Overview

This report takes a fresh look at the prospects for the future of retirement incomes for employees in the UK. Since the Pensions Commission reported around 20 years ago, much has changed in the economic and pensions policy environment. While the introduction of automatic enrolment has been in many respects a great policy success – and the level and coverage of the flat-rate component of the state pension have increased markedly – lower-than-expected growth in earnings and depressed returns to saving make the private saving landscape more challenging.

Key findings

1. There have been several changes to the economic environment since the Pensions Commission reported two decades ago, some making it harder for employees to reach an adequate retirement income and others making it easier. On the one hand, since 2004, the level, coverage and indexation of the flat-rate component of the state pension have become considerably more generous. We take a stylised individual spending a lifetime (from age 22 to state pension age) on close to full-time median earnings (£38,500) and calculate the amount they would have to save privately each year to hit a retirement income gross replacement rate of 67%, which would give them a gross retirement income of around £25,800. We estimate that changes to the state pension would – all else equal – reduce their required saving by roughly one-third from around 9% to around 6% of their earnings. This assumes the state pension is earnings indexed; were it to remain ‘triple locked’, the required private saving rate would fall further.

2. However, other changes to the economic environment – namely, longer life expectancy at older ages, lower earnings growth and lower returns to saving – have more than offset the effects of a more generous flat-rate state pension. Accounting for these changes as well as the more generous state pension, we find that for someone spending their lifetime as a low, middle or high earner, the saving rate required to hit the targets that the Pensions Commission set out is approximately 1–3% of earnings higher than was expected when it concluded its study.

3. In aggregate, private sector employers are contributing a similar amount (as a fraction of total earnings) to their employees’ private pensions in 2021 to what they were in 2005 – approximately 6% of total pay. There have been increases in pension contributions for smaller employers (fewer than 100 employees) over this period (from 2.9% of pay to 3.5%), while among larger employers (at least 1,000 employees) overall pension contributions are almost unchanged at around 8% of pay. We cannot make this exact comparison going further back due to a lack of consistent data before 2005; however, we can be sure that, as a fraction of earnings or GDP, employer pension contributions are around their highest levels since the mid 2000s and are probably higher than they were in the 1990s. Having said that, deficit reduction payments from employers to defined benefit pension funds have fallen in recent years.

4. Projecting forward the savings and retirement incomes of current workers, our baseline model finds that over half (57%) of current private sector employees saving in a defined contribution pension are projected to have an ‘adequate’ replacement rate (as defined by the Pensions Commission) on current trends. This means that a significant minority – around four in ten of this group – appear to be ‘undersaving for retirement’ on this metric. The same modelling implies that over two-thirds (68%) of private sector employees are projected to have an income that would allow them to meet a ‘minimum’ retirement living standard (expenditure of £14,400 per year in today’s terms, assumed to rise with the growth in average earnings).

5. By their nature, these estimates are very sensitive to some of the assumptions made. Our downside scenario, where the return achieved on pension saving is lower by 1 percentage point, implies that over half of individuals are saving too little to hit a target replacement rate and that around 40% would not hit the minimum living standard. On the other hand, a 1 percentage point higher rate of return (meaning a return comparable to that anticipated by the Pensions Commission) and a 10% higher state pension, plus the inclusion of predicted inheritances as a source of future retirement resource, reduces projected rates of undersaving to just under two in ten, with almost 90% expected to achieve at least a minimum income.

6. Certain groups appear more likely to be undersaving than others. For example, compared with the Pensions Commission replacement rate measure of retirement income adequacy, those on higher levels of earnings are more likely to be undersaving than lower earners. While 86% of those in the bottom quarter of earners when in their 50s are projected to hit their target replacement rate, this is so for just 40% of those in the top quarter of earners. This is because the flat-rate nature of the state pension means it provides more income replacement (in percentage terms) for lower earners.

7. However, lower earners are less likely to reach a minimum living standard, reflecting the fact that they have lower lifetime incomes and therefore typically save smaller amounts for their retirement. The combination of lower earners being more likely to reach target replacement rates, but less likely to hit minimum retirement incomes implies that the key issue facing many of these employees is low lifetime incomes, rather than not transferring enough of their working-age income to provide for their retirement. Indeed, many working families currently have incomes below the equivalent of the PLSA minimum living standards: 32% of working couples and 44% of working single people have an income below these minimum retirement income targets. In this context – where significant shares of working-age households do not appear to be enjoying a minimum standard of living – boosting their retirement income without risking eroding their current low living standards further would require redistribution of income towards them, either via higher state pensions, more generous total compensation from their employment, or more generous treatment by the tax and benefit system. In addition, measures to help lower earners remain in paid work up to (or at least up to) state pension age would also increase retirement incomes without reducing take-home pay during working life.

8. Women are slightly more likely to meet replacement rate measures of adequacy but less likely to meet minimum income standard measures. This is because they typically have lower levels of earnings than men. Again, this suggests that appropriate policies to reduce the gender pension gap would require redistribution of income towards women rather than any move to encourage women to save more of their own earnings than men.

9. Within the group of individuals aged 35–59, if we assume that retirement resources will be shared within current couples, then the overall outlook for adequacy is improved. Those on higher incomes are more likely to be on track to hit a replacement rate defined at the couple level instead of the individual level. A much higher proportion of women (82% compared with 57%) are on track to have at least a minimum retirement income, if their retirement resources are equally shared with their partner. People who live on their own in retirement cannot benefit from this resource sharing, and are projected to be much less likely to have a ‘minimum’ retirement income than those living in couples (59% compared with 93%).

10. When measuring incomes after adjusting for housing costs, those who will be private renters in retirement are much more likely to be undersaving than those who are not privately renting. Just under half of private renters are on track to meet the Pensions Commission replacement rate target compared with around two-thirds of those not privately renting. Almost 90% of those not privately renting are projected to hit a ‘minimum’ retirement living standard, compared with just under half of private renters.

11. Results from an economic ‘life-cycle’ model of when during working life people should be saving indicate that there are good reasons for many people to save a greater proportion of their earnings for retirement in the later stages of their working life when their earnings are typically higher and their outgoings – such as mortgage payments, childcare costs and student loan repayments – are lower.