UK has lowest net replacement rates of average earners in OECD
A new report has highlighted markedly low replacement rates for UK savers amid increasing pensioner poverty due to ill health, emphasising the importance of increased saving into private pensions.
The OECD’s latest ‘Pensions at a Glance’ report, launched on Tuesday, shows that the net replacement rate from mandatory parts of the pensions system for UK average-income earners entering the labour market today is 29 per cent. In contrast, the OECD country average is 63 per cent.
UK workers face the biggest retirement cliff edge in the developed world
Based on the organisation’s assumptions “the UK has the lowest net replacement rates of average earners of any OECD country”, said Mark Pearson, OECD deputy director of employment, labour and social affairs.
He noted that, unlike certain other countries, the UK state pension system says: “‘Here’s a baseline, if you want to have a decent standard of living in retirement, [it is] up to you to do something about it’.”
Private pensions could fill the gap
This is where the private pension comes into play. The OECD’s research stated that private pensions could help plug the gap, adding about 30 percentage points to the net replacement rate with a full career of coverage.
Pearson said: “If we’re going to make the current system work, a system that says, ‘We are not going to be providing you with anything more than a very, very basic income’”, then getting more people enrolled in private pensions is crucial.
“That’s always going to be a challenge in the UK; we’re not there yet,” he added.
TUC pensions officer Tim Sharp said: “This report shows that UK workers face the biggest retirement cliff edge in the developed world.”
The research found that obesity, one of the main factors causing health problems, is very common among older people in the UK. More than 20 per cent of people in England aged over 80 are obese, compared with about 15 per cent in the United States and 10 per cent in Italy and Austria, for example.
“Pensioner poverty is growing in the UK – and is being made worse by people retiring early due to ill health,” said Sharp.
He added: “The forthcoming review of auto-enrolment must address this problem and ensure that everyone has a decent income in retirement.”
About 8.7m people have been enrolled into a workplace pension fund since the introduction of auto-enrolment in 2012, according to the Department for Work and Pensions.
Total minimum contribution rates are due to rise from 2 per cent to 8 per cent from April 2019.
However, the OECD’s research voices concerns that these planned increases, which are needed to boost pension adequacy, may encourage more lower earners to opt out, therefore increasing future inequality and poverty risks.
Improve financial literacy
The report emphasised the importance of financial literacy, particularly since the introduction of freedom and choice.
Pearson stressed that with the relatively new pension flexibilities, people may want to spend their lump sum early or underestimate their life expectancy.
“This decision around the drawdown period… becomes very important and very dependent on [savers’] financial literacy,” he said.
Charles Cowling, director at JLT Employee Benefits, agreed on the need for financial literacy.
The ability to “cash in all our savings” through freedom and choice means that “we are storing up for ourselves a major problem if a large part of our population… is no longer able to provide for itself because it hasn’t got the savings”, he said.
Shrinking annuities market a ‘concern’
The Financial Conduct Authority’s retirement outcomes review interim report found that drawdown has become much more popular since freedom and choice was introduced. Before the pension freedoms, more than 90 per cent of pots were used to buy annuities. Now twice as many pots are moving into drawdown than annuities.
The OECD highlighted that removing the guaranteed annual income that an annuity provides could “increase future reliance on the old-age safety net”.
Pearson said the fact the UK annuities market is shrinking is a cause for concern. Earlier this year, Pablo Antolin, the organisation’s principal economist, made clear a preference for annuities in comparison with drawdown and cash products.
Hugh Nolan, president of the Society of Pension Professionals and director at consultancy Spence & Partners, said the pension freedoms had not been well thought through. “The policy to scrap the compulsory annuitisation of pensions was ill-conceived, politically opportune and short-term,” he said.
The idea of sharing the risk via an insurer, so people who live longer get paid out of savings of those who do not live as long, “is what people need”, he added.