage points for the highest earners. Clearly a higher State Pension would improve adequacy, but that doesn’t mean the triple lock is the best way of delivering such an improvement. In particular, the ratchet approach is not well targeted either inter- or intra-generationally. And it means that younger cohorts have to fund the rising cost throughout their working lives. Aside from the policy mechanism via which change occurs, the key point here is that increases or reductions in the value of the State Pension have a big impact on retirement income adequacy, particularly at the bottom of the earnings distribution.
  • Reduced auto-enrolment coverage: Maintaining the high level of private pension contributions that auto-enrolment has so far achieved will be increasingly tough as minimum contributions rise. A significant fall in coverage – we model the share of private sector workers outside of a scheme increasing from 20 per cent to 35 per cent – would have the greatest effect on women and low to middle earners, potentially reducing typical replacement rates by 3 or 4 percentage points.
  • The performance of the economy: If the recent poor performance of productivity growth were to persist over the longer term, we would expect the level of future retirement incomes (indeed the incomes of all households) to be around 30 per cent lower in constant price-terms compared to our central assumption, reflecting a more slowly expanding economy. However, the extent to which retirement incomes will replace pre-retirement earnings is little affected given a similar real rate of return on pension savings in relation to real earnings growth. It’s also possible that investment returns might underperform absent sluggish earnings growth, which would bear down on both retirement income levels and earnings replacement rates. And it is important to note that only DC pensions expose the individual to such risks, so the move towards DC provision leaves future generations more exposed to shifts in the economy than compared to the largely DB system experienced by today’s pensioners.

While these are scenarios around our central assumptions, they represent feasible examples of potential developments in the coming years that could derail future retirement income adequacy. These are among the areas in which policy attention ought to focus.

Our analysis of current and future retirement income adequacy shows neither pessimism nor complacency is warranted

In contrast to other areas of intergenerational analysis, the modelling we set out in this report suggests that retirement income adequacy has the potential to be fairly similar for future generations to the outcomes experienced by today’s retirees. In many respects this is due to action being taken over the past decade to prevent a deterioration in outcomes across future cohorts of pensioners. The outcomes we have projected remain at risk but, compared to areas such as our crises in housing and social care funding, there is a broad consensus and existing policy framework to, at a minimum, respond to future challenges.

Yet policy makers will and should still aspire to drive outcomes for future retirees closer to Pensions Commission adequacy benchmarks, particularly in the context of deeply concerning generational living standards trends in the labour and housing markets. The multiple ways in which policy changes in the coming years can boost living standards in retirement for future generations of pensioners remains a key consideration for the Intergenerational Commission.