THE 2021 FESTIVAL OF SOCIAL SCIENCE RUNNING 1-30 NOVEMBER 2021
Why are pensions important?
What’s on offer?
Each year early career economists at IFS deliver a day of public economics talks, aimed at A-level and undergraduate students who have an interest in economics or might want to pursue a career in public policy research. As part of this year’s Festival of Social Science, we will be live streaming a selection of lectures from the series to anyone who is interested in finding out more about economics. There will be time allowed for Q&A on each topic.
What’s it about?
Why should people save for retirement and why do governments intervene in people's pension saving decisions? How has the UK pension system changed over time? This lecture will discuss key themes around pension saving, specifically discussing the UK policy context.
Who’s leading the event?
Heidi Karjalainen, Research Economist at IFS
Open to
These webinars are primarily aimed at final year undergraduates studying economics, but should be useful to anyone interested in the subject.
good afternoon everyone and welcome to
the event why are pensions important
my name is george stoy i'm an associate
director at the ifs and i'm going to be
chairing today's session
this is the first in a series of public
economics lectures which look at a range
of topics in public economics
and they're going to be on every monday
at the same slot so if you're interested
please join us next week we'll be
talking about income inequality
so what's going to happen today is that
my colleague haley carolinan is going to
talk to you about pensions why we as
economists think that it's important
that people save and how you can
motivate them to save more
she's going to talk for about 40 minutes
and then this can be time for a question
and answer session those aren't those
questions you're gonna be based on uh
questions from the audience so if you
could get typing away on slido as the
talk goes on we'll return to those
questions and see what haiti has to say
about them at the end of the event so
without further ado i'm going to pass on
to haiti
thank you very much george um so yes as
george mentioned i'm a haircut caroline
i'm a research economist at the iff and
i'm going to be talking about
why are pensions important
and
to answer this question um
i'll start by talking about why people
say for retirement
and why why they should save for
retirement
i'll also talk about why uh what is it
about pension saving in particular that
means that governments tend to intervene
in pension saving
uh and i'll finish off with talking
about uh the uk pension system in
particular so how does the uk government
intervene in the in people's pension
saving
and how and why has that changed over
time
so to start off
i'm going to just generally talk about
pension savings as i mentioned why do
people say for retirement why should
they
and i'm going to start by talking about
a standard life cycle model
so this is a model of saving and
consumption that we use in economics
where
we have periods where people work and
they receive income and each in each
period people can choose to either save
or they can choose to consume
so if they they basically face this
trade-off if they consume today they get
the benefit of that today but if they
save they can consume later
um so
and the most that people can consume or
save is the total of the income in that
period and any kind of accumulated
savings from previous period
and i'm going to start by introducing
the most standard version of this model
where we assume perfect certainty so
people can make these decisions with
perfect knowledge of the number of
periods that they will live and work and
so on
and they also know what their income is
going to be in each of those periods and
i'm going to discuss why that might not
be a reasonable assumption in a bit but
i will start with the very standard
version of this model
we could also add things like returns on
savings or borrowing against future
earnings and things like that in this
model but that's we're not going to be
showing that here
so
um so here we're going to be looking at
an individual
and this individual is working from age
22
and they're going to be working until
age 68
and they're they're earning 25 000
pounds a year
and they know that they're they're going
to live until the age 100. so they know
that they will have this 32 years period
of no income
now why might people want to save for
retirement according to this very simple
model well they might want to smooth
consumption so in order to maintain a
level of income and consumption in
retirement people will have to save
during the years when they work
so for example if we assume that this
person wants to maintain a constant
level of consumption and expenditure
shown here by this red line at about 15
000 pounds a year which is the total uh
lifetime income earned by that person
divided by the numbers number of years
that they they live
um they would have to accumulate wealth
during the years when they're working
and then decumulate uh
with this while they're in retirement so
here uh people will be saving this
amount between um their income and
consumption and then in the early or
during the years that they're in work
and then in the later years uh they're
decumulating so dissaving or just
withdrawing that those uh assets and
savings that they've accumulated by that
point
so this is essentially the consumption
smoothing rationale for retirement
savings so people retirement saving is a
way for people to move resources from
the years in which they work
to the periods when they're retired
a particular
and a particular part of pension saving
that makes it so challenging uh is that
even with uh if if we're looking at
people who have no cognitive limitations
they have kind of perfect financial
literacy they understand pensions
completely they don't face any market
distortions or behavioral biases
even for those people what's uh what's
true about their uh what about their
their lifetime is that they don't know
when they will die
and this is something that in the
context of pension saving we call
longevity risk so people face a risk of
living less or more time than what they
had expected to
so for example in our uh in this example
that i showed you um if the person got
to a hundred years old and then realized
that they had
another 10 years of life left they would
have already accumulated all their
wealth by that point and they wouldn't
be able to maintain the level of
consumption that they previously had
so how could we solve for this um so the
way that people kind of traditionally
can protect themselves from longevity
risk is uh by having what's called an
annuity and people can buy a financial
product called an annuity
so this is essentially a product that
guarantees to pay a fixed income to
until until death and like with any
insurance product here the insurance
provider takes on the kind of longevity
risk and you essentially have to pay an
insurance premium for this which in this
case means that the payouts that you can
expect to receive will be smaller than
the amount that you spend
to buy this product in the first place
just to give you a sense of this for
example if you were 60 and wanted to buy
an annuity this week
with a 50 000 pound pension pot you
could buy an annuity that would pay uh
pay you just under two thousand pounds a
year until until death
now that might not sound like a lot uh
especially if you expect that you might
only live
say ten years after sixty but actually
life expectancy for women for example
women who turn 60
now is about 30 years so they can expect
to live up to age 90. so the insurance
company in that case would have to pay
such a woman about 60 000 pounds over
those 30 years
so with this kind of product people can
maintain that stable level of
consumption until the end of their uh
life
so if essentially if people value stable
consumption they can insure away the
risk of running out of income by
purchasing an annuity
so essentially this is why pension
saving is important it's a it's a way
for um to move resources from working
life to retirement and in case of an
annuity or an annuitized
saving product also
can also guarantee an income in
retirement protecting against longevity
risk
now
if we think of the standard lifecycle
model
in this model people face this tradeoff
between saving and consumption
and if they are as the standard model
assumes fully informed that they can
calculate their returns on savings there
are no market distortions and so on
people
according to the model will make the
right choices for themselves when
they're deciding how much to save for
retirement and how much to consume today
and if they're worried about longevity
risk they could annuitize their savings
however in reality what we see is that
is quite a lot of government
intervention when it comes to pension
saving
so we i'll now kind of explain why that
is so why can't the government trust
people with these decisions about their
pension saving
well there are many reasons why people
may not behave as the traditional model
predicts
so we have both behavioral biases
which mean that governments think that
they need to interfere and also some
things that might lead to market failure
so firstly
many of you might have heard of these
behavioral biases also in the context of
pension savings
so some of these include present bias so
this means that people save too little
because they so value consumption more
today and they over discount
consumption in the future so people
might for example think that you know
they will they prefer consumption today
they will start uh saving tomorrow but
then when tomorrow comes around they
will again uh prefer consumption in that
current period uh and and and will not
uh save
uh another very uh
thing that we talk about a lot in the
pensions uh space and his pensions
policy is inertia so this is basically
relates uh the fact that people stick
to a default option um
when it comes to their pension savings
and in general there's more cognitively
difficult decisions so there's this kind
of lack of engagement uh with with
pension-saving decisions and people tend
to not uh react to to changes in their
circumstances and so on
so that's what we mean by inertia
another bias uh that we see in uh is is
in people's thinking is the bias
in assessing probabilities of future
events
so people often inaccurately assess the
risks and uncertainty that um
that are related to
many of the components of pension
savings and they can be overly
optimistic or pessimistic about these
really important aspects so
there are a lot of things that are that
can be uncertain like what are their
lifetime time earnings growth going to
be or what are the kind of level uh
returns that people might expect to see
on their retirement and we also know
from some earlier ifs research that when
people are asked about how
likely they are they think that they are
to survive to a certain age
they're generally too pessimistic about
surviving past
age 75 or 80 or 85 and of course this is
huge importance in the context of
pension savings because it means that um
that people might think that they're
gonna live
uh or die earlier than they actually
will and that that means that they might
not save enough or might run out of
money
so these are the kind of behavioral
biases that we see which mean that uh
governments uh will will want to uh
intervene and fix correct for
uh in addition to this there are other
reasons um so
the pension saving is kind of inherently
a very difficult uh uh difficult um
thing to do
understanding all the different aspects
of risk and return being able to
calculate expected returns accurately
making decisions between different
products and so on all of this is hugely
difficult so a lot of people don't
necessarily have the required level of
financial literacy or
or knowledge of of pensions
um so these are all the kind of all
sort of different biases that push
people away from uh the decision from uh
for to save for a pension
so
a government might want to intervene if
they think that the right decision for
people would be to save
but the government could also decide to
intervene because of market failure in
the pension market
so
in particular in the annuities market
that i talked about so this is the
insurance product that gives people um
an income stream for for until death
um
there's a lot of asymmetric information
in insurance markets which leads can
lead to adverse election and potential
market failure
so essentially again
annuities and insurance against
longevity risk
so of course this kind of guaranteed
income until the end of life is more
valuable for someone in very good health
who is more likely to live longer or
it's not necessarily worth purchasing
for someone who knows or thinks that
they only have a few years of life left
so we might end up in a situation in the
annuities market where the insurance
companies offer annuities based on
assumptions around kind of the average
health and longevity of the population
but only those with very good health buy
these annuities so then these juris
companies end up losing money
on annuities because they end up paying
out for longer than they'd expected and
this can lead to a situation where the
whole market uh collapses or at least
becomes very unattractive for uh most
people
so this is what we call adverse
selection and this is the reason why
these kind of pension products or
longevity insurance as well as well as
other types of insurance like health
insurance and social care insurance
more generally are so difficult for
private markets to provide
there is also another reason why
governments might want to intervene in
pensions and that's for redistributional
purposes um so pensions can
redistribute income between different
people and pensions can do this in a way
that where redistribution is done based
on uh lifetime earnings rather than a
single year of earnings
and this you know is of course important
but this is not what we're going to be
focusing on today
but so this is why the government needs
to intervene in pension savings so the
governments uh generally understand that
pension saving is important because it
helps people smooth their consumption uh
over their lifetime
and they see that because of these
biases and distortions people wouldn't
be doing it if it wasn't for uh the
government uh intervention
so how is it then that governments uh
intervene so i'm now going to be talking
about first just public pension systems
more generally uh before moving on to
the uk uh context specifically
so many countries have uh these public
pension systems where essentially the
way that um governments push people into
saving into for their retirement is by
having them pay taxes and mandatory
contributions
into pensions during their lifetime and
then they will receive a pension benefit
from the state in retirement
we can all also call this sort of social
insurance the government has this
structure to ensure people from
poverty and retirement as well as
longevity risk
um
so
when we're looking at these uh public
pension systems in general i think it's
really important to first make the point
of the kind of context in which most
developed countries find themselves when
it comes to demographic change
so as you know
populations are aging so people are
living longer than ever
this graph
shows that for the uk
um when we're looking at in the 1980s uh
men and women who turned
60 in 1980 how many years were they
expected to to to live at that point so
in 1980 women were expected to live
until 83 and men to 79. now what this
graph shows is that that number uh that
life expectancy has increased for both
uh men and women over uh since the 1980s
but quite dramatically so
women can now expect to live uh seven
years longer and men a whole nine years
longer
and
and also what we see here is that if we
look at these projections for 2060 this
trend is expected to uh continue
so
on this slide i'm going to be talking
about how this affects a public pension
system uh this system where people pay
taxes and mandatory contributions during
their lifetime and receive a pension
benefit from the states in retirement
um in particular what's important to
understand here is i'm going to be
talking about specifically a
pay-as-you-go
public pension system so that's what
this
payg refers to here so this means that
under this kind of system which we have
in the uk for example um
this means that the current pensioners
pension benefits are paid out of current
taxation so it's not paid from the
pension contributions that they paid for
themselves so for example
my pension my tax
payments today
are funding the the
pensions of of retirees today
and then
when i'm in retirement that will be
funded by the taxpayers at that point
um so i'm going to be listing kind of
different demographic trends and show
their impact on these the taxes and
benefits as well as uh the
pay-as-you-go pension system uh in
particular
so
as i already mentioned people
now tend to live longer and what this
means is that uh
the total pension payments for
governments are higher because uh people
because there are all these additional
years in which people
uh will have to
or the government will have to pay their
pension benefit pension benefits
so that means that there's more money
going out uh over uh over time
the other side of this is that you know
of course if people just uh
stayed in work the same number of years
longer than as their life expectancy has
increased we wouldn't necessarily have
this issue of governments having to
pay tax pay these pension payments for
more years but what we see is that
actually people spend more time in
retirement
uh in the last couple of decades or in
the last decade or so
we have seen an increase in the
employment rates among
older workers but for example if we're
looking at older workers uh or men aged
60 to 64 today
their employment rate so is about 60 so
but
about six in ten
men in that age group are in work
whereas in the 1970s it was closer to 80
percent
so essentially people are not uh
retiring kind of sufficiently later to
make up for the increase in life
expectancy so they spend more time in
retirement
people also enter the labor force later
so this is mostly because of university
degrees becoming so much more popular
but in together this means that people
spend a smaller proportion of life of
their life paying taxes
the other thing that we see in most
developed countries is that fertility
rates are falling so that means that
also in the future there are less
taxpayers in total
so both of these things then together
means that there's less money going into
the pay-as-you-go pension system so
essentially we have this imbalance where
we have less money going in more money
going out
and this is a challenge the
sustainability of public pension systems
so what can a government to do to adjust
it for this uh well they could try and
fix this by balancing the size of these
two arrows
so
firstly a government could increase
people's mandatory contributions or
taxes to help pay for the bigger pension
payments
so this is what uh governments in many
european countries have done in
particular
uh so those countries uh trade pension
as a social insurance like i mentioned
uh social insurance is a way in which
the state collects contributions and tax
and then protects us against risks such
as sickness unemployment or or longevity
or poverty in old age
so in the context of pensions this means
that people
pay this pension contributions there
during their working life and then earn
usually an earnings related pension from
the state
in retirement
um so when the contributions are
increased in this social insurance
system you make it more sustainable
because there's more money going in
it also means that there's more
redistribution both for the kind of less
well of pensioners and also from the
younger
generations to older generations but
this choice just come with potential
trade-offs so increasing taxes
can lead to
can lead to labor supply distortions and
what i mean by that is that it can
decrease the incentive to work so when
people have to pay more tax
they are
receiving a lower wage for the given
amount of work that they've done
and they might respond by working less
and this can increase debt weight loss
and this is what we often call the
equity efficiency trade-off
another issue is moral hazard so if
people know that they have a generous
say pension
or public pension they're less likely to
save privately
and this is another trade-off that
governments face when they're increasing
these taxes and promising a more
generous state pension
so what else could the government do
well it could actually reduce the
generosity of the
public pensions so reduce the amount
that is paid out
this should also incentivize private
saving so
essentially pushing uh the
responsibility of the pension saving to
the individual
okay so at this stage i'm going to be
i'm going to explain the uk pension
system so we can look at the ways in
which
the pension system works specifically in
the uk
and also we can look at the ways in
which it has changed in response to the
changing demographics of the population
and then how the
uk government has uh
responded with with more policy uh to to
encourage more private saving or
employer pensions which is a very
important part of the pension picture in
the uk
so
um
so the uk pension system is made up of a
few
different components and i think kind of
a
quick summary of what what this system
is is that it's state provided pension
what which is what i call state pension
uh complemented with some private saving
so we have the state pension uh
so this is or what can also be called
public pension um so this is a um
the government pays this flat rate um to
anyone with over 35 qualifying years so
years in which people have been either
in work or taking care of
young children mostly
and since 2016 this has been a flat rate
pension so everyone with the full quali
number of qualifying years get the same
amount and there's no earnings related
uh part
previously this was actually earnings
related so it functioned more like a
social insurance but this is now a flat
rate pension where the flat rate is
calculated
sort of as a rate that protects older
people from absolute poverty
um and the system is uh pay as you go as
i mentioned before
and anyone over uh the state pension age
uh which today is 66 can
uh
can receive this state pension
but the state pension is just over 9
300 pounds per year which is about a
third of median earnings in the uk so
while it protects people from kind of
absolute poverty it's not enough for
most people
so traditionally employers will also
offer some sort of employer pension for
employees
so because this is not arranged by the
states these are a type of private
pension saving but we call it employer
pension here because employers usually
arrange them and they will also
make some contributions into them on
behalf of their employees
and there are two types of employer
schemes so the first one is defined
benefit
so in a defined benefit scheme as the
name suggests it sets out to formula for
calculating the amount of money that an
employee will receive in retirement
so it could be for example that for each
year of service you get 160th of your
final salary as a pension so if you work
for the same company for 40 years you'd
be guaranteed a pension that's
two-thirds of your final salary
so as this example illustrates most of
the risk with this kind of pension lies
with the employer
so even if your pension contributions
and the returns to those contributions
don't actually cover two-thirds of your
final salary until the end of your life
this is what you've been promised so
this is what the employer will have to
pay you
the so that's the issue with this scheme
from the employers
employees perspective on the other hand
is that they they're not usually very uh
portable so if you leave your job you
would then stop accruing additional
years and you might might lose out
um
but essentially what both the defined
benefit scheme uh and also the state
pension give you is an annuitized income
stream in the sense that you get an
income uh until the end of life which is
which is guaranteed
um now another form of pension saving is
defined contribution pensions so as the
name suggests here the employee
employee and employer
agree a rate at which they contribute to
a pension pot
so the individual can usually choose how
much of their salary they want to put in
and they can also make some choices in
terms of which kind of financial
products
or what kind of risk level their fund
is
is invested in
then as
the person reaches retirement
their pension income will be determined
by how much of their uh of their own
their own pot pension pot so their the
amount of uh money that they've said
into your pension how much they've paid
in and how much that has accumulated
returns
and essentially after the age of 55
people people can decide how to draw
that wealth down
so in this
in this case of the defined contribution
pensions the market risk so how the
stock market performs for example and
how the other assets prices perform and
also the longevity risk so at the risk
of not knowing uh when you what age you
live until
both of these
type of risks in this kind of with this
kind of pension lie with the employee
rather than the employer or the state
um finally people might save for pension
in other ways such as having a house
owning a business having
stocks and shares or arranging their own
pension fund but the key difference with
most of those kinds of
savings is that there's no kind of
commitment device so people could
withdraw those uh savings at any point
whereas with a pension there's usually
uh some sort of age until uh that you
have to wait until before you can
start receiving your uh pension so so
we're not going to be focusing on those
other forms of savings today
so this is the pension system in the uk
in a nutshell and i'm not going to talk
about the changes to this uk pension
system in recent decades
um
and
i'll start by talking about what's
changed in the state pension system then
talk about employer pensions and then
talk about some of the policy responses
to these changes
now
as i already mentioned some countries
have responded to the kind of
demographic challenges to their public
pension system by increasing the amount
of contributions
that people are required to make and
that way ensuring the sustainability of
the system um
and making the system more contributory
and providing more social insurance
now the uk has taken a slightly
different approach uh when it comes to
improving the sustainability of the
pension system
by reducing this generosity of the state
pension
so how have they done that well firstly
the government
phased out or is facing out the earnings
related part of the pension so we now
have this flat rate across everyone
so as i've mentioned this means that the
state pension is now more about
protecting older people from poverty uh
rather than have being this kind of a
pure social insurance where higher
contributions would lead to higher
benefits
on average it means that
state pension is less generous
for people
in addition to that another important
way for in which the government has
reduced the state pension uh generosity
is by increasing the state pension age
so this is the age at which people can
start receiving their state pension
and i'll just show an example
of this uh showing how women's stay
pension age in particular has uh changed
uh over
over time
so
here on the horizontal axis we see the
year of birth of of women and on the
vertical axis we see the age at which
they can start receiving uh state
pension income
so since the 1940s um the state pension
age was 60 for women um
it was 65 for men so in 1995 this
pensions act was put in place that
basically said that the state pension
age of women would start increasing in
2010 and it wouldn't be equal to men's
by
2020. there have been future further
changes since then kind of bringing
forward the uh the increases and also
adding more increases for uh for people
born later
but this
what this picture shows is just how
dramatic the change was and just what a
big difference it made to the generosity
of uh state pension so if we compare a
woman who was born in uh 1949 uh who
started receiving the state pension uh
in 2009 when they turned 60.
if we now compare them to someone uh
born in 1961
so they would have also turned 60 this
year but actually they would only start
receiving the state pension income at
the age of 67.
um so essentially they
they are getting paid the same pension
income which is over nine thousand
pounds a year for seven years less than
the women who were born
just 12 years earlier
so this kind of shows uh just how this
change in state pension age affects
people and affects helps
helps make the system more sustainable
um
these increases from to 66 and 67 also
apply to men and for someone for example
in my generation the current legislative
state pension is 68 but it's also likely
that it's going to continue to increase
as life expectancy uh increases
so
that's basically this
the
state pension side of the picture so
we've seen a reduction in generosity
there
just as a
as kind of a side note here
in other countries
the conversation often revolves around
what happens in terms of the state
pension but in the uk concepts it's also
really important to think about the
employer pension uh as i mentioned so
and that's that's played a really
important part in the uk pension saving
picture for a very long time
so
in the uk pension system the state
pension has been this less less
significant source of income uh than in
a lot of other countries so here we see
the net replacement rates for average
earners across the oecd so what these
bars basically show is um
the how much um
what percentage of the um
the net income an average earner will
earn from state pension compared to the
average earnings so as i mentioned this
is about 30 percent in the uk whereas in
some countries it's sort of close to 100
percent and even the average is
as well above 50
so this is why in the uk when we're
talking about pensions uh it's really
important to also talk about the
employer side of the picture because the
state pension only makes up one uh part
of pensions
but the state pension is not the only
part of the system that's become less
generous so i talked about the
definition between defined benefit and
defined contribution schemes and as you
might know a lot of the defined benefit
schemes have actually come to an end and
have been pha are being phased out
for very similar reasons that the state
pension has become less generous
they're not sustainable because
especially as people's life expectancies
keep on increasing
so companies are
have been tied to paying out these
pensions for much longer than what they
had expected
so partially as a result of this a
much more prevalent form of employer
pensions is now defined contribution
pensions
so the employers still have to pay
pension contributions on behalf of their
workers but the difference is that
they're not liable for any future
payments
as they would have been under the uh
defined benefit schemes
so essentially what we've seen uh in the
uk is this transfer of risk so where
previously the market risk and the
longevity risk of pensions
lied sort of almost solely on the states
and the employer the risk has now been
transferred to the individual and it's
their responsibility to ensure adequate
income
in retirement
but as i discussed in the first section
there are
there are many biases which mean that
people don't save optimally
and individuals aren't actually
necessarily best placed
to make these really complex decisions
about retirement saving
so because the
because the government has now
transferred the risk to individuals they
again have to then intervene to try and
overcome the biases in pension saving
and encouraging people to save more
privately so how did the uk government
do this
so i will now talk about a couple of the
policy responses uh to the transfer
of risk
so the first very well-known policy
response is known as automatic
enrollment so this was introduced in
2012 um so since then every employee age
22 to 64
earning above 10 000 pounds a year must
be automatically enrolled to a pension
scheme
so this policy tackles both inertia
because it doesn't require engagement
from people
and it also
tackles press and buyers by nudging
people into saving today
and this policy has been hugely
successful in encouraging people to save
uh for a pension uh especially uh when
considering that really the only thing
that's changed here is the is the
default uh option
so
uh what i'm gonna show here so this
chart shows um the impact of automatic
enrollment on employees but first i'm
gonna show what is what percentage of
working individuals who are
self-employed are saving into a private
pension
so what we see here is that in the late
1990s about half of self-employed people
were saving into a pension and this has
been this has been declining over time
all the way to where we are today which
is below 20 percent
and what you need to know uh know here
is that self-employed people are not
subject to
uh to
uh automatic enrollment because they
don't have an um employee employer
essentially
um so so what does the picture look like
for this uh employees instead
so we can see that in the late 90s the
rates of pension saving were pretty
similar for self-employed people and
employees and what we've seen uh what we
saw from the late 90s to 2012 was this
uh decline uh also among employees not
quite as steep as one self-employed but
still a decline in pension saving of the
self-employed people
but since 2012 we really see this huge
impact of automatic enrollment on
pension savings uh of uh of employees so
very uh very quickly um the
the rates of pension savings started
increasing and that's also considered
the rate has continued to increase uh
since this data set as well
so this policy essentially pushes people
into saving into a private pension
but there's also another side to this
another
policy response that the government came
up with so in order to make sure that
pensions are
an appealing way of saving for most
people so that they don't have uh they
don't they have less of a reason to opt
out
uh the government also responded by
introducing what we call pension
freedoms
so previously most people
who had a pension a pot and had
saved privately into a pension
had to buy an annuity with their pension
pot so even though this was money that
people had kind of saved themselves the
rules of how people could access this
money were very restrictive
since 2015 however uh people can
uh people can now uh
still withdraw 25 of their
pension pot tax-free and they can also
draw down the rest of it flexibly after
the age of 55. so people can decide what
they want to do with the with the money
that they have saved into their pension
so
um just to summarize this uh this
section
uh the uk has moved from kind of
providing this public pension
as a form of social insurance uh to
reducing the generosity of the state
pension which makes the system more
sustainable but leads to a need for
individuals to save privately
so is ensuring sufficient income and
retirement is increasingly the
responsibility of individuals rather
than the states or the employers so in
order to encourage people to save
privately
what the government has done is
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try to nudge people into saving
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by introducing automatic enrollment
which then overcomes things uh biases
such as inertia and present bias
and also um
and also then they've introduced pension
freedoms
which give people more freedom when it
uh
when it comes to choosing how to draw
down their pension wealth
this is maybe
was a surprise to many people given that
many of the same biases and distortions
that we see when it comes to the
accumulation phase so the saving phase
also apply at the saving phase so people
still might be biased by things like
present bias and so on
but this does make pension saving
perhaps a more appealing
way of saving for many people
so i will now
just conclude
um so pension saving
is
is important because it helps people
smooth consumption throughout their
lifetime
but as with most saving people might not
behave optimally because of
these many behavioral biases
and also other distortions which are
also things like longevity risk uh not
knowing um or being overly optimistic or
pessimistic about uh
life expectancy and so on uh all of
these things are particularly
challenging for uh pension saving
so this means that in most countries or
in most developed countries that these
governments have decided to intervene uh
when it comes to pension saving
and in the uk the changes in the uk
pension system means that there's been
this risk transfers from uh from
employer and state to individuals so and
then uh but that means that then the
government has had to respond by nudging
people into private saving um and then
giving them more freedom in terms of uh
how they want to withdraw their savings
and i think
uh just a thought to finish on i think
especially in the uk context where
there's so much of the responsibility of
pension saving lies with the individual
it's really increasingly important for
people to have an understanding
of of pensions
and the pension system
so i hope this uh talk has kind of
helped you get started on that path um
thanks very much and i think we we're
now ready for some q a
thank you haley that was great
so we do have uh several questions on
slider
so
the most popular one seems to be
what did uh covert 19 do to impact on
sorry how did kobit 19 impact pension
saving in the uk
right so covet 19 um is is obviously a
very um
was well did a lot to to the um
in terms of things like
uh the effect that it had on people's
incomes the effects that it had on uh
people's uh uh or stock markets and so
on so there are a lot of things that we
kind of would think or might think that
would have affected pension savings so
but actually what we see
from the data or the early data at least
is that
actually the
pension participation rates remained
very similar
to what they have been before
people didn't seem to be opting out of
of pensions either uh they didn't seem
to be reducing their contributions and
so on so this is actually quite uh quite
surprising in in
or you might think that it's quite
surprising especially as something like
a quarter of the uk workforce was
furloughed so it was facing a
you know 20
uh at least a 20 cut in their uh in
their incomes so
so so basically the
i guess what we could uh take away from
that is that uh even in the context of
uh kobit 19 we still saw this kind of
really uh strong evidence for uh for
inertia
um of course you know it might be that
people didn't need to save
or stop saving because they were
consuming less for example
um but actually uh what we also see in
the data is that a lot of people were
saving more
um but again we don't really see
evidence of of people increasing their
pension contributions so
whereas that might have been kind of
very beneficial for the people who were
who ended up
saving saving more
so again this seems to be this evidence
of inertia both in terms of not
responding to negative shocks uh to
incomes or uh negative events but also
uh we didn't really seem to have any uh
any movement in the other direction
either so uh yeah that's that's that's
that's uh it looks like there wasn't a
lot of engagement with pension saving
despite this kind of very uh
very salient and very uh large um uh
events that was was happening but
obviously it affected the value of the
stock market quite a lot so it was a big
drop and then subsequently it's gone up
so
is that do we think that's likely to
affect people
behavior going forward
yeah so that's a really uh that's a
really interesting point um i think so
there was because people now have this
freedom to decide what they want to do
uh with their pension savings i think
there was this fear that people might
you know get scared by what's happening
in the stock market and might withdraw
uh withdraw a lot of their uh funds but
actually we didn't see that happening so
actually there were less um less
withdrawals from from this
private or defined contribution pensions
during kovid again might be because
people were consuming less and so on but
we don't really see
evidence evidence of that
i think also um
many of the the way that these many of
these pension funds are structured is
that if you're close to retirement
so you're kind of getting close to
thinking about withdrawing
the pension funds the risk profile will
usually be a little bit different where
actually more of your uh more of your
pot will be invested in things like
bonds that don't respond in the same way
to market fluctuations so for example
you know stock markets fell by
um you know 20 30 percent in march 2020
whereas we didn't really see a similar
effect in um in a lot of these uh bond
markets so
so essentially for the people who were
already kind of thinking about
withdrawing
their assets were probably already
invested in um
in a way that means that they weren't as
um
as affected
and obviously for for
uh younger people whose pensions are
invested in um in
the stock market
that they did recover very quickly so
hopefully it kind of does give people uh
some comfort in that even if you see uh
temporary dips in the in the stock
market uh overall that's that's a good
place to uh put your pension money
because then over time uh they will uh
they are
most likely to recover
that's interesting so you talked a
little bit about pensions freedoms there
there was one question asking relating
this a little bit back to the theory
that you were talking about earlier
which was so when these pension freedoms
were introduced did people stop buying
annuities did did things change in the
market you talked about adverse
selection before but is that is that
something that you know we actually saw
in practice
yes uh yes uh it is so basically
as i said the um the rules used to be
that for a certain size of pension pot
you had to buy an annuity so the market
was there
once the pension freedoms were
introduced actually these days we we see
a very small minority of people buying
annuities so the market is
is still there it didn't completely
collapse but the it's it's quite
unattractive for for most people in
terms of the uh products that can be uh
can be offered so we did see kind of
adverse selection happening in practice
there and
and
a lot
people
um a lot less people nowadays have uh a
lot fewer people nowadays have these
annuities
do we think it's likely that they would
reverse that would we think that a
future government might think about the
reintroducing compulsory neutralization
um well i mean i think it's a well i
think it's
i'm not sure i have a uh
immediate view on uh well at least how
quickly that would happen i think
pension freedoms for a lot of people is
quite a popular uh popular thing uh you
know the fact that you can uh withdraw
this money that you know you have saved
yourself uh if if you need to you know
say
uh well what we find again in research
is that a lot of people might
use it to
help their children by you know get on
the property ladder or uh use it for a
big holiday or so on which you know
isn't necessarily what we want them to
do with their pension money but it means
that it's a very kind of popular thing
uh so it would be kind of politically
really quite difficult to go back to go
back to that especially now that people
are so used to the fact that uh their
pension money they can kind of use as
as they wish
so
yeah it would be difficult and
especially when it comes to
you know pensions
um
so you know if if i
um if we make decisions on or changes
into
how people
uh how people can access their pension
funds for example
uh if that applies to everyone then that
would mean that you know some of those
people saved that money
uh kind of decades before
um and so
so it's quite difficult to make these um
changes because it kind of has an impact
a very long lasting impact and and can
um change how people might have viewed
their pensions uh uh yeah when they were
saving earlier on in life so okay
so what another question is again about
annuities but someone asked why can't
the insurers invest the money that
pensioners pay in when buying annuities
and maybe they do so if they do they
take the money that people use to buy
the annuity in the first place and then
invest that themselves the example here
is if they got a four percent return
from those investments then they could
just provide those four percent
annuities forever
um yeah so people um the pension funds
um
can can do that and i think they do do
that as well uh where they
will want to
um yeah invest in assets where uh where
the
uh the payments uh
uh
that can kind of help create this
profile that they kind of stable profile
of um payments in the future
um
but i think you know the kind of
issues of adverse election and so on
still remain in that for some people the
price
uh the kind of insurance premium um will
be difficult to set in a way that that
means that it's kind of
a um a
uh
attractive um product for for certain
people to buy
uh and then that could you know leads to
those those same same kind of issues
indeed
so another question asked are the
increases in the state pension age
unique to the uk or they happening in
other countries too is this a is this a
global problem or is this just something
that the uk is
is dealing with
no i think it is definitely happening in
other countries
in other countries as well
uh because obviously every or most
countries are are facing this same same
issue so and and most countries are also
facing this kind of combination of uh
issues that i mentioned so you know
people working for longer uh
you know
since the kind of 70s uh having reduced
um or retiring earlier
uh
starting joining work the workforce
later and also fertility rates falling
so
um so most countries are facing those
same issues and and
and most countries have recognized that
even with um
increases in the mandatory contributions
it's not enough to kind of make up for
for those so then the other thing that
they've had to do is also increase uh
increase their pension um
save pension age
of course we also then have
examples from countries like france
where
you know there are
there's a push for for that to happen
but actually again politically it's it's
been a lot more difficult than it has
perhaps been in the uk so
um so
so yeah that's that's kind of
uh
somewhat a difference although
interestingly you know the
for example the increase in the women's
state pension age for
five years was introduced in 1995 and
only implemented from 2010 onward so the
issue there was that a lot of people
didn't actually know about know about it
and didn't know that it was happening so
maybe that was uh
made it politically a little bit easier
to implement but um but yeah that's well
of course some people still be very
upset exactly exactly yes yeah
so i mean i guess
thinking about all those those pressures
there's a couple of questions here that
are quite related which is what do we
think the the future of of pensions
looks like so someone asked you know
given all of these trends do you think
that there will be a public pension
system in future or by the time you
retire and someone else has also asked
you know you refer to the uk state
pension as a pay as you go but it's
actually a state benefit what are the
chances the government may decide to
save funds by making it means tested so
do you think that means testing or just
getting rid of the public pension system
entirely are possible reforms the future
well i think that getting rid of it can
um completely is uh
is sort of yeah
uh unlikely to happen i think what the
government wants to do is
um is is protect people from uh kind of
as i said absolute poverty or being uh
living in poverty
in retirement
uh and also
especially when you have this kind of
the private saving is very flexible
um
government wants that there is
or
there is this kind of
minimum amount or
a relatively small amount that people
will receive
um no matter what happens to kind of
their in their private pension savings
so i think that is um
that is likely to
remain in in place that well that's my
my view at least
um of course the means testing is
something that you know could happen
especially in the uk so the state
pension is
only um
only tied to your state pension age so
you know there are people who might be
working in
uh still past their state pension age
who are receiving the state pension uh
so maybe you know something like that
could change uh or uh
or you know people who have very large
uh private benef private pension pots um
uh
would not receive that but i think at
the moment the um
we don't want to create um
kind of a disincentive for private
saving by saying oh if you have more
private saving you're not going to
receive the um
the
public pension or you know if you
if you continue working you're not gonna
receive the public pension so
um so yeah it's it's i don't think it's
gonna happen anytime soon but of course
uh we'll see
we'll have to see how these things um
um develop um in the in the future
yeah as you say most most most of the
policy seems to be kind of pushing
towards increasing incentives for
private savings so you talked about
automatic enrollment and there were a
couple of questions there as well
i mean do we given it seems to be very
successful do you think it should be
applied to everyone rather than you know
just doing just to employees certain
places
yeah so um
so there are a couple of um
the
automatic enrollment has been very
successful but there are some issues
with it
it is a completely sort of blanket
policy right so
so what some ifs research has found for
example is that there are some um
some
very financially vulnerable people who
for example say that they can't keep up
with their bills they don't have any
kind of liquid savings
and so on and you know before automatic
enrollment a very small proportion of
those people were saving into um into a
private pension probably you know
because it made sense for them to be
spending it on things like bills um
today
um after automatic enrollment you don't
really see a difference um in the rates
of um of
private pension saving between that
group and the groups that aren't um
financially vulnerable so so there is
already an kind of argument that you
know should we really be pushing those
people into into pension saving who are
struggling um struggling today and for
whom you know if their incomes are um
quite quite low the the
uh kind of income that the state pension
provides relative to their uh incomes in
or in their life
earlier in their life is actually you
know
kind of more palatable so
so i think that's kind of
one of those things why for example
currently
automatic enrollment only applies to
people
who are earning more than 10 000 pounds
a year
um and you know there's
there's a bit of a question mark of
whether that should be uh lowered and
and and probably makes sense that it's
it's not at least immediately
there's not an argument for changing the
amount that people should put in maybe
you could differentiate that by
how much people earn in the first place
yeah so but that's definitely something
that could be done um the
uh the the thing with that is also that
you know earnings is kind of only one
part of
uh of of your financial situation in a
way um so you know
they probably should take into account
other things like you know whether you
have a mortgage or whether you have
still paying your student loan or
whether you have children
uh whether your children live with you
uh all those things of course we could
try and um incorporate all of those
things into defining the default rate
but that's not okay so it gets very
pretty complicated pretty quickly so uh
but again yeah we've done some research
on um on those kind of um looking at
uh
how should people save and and find that
you know all of these things play into
um how much people should be saving so
yeah it's a bit more
complicated in that sense and just
finally i mean we touched this has all
been for employees what about the
self-employed it seemed to be quite a
worrying trend that was that was falling
quite so fast
yeah so the self-employed is definitely
something that the government is quite
um a group that the camera are quite uh
worried about
uh the difficulty there of course is
that they don't uh have this kind of
stable uh
or they don't have an employer who will
enroll them into this and also they
um so they don't have a paycheck where
you kind of deduct the pension payments
from so kind of just technically it's
difficult but also a lot of the
um for a lot of the
self-employed people uh for example they
face um
large fluctuations in their incomes
again they were grouped that were very
severely affected in the early stages of
covet 19 so
so for those for that group it might
actually make you know for a lot of them
it makes more sense to keep their
savings in a more liquid form that they
can access if they uh have issues with
their business uh for example so so yeah
they there's there are also arguments
for uh trying to increase uh some some
sort of saving among that group but um
um but the government's kind of running
some pretty interesting trials into
trying to find what it is that
um the kind of product that actually
would benefit those uh people the most
great well we'll have to look forward to
future research into that uh yes so
learn the answers anyway thank you very
much haley that was that was really
interesting uh for those of you who've
enjoyed it next week we'll be back to
talk about income inequality uh how it's
changed over time and why we might care
about it so until then have a good week