Interactive Investor

Is the UK state pension really the worst in Europe?

9th November 2022 09:24

by Alice Guy from interactive investor

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Britain’s pensions system has attracted criticism and its very existence, certainly in its current form, is under threat. Alice Guy compares our pensions with those available in Europe.

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The state pension is in the headlines again with yet more rumours that the triple lock could be scrapped.

It would make a huge difference for pensioners as keeping the lock - which guarantees the state pension will rise by the highest of inflation, wages and 2.5% - would see the state pension increase to £10,600 in April 2023, while scrapping it would see the pension increase to only £10,156.

With the state pension in the balance, we take a look at how the UK system compares to other countries in Europe. Is the UK state pension, as often claimed, really one of the worst in Europe?

Like Marilyn Monroe in Some Like It Hot, are UK workers getting the fuzzy end of the lollipop?

Apples and pears

Comparing the UK system with those across Europe is like comparing apples and pears.

The UK state pension is a flat-rate pension that’s based on the number of years workers have made National Insurance (NI) contributions. No matter how much NI you’ve paid over the years, you’ll get the same amount, based on the number of years you’ve paid in.

It’s a kind of safety net that is supposed to make sure pensioners stay out of poverty, but not give them a massive income.

Contributions to the UK state pension are hard to measure as they’re based on National Insurance contributions. But NI is really just another type of tax and not all of it is used to pay the state pension.

Since auto-enrolment - where employers are now required to auto-enrol employees into a workplace pension scheme - the idea is that we boost that pension provision by paying into a private workplace pension. It’s essentially up to us to make up the difference and try to invest and save for a comfortable retirement.

In contrast, many countries have a much broader state pension system where the amount you get is based on your contributions. In those countries, state pension contributions are much higher and there’s less reliance on private pensions.

Salary-linked state pensions

Here are a couple of examples of how salary-linked state pensions work.

Germany

The current German state pension is based on contributions and guarantees at least 51% of workers’ average wages, dropping to 48% by 2025. There is no maximum ceiling and what you get depends on contributions.

The state scheme is financed by a payroll tax of 19.6% up to a maximum amount, paid half and half by employer and employee contributions, rising to 20% contributions by 2025. The current state pension age is 65, but it is gradually rising to 67.

Germans can also contribute to additional workplace and private pensions, but many rely on the generous state pension.

France

France’s pension system is also based on career earnings. There are two main types of compulsory pension, and most people don’t bother with private pensions.

The basic state pension pays a maximum of 50% of average earnings (with an upper ceiling on contributions). It's based on the number of years worked and how much was paid in contributions and is financed by social security contributions by employees and employers. Workers need to work for 42 years to get a full state pension and their entitlement is based on their 25 highest earning years. Workers can start claiming pension when they reach 62 although this age is gradually being increased to 67.

In addition, there is a complex range of compulsory occupational pensions where employees and employers have to contribute an extra amount. They work on a points system depending on workers' salary and profession.

Flat-rate pensions

But there are a few countries including Denmark, the Netherlands and Ireland that also have a flat-rate state pension like the UK. Here is how it works in the Netherlands.

Netherlands

The Dutch state pension system is based on three levels of pension: a basic flat rate, a collective workplace pension and a private pension.

The basic state pension provides a basic level of income of £162 per week for members of a couple and £237 for single people.

The second source of Dutch pension benefits are compulsory collective pension schemes connected to an industry or company and managed by pension funds or insurance companies.

Companies pay monthly contributions into the pension funds on behalf of their employees. The capital is invested, and the returns pay for the benefits of current and future retirees. Employees can choose what kind of scheme they prefer to have within their pension fund.

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How does the UK state pension compare?

To compare the UK state pension with other countries across Europe, we really need to include private and workplace pensions. The state pension provides a basic income, but workplace and private pensions, boosted by pension tax relief, can help us achieve a comfortable retirement and are a key part of the UK pension system.

However, looking at the table below you can see that the UK government spends far less on the state pension, as a proportion of GDP, than many other countries. Even if the £43 billion spent on pension tax relief is added in, government spending on pensions still lags behind most countries in Europe. Levels of pensioner poverty are also higher than other countries in Europe, suggesting many pensioners are struggling to supplement the flat-rate UK state pension.

A 2022 government report commented that, “The OECD collects standardised data on each member country’s social expenditure on state pensions and pensioner benefits. In six countries, social expenditure on old-age pensions in 2017 accounted for over 10% of GDP. In the UK the figure was 4.7%.”

The report also found that, even once state and private pensions were aggregated, the UK had a lower-than-average “replacement rate” than the average EU country. Replacement rate is a measure that compares pension earnings to previous income. “The analysis shows that the UK has an overall net replacement rate of 58.1% from mandatory pensions for an average earner, below the OECD average of 69.1% and the EU average of 70.8%.”

As far as the future is concerned, the one silver lining is that since new auto-enrolment pension rules, more Britons than ever before are now saving into their workplace pension. It’s only with a combination of the state pension and workplace or private pension saving that we can ensure we have enough for a comfortable retirement.

Country

State pension age

Pension amount

% of GDP spent on pensions

% of pensioners in poverty

UK

66 years old, rising to 67 and then 68

Flat rate of £185 per week

4.7% (plus pension tax relief – around 1.4% of GDP)

15.5%

Germany

65 years old, gradually rising to 67

48% of average earnings

8.0%

9.2%

France

62 years old, gradually rising to 67

50% of average earnings

11.9%

4.4%

Italy

67 years old and rising

Based on average earnings.

11.5%

11.3%

Denmark

67 years old

£360 per week for a single person and £265 per week for each member of a couple (means tested)

8.0%

3.6%

The Netherlands

65 years old, gradually rising to 67

£237 per week for a single person and £162 for each member of a couple.

5.1%

5.2%

Australia

66 years old and six months, rising to 67

Means tested based on your assets.

3.9%

23.7%

Japan

65 years old

Basic and earnings-related elements.

8.2%

20%

United States

67 years old

Based on average earnings with a capped contribution.

6.4%

23%

Source: Pensions: international comparisons Research Briefing (11 March 2022), The Cleiss (Centre for European and International Social Security Liaisons), Expatica Communications.

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