What to expect from Labour’s major pension shake-up

Developments in the pension space always come thick and fast but the start to this week proved particularly eventful.

On Monday alone the government launched a fresh review of the pension savings landscape to address the UK’s looming retirement crisis and unveiled plans to place the state pension age under the microscope.

In addition, proposals to bring pensions into the scope of inheritance tax (IHT) were ushered into draft legislation, despite stark warnings about the problems the policy might cause. We’ll park analysis on that complicated topic for another day as it warrants a standalone article.

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The prospect of millions of people retiring with inadequate income is very real but boosting savers’ retirement pots and securing the state pension’s long-term future are sizeable tasks.

The workplace pension arena is undergoing a pivotal shift, with future retirees less likely to enjoy old age with a ‘gold-plated’ defined benefit (DB) pension, which secure a guaranteed income. Instead, they’re accruing pots of money through defined contribution (DC) schemes, which require more engagement and in many cases greater personal funding.

Furthermore, pension participation among self-employed workers remains painfully low and the state pension is set to burst at the seams, according to a respected think tank.

This all paints a rather concerning picture, particularly given the country’s financial position, and ongoing cost-of-living crisis. Liz Kendall, the work and pensions secretary, warned that Britain faces a “tsunami of pensioner poverty” unless things change.

Let’s examine what Labour’s reviews may seek to focus on.

Pension Commission revived

To get things started, the government has breathed new life into the landmark Pensions Commission responsible for conjuring up auto enrolment, the revolutionary workplace pension initiative, some two decades ago.

Baroness Jeannie Drake, Sir Ian Cheshire and Professor Nick Pearce will spearhead the Commission, seeking to unravel the complex barriers stopping people from saving enough for retirement. The trio will examine the pension system as a whole, learn what is required to create a strong, fair and sustainable pension system, and report back its findings and recommendations in two years’ time.

New government data underlines the task at hand. Four in 10 (nearly 15 million) people are not saving enough for later life, while 45% of working-age adults are sticking nothing at all into a pension. Looking ahead, the government calculates that those retiring in 2050 will have £800 (8%) less private pension income than today’s pensioners.

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The Commission must place pension engagement and financial literacy front and centre, working out ways to encourage people to pay closer attention to their retirement savings. A recent report by the Department for Work and Pensions (DWP) found that only 46% of all private pension holders aged 40 to 75 had reviewed the value of their savings in the last 12 months.

Auto enrolment set for long-awaited review

The Commission will inevitably home in on the workplace pension landscape, digging into the existing auto-enrolment framework and discerning whether it’s fit for purpose.

The overwhelming view among experts is that it needs a thorough rejig, with concerns that minimum contribution levels are too low to accrue the savings needed to retire in financial comfort.

Under current auto-enrolment laws, if workers pay 5% of qualifying earnings (between £6,240 to £50,270) into their workplace pension, their employer must pay 3%. There is also a £10,000 earnings trigger, meaning you must be paid at least this amount over the course of the tax year to be automatically enrolled.

Jacking up minimum contributions levels to, say, 12% or 15%, is an obvious solution to enable workers to automatically build bigger pension pots. But this is not without its complications. There are affordability hurdles to consider. Businesses have recently been hit with higher national insurance (NI) bills and the rising cost of living continues to hit workers’ pay packets. Additional pension contributions for both groups might not be well received or practical.

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Businesses were recently offered some reassurance from Thorsten Bell, pension minister, who told TheSunday Times: “We are ruling out any increase in pension contributions in this parliament. I want everyone to focus on what is the right, long-term answer.”

However, beyond 2029, reform seems fair game. “The Commission will make proposals for change beyond the current parliament to deliver a pensions framework that is strong, fair and sustainable,” the government said, indicating that some kind of road map might be developed.

For higher contributions to be palatable for both businesses and workers, they may need to be increased gradually over time – much like when auto enrolment was ushered in. The government faces a crucial balancing act here. Harnessing the inertia of auto enrolment and raising minimum contributions is recognised as the most effective way to boost workers’ retirement, but increasing them too quickly could run the risk of savers opting out of their pensions altogether.

In terms of other potential solutions, abolishing the lower earnings limit for contributions, meaning you start saving from the first pound you earn, and reducing the age for being automatically enrolled from 22 years old to 18 years old received Royal Assent on 18 September 2023, but nothing has happened since. Pushing this legislation through is a logical step to tick up the pension savings of younger and lower-paid workers – especially as only one in four low earners in the private sector are paying into a pension.

Tackling the self-employed pension crisis

One of the main limitations of auto enrolment is that it’s only available to employed workers, leaving people who work for themselves out in the cold.

Addressing low pension participation among the self-employed is one of the biggest challenges the Commission faces.

Over three million self-employed are not saving into a pension, according to government figures. We should, however, note that pensions aren’t the only way to save for retirement. Some self-employed workers could be using alternative assets such as buy-to-let properties, have business interests to sell or generate a future income from, or prefer individual savings accounts (ISA). Plus, as the DWP report notes, “self-employment may offer opportunities for people to keep working longer in life”. Not everyone wants a “hard stop” retirement.

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That said, while some may endeavour to work during their later years, this is largely dependent on having sufficient physical and cognitive health – two things we largely can’t control. It’s vital to have savings to fall back on.

Making sure the self-employed have greater access and awareness to retirement saving opportunities is a key area for reform and the government may need to get creative. There are practical challenges to expanding auto enrolment to this group, such as no fixed monthly salary to deduct contributions from and no employer to split the tab.

Homing in on state pension age

Amid concerns about the future sustainability of the state pension, the government has launched its third review of the state pension age.

Under the Pension Act 2014, the government must review the state pension age once every six years. The previous reviews took place in 2017 and 2023, so the new instalment is arriving early, illustrating just how pressing the matter has become.

Labour’s review will be split into two parts - one conducted by Dr Suzy Morrissey and the other by the Government Actuary’s Department - and will assess things like the merits of linking state pension age to life expectancy, including fairness between generations, and the role of state pension age in managing the policy’s long-term sustainability.

We can assume a core aspect of this review will home in on the timetable for future age increases. The age you can claim your state pension is currently 66 but rising to 67 in 2028 and scheduled to hike to 68 between 2044 and 2046. The Cridland Review, conducted in 2017, recommended the increase to 68 should be brought forward to 2037 and 2039. While the government accepted this proposal, the existing system remains unchanged…for now.

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A further consideration is whether to raise the state pension age even higher. A report last year by the International Longevity Centre suggested it should be hiked to 71 by 2050 to remain affordable.

Accelerating the timetable or increasing the age of entitlement are not decisions to take lightly. The full state pension is currently just under £12,000, and although this alone isn’t enough to fund a comfortable retirement, it’s a crucial form of inflation-proofed income to meet day-to-day costs. If people must wait an extra year to claim it, especially if introduced at short notice, they’ll need to plug the gap with other savings or work a bit longer than planned.

The counter consideration is that the state pension is becoming increasingly expensive to run. With the retirement population increasing, taxpayers might be forced to shoulder more of the burden, at a time when UK tax revenues are already at a 70-year high.

It would be remiss not to mention the triple lock - which guarantees the state pension uprates every year by the highest of inflation, wage increases or 2.5% - although that policy appears out of scope for this review. The Institute for Fiscal Studies (IFS) recently warned that the state pension age could rise to 69 and 74 by 2049 and 2069, respectively, unless the triple lock is reformed.

In any case, the triple lock will remain for this parliament. But as it is set to cost three times the original estimate by 2030, future governments may have little choice but to confront its long-term viability. The problem is the full state pension alone is not enough to rely on in retirement, yet for many retirees it's their core source of income. Healthy future increases are needed to keep their heads above water.