The Economy: 8. Pensions

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Welcome to Understand the Economy, the podcast that takes you back to basics to explain how economics affects our everyday lives.

In this episode, pensions.

No, don't switch me off, I promise they're important, very important!

But we really don't think about them enough, often until it's too late.

And maybe you think you've got your pension sorted.

Even if you have, though, you may end up paying more tax to pay for someone else's pension.

So, this is really everyone's problem.

A pension is money you receive when you've retired.

We've made the decision in the UK that the state will give everyone some money once they get to a certain age.

But as we'll hear, that decision was made a long time ago when people didn't live as long as they do today.

I'm joined in the studio by Rajiv Prabhakar.

He's a senior lecturer in personal finance at the Open University and the author of Financial Inclusion, Critique and Alternatives.

Welcome Rajiv.

Thank you, Tim.

So we should start at the beginning.

State pensions.

At the moment, how do they work?

So you build up a national insurance record, which could be either in work or if you're caring and once you reach retirement age you get something called a new state pension, where everyone gets a flat rate.

They're an example of what is called an unfunded system.

So in effect, the taxes of the current generation of people of working age pay the guaranteed pension of the retired.

And so when people who are pensioners, when they say, I've paid in all my life, that's sort of true.

They've paid national insurance contributions, they've paid taxes, they have paid in all their life.

Yep.

But in another way, it's not true, because that money that they've paid in, that was paying for something else back in the day.

And their current pensions are being paid for by the current taxes and national insurance contributions of the working population.

Exactly.

I was always told you get your pension when you're 65, that's your retirement age as a man.

60 if you're a woman, that's not true anymore, is it?

No.

So the state pension age is the same for men and women.

So currently, in 2022, the state pension age is age 66, and it's due to rise to 67.

and then by the mid I think in my 2040s it's going to rise to 68 years old.

So the pension age has been going up so why is that

the key thing is we're talking about demography people are living longer which is a great thing but this then raises a challenge for state pension systems because people could be living 20 on average 20 years after retirement.

How are you going to pay for this via taxes?

As it happens, women tend to live live longer than men.

And so there's a rationale first for equalisation, but secondly, for raising the state pension age.

And as I understand it, there's two different things going on, and they're both causing a problem.

The first is that people are living longer.

And the second thing is, well, the baby boomers are retiring.

So that's a very big generation born in the 20 years after the war, and they're entering retirement.

And the generation following them, poor hardworking Gen Xers like me, we're smaller.

So you've got a smaller working age population working away to fund the retirement of these baby boomers.

There's loads of them and they live forever.

This seems like it potentially is a big problem.

I mean, is the whole system unsustainable?

We could also, our government could also, encouraging the population to save more into personal or private pensions.

So we've seen initiatives, for example, in the UK as things such as the automatic enrolment into a workplace pension, which is now 10 years old.

Yeah.

Now, I want to come back and talk about these various initiatives to get people to save for their own retirement rather than relying on the state.

But before we do, I wanted to bring in our resident historian, Victoria Bateman from the University of Cambridge.

And as she usually does, Dr.

Bateman brings us more war stories.

By the 17th century, Britain had been building its military and fighting ever more wars, and with it came a growing number of injured servicemen, many of whom fell into poverty after their injuries, unable to fight anymore.

And so in 1681, King Charles II decided to do something about this problem.

What he did was to grant a royal warrant for the building of the Royal Hospital in Chelsea to care for those who were, to quote, broken by age or war.

But there were many more injured and elderly servicemen than could fit in these two hospitals.

And so the military started rolling out a pension scheme that would be to some degree recognisable to us today, that came in the form of a weekly payment in financial terms rather than having to live in in a hospital or an institution.

In 1859, it was rolled out to everyone in the military, and it became the precursor to the 1908 old age pension that was introduced for pensioners right across the UK for anyone who was aged 70 or above who was in financial need.

And that pension gave the equivalent of, in today's money, £27

and was collected from the local post office.

Dr.

Victoria Bateman.

And just to put that retirement age of 70 in context,

not many people lived to the age of 70 at that time.

It was 1908, and for that generation of pensioners, they would have entered adulthood around 1860.

And life expectancy was 58 for men and slightly more for women.

So if anybody made it to 70 to claim this pension, it was already quite an achievement.

Today, the generation who are currently getting their pension aged 66, on average, they're going to live until they're 85 or 87.

So many, many more years in retirement.

Bajeev Prabhakar, we've talked about dealing with this aging population by getting people to save more for themselves.

So are we any good at saving for our own retirements?

Actually, it can be really complicated to design a savings plan over your own lifetime because there's lots of unexpected things, there's lots of other factors you don't know about.

The pension system is really complex.

That's one thing.

But even if

you manage to design a savings plan that can kind of look into the future and give you enough income, can you stick to it?

There are times in which there's simply going to be cost of living pressures.

So, for example, you may need to pay off a student debt, you may need to get a mortgage if you've got children, you may need to pay that.

So, actually, people are going to be buffeted through their whole life by these kind of things, which will put pressure on a pension, which is, in effect,

a long-term saving.

Turn it down a bit.

I'm looking over at my producer.

She's crying quietly in the corner of the studio.

She's a bit younger than we are.

It's a hard life you're describing here, being buffeted.

Right.

Second thing, there's been a school of thought called behavioural economics, which fuses together psychology and economics.

And what some economists have said, another problem, is actually they tend to prioritize today over tomorrow.

This is sometimes called present bias.

So I'm trying to save up for my pension, but then an old friend says, oh, do you want to go out?

to a restaurant and I'm thinking, well, I don't really have the money to do that this week because I need that money to save towards my pension.

I made that plan.

But your friend's asking if you'll go out and you can't say no to your friend.

And so you say yes and you spend that money.

And just once, it doesn't matter.

But the trouble is that's going to happen all the time.

Your entire life is going to be, you're going to be presented with these temptations that it's going to be hard to say no to.

Correct.

And then the main kind of policy example of which is this automatic enrolment into a workplace pension.

What the insight of economists here is saying, okay,

all of us have these kind of biases.

We're humans.

we're not robots.

Can we design a personal pension system in a way that harnesses the kind of biases that we all exhibit to encourage us to save more?

So the idea here is when you join a company and you're asked if you want to sign up for that company's pension, and the idea would have been, well, the company's going to contribute, the government's going to contribute, of course you want to do that.

But very often people actually don't because of these biases you described, because they're focused on their problems right now they don't want to think about their pension so the the automatic enrolment says actually we're not going to ask you we're just going to tell you it's it's happening you can opt out but otherwise it's just going to happen automatically exactly and actually if you look at what's happened with the automatic enrolment into a workplace pension which was introduced from 2012 so it's 10 years since what's happened is that the membership of pension schemes has uh increased by about tenfold yeah I mean that's amazing.

It's worth holding on that.

Ten times as many people enrolled now because of automatic enrolment.

Correct.

And that that sounds like the problem's been solved then.

Has the problem been solved?

No.

Oh.

Because for automatic enrolment, people are typically contributing 8%.

However, for an average earner, 12%

will be needed to provide enough money in retirement.

So and that maybe doesn't sound like a big gap, but they've only got two-thirds as much money as they need.

And so, in retirement, if that continues, they're only going to have two-thirds the pension income that they need.

I wanted to ask about pensions for men versus pensions for women.

We all know there's a gender pay gap.

Women, on average, earn less than men for a whole bunch of different reasons.

Should we presume that there's a pensions gap?

Do we even know if there's a pensions gap?

Actually, this is one of the key challenges facing public pensions, because there is an increasing focus on what is called a gender pensions gap.

there's a growing awareness actually retirement outcomes for women are systematically worse than for men.

So, for example, if we look at something like income, there's a 40% shortfall for women compared to men.

Also, the gender pension gap, if we look at, say, income, is about double the gender pay gap.

So, the pension gap is twice as bad as the pay gap?

Yes, roughly, yeah.

Wow.

So, what's driving the gender pension gap is really to do with private pension provision.

And put very bluntly, women do a lot more unpaid caring than men.

Yeah, right.

How does that affect it?

Well, it affects in a couple of ways.

Number one, they're out of the workforce, the paid workforce, and they're doing unpaid caring.

So they don't have the opportunity to build the private pensions.

But the second strand is that when they do come back into the workforce, predominantly they take part-time work, which then feeds into their pension contribution.

And why is that important?

Women live longer than men, and so they will live a longer life by having going to have less money coming in.

Rajiv, I was wondering, my niece has just had twins.

Oh, congratulations!

Oh, they're so cute!

They're so cute.

They are going to turn 78 in the year 2100.

And I was curious: do you think in the year 2100 those 78-year-olds will get a state pension?

And if not, how are they going to be providing for their own retirement?

Wow, that's a hostage to fortune.

No one is going to hold you hostage to this.

We'll all be dead by then.

Hopefully, they won't.

My instinct is that actually, there will still be some form of public state pension.

Because one of the things that the state pension does is to stop poverty and retirement.

And actually, sometimes people can't work, sometimes can't be in paid employment.

How are they cared for?

So I think that some form of state assistance will still be there, but there will also be a growing emphasis also on saving for retirement.

And I suspect there'll be changes to the state pension age.

Rajiv Pabakar of the Open University, thank you so much.

Thank you, Tim.

So the good news is, Rajiv says that even if you live to 2100, there will be a state pension.

The bad news is, it may not be as generous as you're hoping for.

So get saving, babies.

Understand the Economy was presented by me, Tim Harford, and produced by Phoebe Keene.

The researcher was Drew Hindman, and the series editor was Claire Fordham.

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