Reeves faces difficult decisions at next week’s Budget, but tampering risks creating more problems in the long-term, writes KPMG’s Stephen Collins
As the Chancellor prepares to unveil the 2024 Budget, pensions tax is a key focus. However, we need to consider any proposed tax changes in the context of the broader pensions landscape. While difficult decisions on public finances will inevitably need to be made, it will be important not to compound the problem of the future fitness of pensions faced by so many people.
Only last month, the Institute for Fiscal Studies published findings that more than 30 per cent of current private sector employees are not expected to reach a “minimum retirement living standard” of £14,400 a year. This is on the back of the Association of British Insurers and Pensions and Lifetime Savings Association publicly stating that contributions will need to rise significantly if the capacity of pensions in the long-term was going to be addressed. It is clear the system is already strained, and action is needed to repair this gap.
So, what drives this gap? There are several factors that can be identified. Firstly, in the UK, the disparity in pension benefits across generations is significant. Previous generations benefitted from the prevalence of defined benefit (DB) schemes during their working years; however, in contrast, Generation X and Millennials have seen a shift from DB to defined contribution (DC) schemes, resulting in lower and less predictable pension outcomes. The number of members actively building up a private-sector DB pension in the UK fell from 2m in 2012 to 700,000 in 2023.
Generation Z, currently in the early stages of their careers, are likely to face significant hurdles in building adequate pension benefits, given economic instability, repaying student loans in some cases, grappling with getting on the property ladder and the rising cost of living. In eyeing potential tax rises, the Chancellor will need to ensure future generations are not further put off from saving into their pensions.
Secondly, the divide between public and private sector pensions in the UK is another critical issue. Public sector DB schemes offer more generous benefits and provide greater certainty than DC schemes common in the private sector, which means there is a disconnect between quality of living in retirement. This issue may be a challenging one for the Chancellor to grapple with, given the different structure of reward in the public and private sector.
Thirdly, the gender pensions gap remains a pressing concern. The Pensions Policy Institute identified different working patterns and the gender pay gap as the key factors contributing to women holding 62p of pensions wealth for every £1 held by men.
If this all sounds a bit doom-and-gloom, let’s look at some of the positives. One of the most successful initiatives to encourage pension savings, particularly in the private sector, has been auto-enrolment. Introduced in 2012, auto-enrolment applies “nudge” (or rather, shove) theory. It forces employers to automatically enroll eligible workers into a workplace pension scheme but does give workers the choice to opt-out.
Did it work? Absolutely! The proportion of private sector workers saving for retirement has more than doubled in a decade. While there is evidence that average contributions rates reduced (suggesting some employers treated the minimum rate as a default rate), subsequent increases to the auto-enrolment contribution levels appear to have reversed most of this trend.
As the Chancellor considers changes to pensions taxation in the upcoming Budget, it is essential to keep the fit-for-purpose nature of long-term pensions in mind. Some of the most talked-about policy options will increase tax receipts but risk making saving for retirement less attractive for workers and their employers. Ensuring that pensions are adequate for all requires further encouragement of pension saving. Only then can we hope to secure a financially stable future for the UK’s retirees.
Stephen Collins is pensions senior manager at KPMG UK