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Social Security Privatization: Experiences Abroad
January 1999
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CHAPTER III

THE PENSION SYSTEM IN THE UNITED KINGDOM

The United Kingdom reformed its pension system as part of the policies that led to reducing the government's role in the economy. The Conservative government, whose rule lasted from 1979 to 1997, curtailed the power of trade unions, privatized many public enterprises, and reduced government regulation. In addition, the government cut back on welfare programs and made labor markets more flexible. Those government policies aimed to restore market incentives and limit the rapid growth of the state sector to overcome the United Kingdom's sluggish economic performance during most of the postwar period.

The government made several changes to its pension system in 1986 and 1995. One of the most significant changes enacted in 1986 allows people to partially opt out of the public pension system in favor of private pensions. In return, those workers receive a rebate on their pension contributions. In addition, the United Kingdom changed the benefit and indexation rules of the pension program in 1986 and instituted another reform in 1995, substantially reducing future benefit levels. Box 2 explains some of the terms used for U.K. institutions and programs.
 

BOX 2.
TERMS USED IN THE UNITED KINGDOM'S PENSION SYSTEM

Government Pensions

Basic State Pension. A basic pension paid by the government to workers who have contributed for a sufficient number of years. The size of the pension varies with the years of contributions but does not depend on previous earnings.

State Earnings-Related Pension Scheme (SERPS). A supplementary government pension, paid in addition to the basic state pension. SERPS benefits depend on the number of years a worker contributed and previous earnings.
 

Financing

National Insurance Fund. A fund that finances social security and welfare benefits in the United Kingdom. Among other benefits, the fund finances the basic state pension and SERPS benefits, parts of the National Health System, and unemployment benefits.

National Insurance Contribution. A wage-based contribution to the National Insurance Fund. Employees and employers both contribute on the basis of a worker's earnings. Contribution rates differ for employers and employees, and the rates also depend on participation in private pension plans. Contributions are subject to lower and upper earnings limits for employees and a lower earnings limit for employers.
 

Private Pensions

Occupational Pension. A pension plan offered by employers. In most cases, workers and employers contribute to occupational pension plans, and occupational pensions pay a benefit according to previous earnings and length of service.

Appropriate Personal Pension. A private individual pension plan financed with worker contributions. Retirement income depends on the investment returns of the savings in personal pensions, which are offered by banks, insurance companies, and other financial institutions.

Contracting Out. A special provision in U.K. law that permits workers to opt out of SERPS. In return, workers receive a rebate of some of their national insurance contributions. Workers qualify for the rebate by participating in an occupational pension plan or by setting up an appropriate personal pension.

 

OVERVIEW OF THE PENSION SYSTEM IN THE UNITED KINGDOM

The United Kingdom's current pension system consists of three tiers. The first tier provides a basic state pension. The second tier provides a mandatory earnings-related pension. The government offers an earnings-related pension, or if a worker opts out of the government system, an employer-sponsored plan or a personal pension plan provides the pension. The third tier, which is not discussed in this paper, is completely discretionary and consists of additional contributions to a company or personal pension plan or any other form of saving.

Both the government's basic state pension and its supplementary pension are financed by the National Insurance Fund, which receives the proceeds of a payroll tax. (Besides state pensions, the fund also pays for part of the National Health Service, unemployment benefits, and other government support programs.)

Until 1975, employees and employers financed the National Insurance Fund with lump-sum contributions not related to earnings. In 1975, the government replaced the lump-sum contribution with an earnings-related contribution, up to a ceiling, similar to the U.S. payroll tax. The U.K. payroll tax is called the national insurance contribution; contribution rates are set annually with the budget.

In almost every year between 1948 and 1989, the U.K. Treasury made supplementary payments to the National Insurance Fund from general revenues. Although the government initially intended to prefund the basic state pensions by accumulating a stock of assets, the fund has been financed on a pay-as-you-go basis from the beginning: workers who retired at their pensionable age after 1946 received benefits without having contributed to the system, and those benefits were financed by contributions from the working population.

The Basic State Pension

In 1946, the United Kingdom passed the National Insurance Act, which provided for the basic state pension and other social insurance benefits. The value of the basic state pension was set just above a deemed subsistence level, and workers who wished to obtain higher pensions had to purchase additional private insurance.

Through the years, the most dramatic change in the basic state pension has been the change in indexation rules. The value of the pension was adjusted in discretionary steps until 1975. Between 1975 and 1981, benefits for retirees were automatically adjusted by the larger of the growth in earnings or inflation. Since 1981, the pension has been indexed to the price level, resulting in a significant decline of benefits relative to earnings over time. For long historical periods, earnings have grown faster than inflation because earnings growth reflects both the increase of the price level and the increase in economic productivity over time. In 1978, the pension for all workers was 20 percent of the average earnings for males, but it had fallen to 15 percent in the early 1990s and is expected to fall to 9 percent by 2030.(1) The full basic state pension was £62.45 per week in fiscal year 1997-1998 (about US$101 at average 1997 exchange rates).(2)

The basic state pension does not depend on previous earnings: all qualifying retirees receive a pension based solely on years of coverage, which refers to the number of years the pension system credits to the worker when determining pension benefits. A full pension requires that workers make sufficient contributions for at least 90 percent of their working lives. (Working lives are between the ages of 16 and 65 for males and 16 and 60 for females.) The pension is reduced proportionally if the coverage is less than the required years, but workers may receive credits for childrearing, caregiving, education, disability, and unemployment. Workers whose coverage is less than the number of years needed to qualify for 25 percent of the full pension do not receive the basic pension.(3)

The State Earnings-Related Pension Scheme

The 1975 Social Security Act established a new state earnings-related pension scheme (SERPS) for supplementing the basic state pension and a proportional payroll tax for financing the National Insurance Fund. Workers may opt out of SERPS if they are enrolled in an approved occupational (employer-sponsored) pension or if they establish a personal pension.(4) People in the United Kingdom refer to the decision to opt out of the government program as "contracting out."

SERPS benefits are based on earnings subject to certain limits. Workers receive no benefits if their weekly earnings are less than the lower earnings limit (£64 in 1998), and they receive no additional benefits for weekly earnings above the upper earnings limit (£485 in 1998). In addition, the upper earnings limit is indexed to prices rather than wages, so the value of the SERPS pension in relation to average earnings will decline over time as real wages grow.

The National Insurance Fund finances SERPS benefits (and other welfare programs) with payroll tax revenues. Employees who do not participate in an occupational pension plan and have weekly earnings above the lower earnings limit must contribute 2 percent of the lower earnings limit plus 10 percent of any earnings between the lower and upper limits. Employers must also make earnings-related contributions. Employers' rates rise from 3 percent to 10 percent and are not capped at the upper limit. Self-employed workers expecting to earn more than £3,590 for the year must contribute £6.35 a week plus 6 percent of their net income between £7,310 and £25,220 a year.

In the wake of the 1986 and 1995 reforms, the United Kingdom also substantially reduced its future SERPS obligations by curtailing those benefits. The adjustment that most significantly reduced SERPS benefits involved changing the method of determining benefits. For pensioners retiring between April 1999 and April 2009, SERPS benefits will gradually decrease from 25 percent to 20 percent of average earnings. In addition, the calculation of average earnings will be based on lifetime earnings, not on the 20 years of highest earnings.(5)

A variety of other changes have reduced the cost of SERPS. In the future, widows and widowers over 65 will inherit half of their spouse's SERPS rights instead of the full amount. The 1995 pension reform also removed the government's obligation to provide limited price indexation for the occupational pensions that qualify for contracting out of SERPS. Finally, the pensionable age for women will rise from 60 to 65 after 2010.
 

CONTRACTING OUT WITH OCCUPATIONAL PENSION PLANS

Workers covered by an approved occupational pension plan do not have to participate in the government's SERPS. Since the introduction of SERPS in 1975, workers who were already covered by an approved occupational defined benefit pension plan or who had just joined such a plan could opt out of SERPS. A defined benefit plan offers a pension based on a worker's salary and years of coverage, similar to SERPS. (Employers, however, may not force their workers to join the company pension plan.)

Another type of occupational pension plan is the defined contribution plan. In such a plan, a pension depends on the assets a worker has accumulated in an account during his or her working years. Since 1986, the government has also allowed participants in those plans to leave SERPS. The regulations governing the rebates for taxation and withdrawal of funds from occupational defined contribution plans generally match the regulations established for personal pensions and are discussed in the following section.(6) Unless otherwise noted, the term "occupational pension plan" refers to a defined benefit plan.

An occupational pension plan substituting for SERPS must meet certain requirements to receive government approval. In general, occupational pensions must provide benefits that are at least as generous as those received under SERPS, and the plans must be funded according to actuarial principles. Since 1995, occupational pension plans have had to increase pension benefits by the rate of inflation or by 5 percent per year, whichever is less.

Employers and employees who contract out of SERPS receive a rebate on their national insurance contributions. Currently, employees in an occupational pension plan receive a 1.6 percent contracted-out rebate. Instead of paying 10 percent on earnings between the lower and upper limits, those employees contribute only 8.4 percent of their earnings between those limits (see Table 5). Employers also receive a contracted-out rebate of 3 percent of earnings between the two limits.
 


TABLE 5.
NATIONAL INSURANCE CONTRIBUTION RATES IN THE UNITED KINGDOM, FISCAL YEAR 1998-1999
Weekly Earnings Remaining in SERPS Contracting Out of SERPS

Employee Contributions
 
Less Than £64 0 0
£64 to £485 2 percent of £64 plus 10 percent of earnings between £64 and £485 2 percent of £64 plus 8.4 percent of earnings between £64 and £485
More Than £485 2 percent of £64 plus 10 percent of £485 2 percent of £64 plus 8.4 percent of £485
 
Employer Contributions
 
Less Than £64 0 0
£64 to £109.9 3 percent of earnings 3 percent of £64
£110 to £154.9 5 percent of earnings 5 percent of £64 plus 2 percent of earnings between £64 and £154.9
£155 to £209.9 7 percent of earnings 7 percent of £64 and 4 percent of earnings between £64 and £209.9
£210 to £485 10 percent of earnings 10 percent of £64 plus 7 percent of earnings between £64 and £485
More Than £485 10 percent of earnings 10 percent of £64 plus 7 percent of (£485-£64) plus 10 percent of earnings above £485

SOURCE: Congressional Budget Office using data from the U.K. Department of Social Security.
NOTE: SERPS = state earnings-related pension scheme.

The amount of employees' and employers' contributions to an occupational pension plan depends on the particular plan. In 1991, over 70 percent of private- and public-sector employees in defined benefit plans contributed between 5 percent and 7 percent of their salary. Nonetheless, almost 19 percent of private-sector employees did not have to contribute at all to their pensions.(7) Employer contributions vary depending on the benefit rules established for the pension plan and the investment returns of the pension fund. According to some estimates, employers contribute about 10 percent of salaries on average.(8) In the case of occupational defined contribution plans, the total contribution must at least equal the combined contracted-out rebate of the employer and the employee.

Contributions to pensions and pension savings are exempt from income taxation up to a limit. In defined benefit plans, the maximum tax-free employee contribution is 15 percent of earnings, and in fiscal year 1998-1999, only income up to £87,600 is tax-free. The total tax-free contribution of employers and employees may not exceed 17.5 percent of salary, with higher limits for workers older than 50.(9) (Employers may contribute more, but those contributions are taxable.) In addition, investment income and capital gains of pension funds are not taxed. Moreover, workers may withdraw tax-free an amount up to 150 percent of their annual income in their last year of work in exchange for a lower pension. Normally, the pension from occupational pension plans is fully taxable under the income tax laws.(10)
 

CONTRACTING OUT WITH PERSONAL PENSION PLANS

The 1986 reform allowed workers to opt out of SERPS and establish personal retirement accounts, called appropriate personal pensions. Banks, mortgage companies, insurance companies, investment trusts, and other financial institutions offer those plans. If a worker is enrolled in an occupational pension plan and receives the rebate for opting out, however, he or she may not enroll in a personal pension plan as well.

Workers who establish personal pensions and their employers must initially pay the usual national insurance contribution rates, but workers receive a rebate later on. At the end of the fiscal year, the Department of Social Security pays a rebate from the National Insurance Fund into the personal pension of a worker's choice. Those investments are made with an average delay of about nine months, during which the worker receives no investment returns.(11) Since 1997, the rebate for personal pensions has differed from the rebate for occupational defined benefit plans and has become dependent on age. The rebate starts at 3.4 percent of earnings and increases to 9 percent for older employees.

From 1988 to 1992, the government encouraged contracting out to private pension plans by establishing an incentive program. During that period, the government paid not only the standard contracting-out rebate to personal pensions but also an additional 2 percent incentive tax rebate. Since 1993, the incentive tax rebate has dropped to 1 percent of earnings for people older than 30.

Personal pensions receive special tax treatment similar to that of occupational pension plans.(12) The investment returns and capital gains accruing to personal pensions are exempt from the income tax. Moreover, contributions to personal pensions, whether made by the employee or employer, are tax-free up to a limit. The maximum permissible tax-free contribution to a personal pension starts at 17.5 percent for workers age 35 and younger and increases incrementally to 40 percent for workers older than 60 (see Table 6). In addition, the amount of earnings to which those rates may be applied is capped at £87,600 in fiscal year 1998-1999. Although contributions in any single year are limited, a worker may carry forward unused tax relief for up to six years. If, for some reason, a worker decides not to make a full contribution in a given year, that worker may then contribute an amount exceeding the cap in a following year.(13)
 


TABLE 6.
MAXIMUM TAX-FREE CONTRIBUTIONS TO AN APPROPRIATE PERSONAL PENSION, BY AGE
Age (Years) Maximum Contribution
(As a percentage of
income below £87,600)

Under 36 17.5
36 to 45 20.0
46 to 50 25.0
51 to 55 30.0
56 to 60 35.0
Over 60 40.0

SOURCE: Congressional Budget Office using data from David Blake, "Pension Choices and Pension Policy in the United Kingdom," in Salvador Valdés-Prieto, ed., The Economics of Pensions: Principles, Policies and International Experience (New York: Cambridge University Press, 1997), p. 295.

Special rules govern the withdrawal of funds from a personal pension. The portion of assets accumulated from the government rebate must be annuitized at some time when the worker is between the ages of 50 and 75 and be indexed to inflation up to 3 percent (referred to as limited inflation protection). That annuity must also provide a 50 percent benefit for surviving spouses.(14) Of the remaining account balance, 25 percent may be withdrawn tax-free in a lump sum. The rest must also be converted into an annuity when the worker is between the ages of 50 and 75, but the annuity does not have to be indexed to inflation or provide survivor benefits. Before any of the retirement savings are annuitized, a worker may withdraw certain amounts from the savings--an action known as an "income drawdown." Annuity payments and income drawdowns are taxable as regular income.
 

THE EFFECT OF PENSION REFORMS ON GOVERNMENT FINANCES AND NATIONAL SAVING

By allowing workers to opt out of SERPS, the government lowered the revenue of the National Insurance Fund. By 1995, almost 6 million workers, or 25 percent of the workforce, chose to purchase personal pensions. About 5.4 million of those workers had been previously enrolled in SERPS; the rest left occupational pension plans.(15) As mentioned, the government incurred additional costs by offering a special incentive rebate to workers who opted out of the system.

The United Kingdom faces some of the typical costs of making the transition from a pay-as-you-go system. Those costs arise because retirees and older workers continue to collect government-financed benefits, and younger workers who opt out of SERPS reduce their national insurance contributions. Moreover, workers who have opted out may still claim SERPS benefits according to the number of years they were covered under SERPS.

The U.K. government has been able to manage those transition costs fairly easily for several reasons. First, since not all workers opted out of SERPS, the pension system has been only partially privatized. (Of course, the government also retained obligations in SERPS for workers who remain in the program.) Second, because SERPS is a fairly young program, a relatively small number of current retirees receive any benefits. Most retirees receive benefits only from the basic state pension, which is less generous. Third, changes in the program's tax rate of up to 1 percentage point do not require parliamentary approval. Changes in national insurance contribution rates are therefore easier to implement than changes in income taxes. According to some analysts, the national insurance contribution rates have been about 2 percentage points higher than they otherwise would have been.(16) Finally, in some years the National Insurance Fund has received transfers from general revenues, which helps reduce the fund's deficits.

In addition, the reforms in 1986 and 1995 substantially reduced future benefits from SERPS. As mentioned, SERPS benefits were cut back from 25 percent of wages to 20 percent. Table 7 shows the effects of those reforms. Although the cut in benefits lowered the cost of SERPS, much of the reduction in long-term liabilities stemmed from workers contracting out of the program.
 


TABLE 7.
EFFECT OF U.K. PENSION REFORMS ON THE COST OF SERPS (By fiscal year, in billions of pounds at 1994-1995 prices)
1994-
1995
2000-
2001
2010-
2011
2020-
2021
2030-
2031

Original System 1.8 4.2 12.0 25.0 41.0
1986 Reform 1.8 4.2 9.2 14.5 18.7
1995 Reform 1.8 4.2 8.4 10.9 12.0

SOURCE: Congressional Budget Office using data from Alan Budd and Nigel Campbell, "The Pensions System in the United Kingdom," in Martin S. Feldstein, ed., Privatizing Social Security (Chicago: University of Chicago Press, 1998), Table 3.5.

Because of the cut in SERPS benefits, the basic state pension accounts for most of the government's remaining obligation. Although basic benefits are projected to decline substantially relative to average earnings, the cost of the basic state pension is still expected to rise from £26.9 billion in 1994-1995 to £41.9 billion (in 1994-1995 prices) in 2030-2031, more than three times the projected cost of SERPS. That increase reflects the aging of the U.K. population, which more than offsets the cuts in benefits per recipient.

Nonetheless, because of the 1986 and 1995 reforms, the overall payroll tax rate is expected to fall from 18.3 percent in fiscal year 1994-1995 to 17.4 percent in 2030-2031 (and then to 14.1 percent in 2050-2051) despite demographic pressures.(17) Because the national insurance contribution rate is probably 2 percent higher today than it otherwise would have been, the United Kingdom's reform also reflects the trade-off between higher costs for funding today and lower costs for pensions in the future.(18)

National Saving

The extent to which the U.K. pension reform affected national saving depends on the extent to which it changed public and private saving. The changes to public saving are fairly straightforward: although the rebate of national insurance contributions works to reduce government revenues, the government raised national insurance contribution rates; therefore, government saving did not decline after the pension reform. In the long run, benefit cuts will further alleviate budgetary pressures and possibly increase public saving. The response of private saving to the pension reform is unknown. If U.K. workers are prudent and forward looking, they will not only save in personal pension plans but also make up for their loss of SERPS benefits by saving more in general. If government saving stays the same, any increase in private saving resulting from the pension reform will also increase national saving.
 

REGULATION OF PENSION PLANS AND COSTS

Few regulations govern investments in and sales of personal pension plans in the United Kingdom. Some people have had concerns, however, about the charges for personal pension plans and annuities.

Regulation of Investments and Sales

Neither occupational nor personal pension plans are subject to strict investment regulations. Generally, those plans must invest according to the so-called prudent-man rule, which requires that investments be sufficiently diversified. No more than 10 percent of investments may be made in the same asset, and plans may not invest more than 5 percent in the company offering the plan.

A variety of financial institutions, including insurance companies, banks, and mutual funds, offer personal pension plans. Each provider commonly offers its customers investment options with varying degrees of risk. A typical personal pension plan has 55 percent of its investments in U.K. equities, 40 percent in international equities, and 5 percent in bills and bonds.(19)

Following the so-called mis-selling scandal, the government tightened oversight of personal pension plans in the mid-1990s. The mis-selling scandal involved salespeople wrongly advising workers to leave occupational pension plans and join personal pension plans. Many of the 560,000 workers who switched from occupational pension plans to personal pension plans suffered predictable losses in future retirement income because they lost vesting rights in the occupational plans. Consequently, the U.K. Securities and Investments Board started a thorough review of all such cases and found extensive evidence of high-pressure sales tactics that overstated the benefit of switching to the new plans. Compensation of those who suffered losses has been slow, however, and will impose considerable costs on pension plan providers.(20)

To protect workers, the Securities and Investments Board introduced stricter rules governing transfers between occupational and personal pension plans in 1994. New pension transfer contracts must now include a 14-day cooling-off period during which workers may back out of the contract. In addition, every transfer recommendation must include a written explanation of why the pension adviser believes the transfer is favorable. The adviser must use a computer program that analyzes the value of the transfer and must share the results with the worker.

Furthermore, the Securities and Investments Board established new standards designed to remove negligent or corrupt pension advisers. Only a restricted group of trained individuals may now work as pension advisers. Moreover, the board requires pension transfer advisers to establish separate and independent units to double-check every transfer recommendation.(21)

Annuitization

Members of personal pension plans use funds remaining after a permissible lump-sum withdrawal to purchase an annuity from a life insurance company. Members must make the purchase before age 75. Most personal pension plans include an option for annuitization through the plan's life insurer. The worker can withdraw his or her funds from the plan, however, and purchase an annuity from another life insurer (known as an open-market option). The market offers a variety of annuities: annuities with or without coverage of survivors, flat annuities, and annuities with escalating benefits. Insurers also offer inflation-indexed annuities.(22) U.K. insurers may segment the market into risk classes and are reportedly offering higher-yielding annuities to sick people and those with unhealthy habits such as smoking.(23)

Costs of Personal Pensions and Annuities

Savings in personal pensions are subject to several charges, which can differ substantially by provider. In addition, the cumulative effect of the charges on a worker's ultimate pension is often difficult for a worker to assess. Most personal pension providers charge commissions on new contributions; some also withhold a certain percentage of the first contribution to the fund as a commission. Moreover, personal pensions have charges on assets, lump-sum administrative charges, and penalties for withdrawing funds or exercising an open-market option for annuities.

One recent study examines a personal pension plan with excessive charges to illustrate the variety of fees.(24) The plan had a repurchasing value that was 5.3 percent below its sales price, and annual management charges were 1.5 percent; the plan also withheld 40 percent of the start-up contribution as a commission. Moreover, the plan charged a monthly lump-sum fee of £2 and a 5 percent penalty for leaving the fund and purchasing the annuity from another provider.

Of course, that example reflects an extreme case, not the average cost of personal pensions. According to one estimate, average costs for U.K. personal pension plans include charges on new contributions of approximately 10 percent and management charges of 0.6 percent to 0.7 percent of assets per year.(25) According to some other estimates, personal pension plan charges reduce the fund value of a five-year investment plan with monthly contributions of £200 and retirement at age 65 by an average of 13 percent, with a minimum charge of 3.3 percent and a maximum of 24 percent. Those costs are equivalent to reducing investment returns by an average of 1.5 percentage points.(26)

The U.K. annuities market suffers from imperfections similar to those in the U.S. market.(27) First, people with long life expectancy (the bad risks for insurance companies) are more likely to purchase annuities than people with short life expectancy, a problem known as adverse selection. That behavior is reinforced by the U.K. policy of allowing people to defer annuitization until age 75. People who think they will not live until age 75 delay annuitization because they can bequeath the remaining account balance. According to some estimates, adverse selection reduces the value of annuities for a 65-year-old male by 15 percent.(28) Second, identical annuities are often sold at puzzling price differentials: in 1994, the fixed annuity for life offered to a 65-year-old male for a premium of £10,000 varied between £1,158 and £888 per year, a difference of 23 percent.(29)
 

SYSTEM PERFORMANCE

The U.K. pension reform successfully reduced the government's long-term costs for the state earnings-related pension scheme. Two policies have reduced those costs: encouraging workers who had not previously participated in occupational pension plans to provide for their own retirement income through personal pension plans and cutting the benefits offered to those who remained in SERPS. By 1995, almost 6 million people--about 25 percent of the workforce--had chosen personal pension plans. Another 9.3 million workers participated in occupational pension plans.

Because the government acted early and participation in personal pension plans is voluntary, opposition to those policies was minimal. By the time future SERPS benefits were cut significantly, a relatively small number of workers had accrued significant pension rights in that program. Moreover, every worker who left SERPS did so voluntarily and may return to SERPS if desired. By basing tax rebates on age, the government has greatly reduced the incentive for workers to return to SERPS at older ages.

In addition to the inappropriate advice offered by pension providers and the personal pension plans' complicated fee structure, other concerns have been raised about the U.K. pension system. First, the complex system requires workers to choose among SERPS, personal pensions, or occupational pensions, which can be difficult. Moreover, the best choice depends on each worker's characteristics such as how often he or she switches jobs or participates in the workforce.

Second, choosing to invest in a personal pension rather than SERPS is particularly advantageous for younger workers. The highest percentage of people with personal pension coverage is among full-time workers ages 25 to 34 (37 percent of males and 26 percent of females). Because younger workers enter and leave the workforce more often than older workers, their contributions to personal pension plans tend to be more erratic and smaller. Only half of those people with personal pensions in fiscal year 1992-1993 had positive wages in fiscal years 1990-1991, 1991-1992, and 1992-1993. In addition, only about 50 percent of participants in private pension plans made contributions beyond the government rebate to their accounts, raising some concerns about the adequacy of retirement savings.(30)

Third, people with low earnings do not find personal pensions attractive because those pensions charge proportionately higher amounts for workers with low and unstable contributions. As a result, the highest percentage of workers without an occupational or personal pension is among low-income workers: 65 percent of full-time workers earning more than the lower earnings limit of £64 but less than £100 a week had neither a personal pension plan nor an occupational pension plan.(31) The reduction of future SERPS benefits affects those workers the most; those workers could become a fiscal risk if their future retirement income must be supplemented by welfare benefits.


1. Alan Budd and Nigel Campbell, "The Pensions System in the United Kingdom," in Martin S. Feldstein, ed., Privatizing Social Security (Chicago: University of Chicago Press, 1998), pp. 99-127.

2. Fiscal years in the United Kingdom begin on July 1 of one year and end on June 30 of the following year.

3. In addition to the basic state pension, the U.K. government pays welfare benefits (a noncontributory pension) to people older than age 80 with either no or very small pension entitlements.

4. See the section on contracting out with occupational pensions in this chapter for more detail on requirements for occupational pension plans.

5. U.S. Social Security Administration, Social Security Programs Throughout the World (1997), p. 369.

6. Occupational defined contribution plans play a small role in the United Kingdom, covering only about 2 percent of workers contributing to pensions other than the basic state pension in 1991. See Andrew Dilnot and others, Pensions Policy in the UK: An Economic Analysis (London: Institute for Fiscal Studies, 1994), Table 2.4.

7. CBO calculations using data in Budd and Campbell, "The Pensions System in the United Kingdom," Table 3.7.

8. David Blake, "Pension Choices and Pension Policy in the United Kingdom," in Salvador Valdés-Prieto, ed., The Economics of Pensions: Principles, Policies and International Experience (New York: Cambridge University Press, 1997), pp. 277-317.

9. Ibid., p. 294.

10. Dilnot and others, Pensions Policy in the UK, pp. 90-91.

11. Blake, "Pension Choices and Pension Policy in the United Kingdom," p. 291.

12. See Dilnot and others, Pensions Policy in the UK, p. 104, for a description of the tax treatment and withdrawal rules for occupational defined contribution plans.

13. Blake, "Pension Choices and Pension Policy in the United Kingdom," p. 286.

14. John A. Turner and Noriyasu Watanabe, Private Pension Policies in Industrialized Countries: A Comparative Analysis (Kalamazoo, Mich.: W.E. Upjohn Institute for Employment Research, 1995), p. 38.

15. Richard Disney and Paul Johnson, "The United Kingdom: A Working System of Minimum Pensions?" in Horst Siebert, ed., Redesigning Social Security (Tübingen, Germany: J.C.B. Mohr, 1998).

16. Ibid.

17. Ibid., Table 1.

18. The British National Audit Office reported in a widely cited study in the early 1990s that the cost of opting out exceeded the present value of future savings for the government; however, according to Budd and Campbell, "The Pensions System in the United Kingdom," p. 110, the study did not include the full effect of opting out of SERPS and the related decline in future public pension costs.

19. David Blake and Michael Orszag, "Towards a Universal Funded Second Pension" (draft, The Pensions Institute, London, October 1997), p. 103 (also available at http://www.econ.bbk.ac.uk).

20. "Social Security Switch in U.K. Is Disastrous: A Caution to the U.S.?" Wall Street Journal, August 10, 1998, p. A1; and "Taxing Reforms for British Retirees," Washington Post, August 9, 1998, p. R1.

21. Blake and Orszag, "Towards a Universal Funded Second Pension," p. 80.

22. Ibid., p. 124.

23. Budd and Campbell, "The Pensions System in the United Kingdom," p. 115.

24. See Blake and Orszag, "Towards a Universal Funded Second Pension," p. 83.

25. Ibid., Table 3.10.

26. Richard Disney, "Comment," in Martin S. Feldstein, ed., Privatizing Social Security (Chicago: University of Chicago Press, 1998), Table 3C.3.

27. For a discussion of U.S. annuity prices and market imperfections, see Congressional Budget Office, Social Security Privatization and the Annuities Market, CBO Paper (February 1998).

28. David Blake, William Burrows, and J. Michael Orszag, "Stakeholder Annuities: Reducing the Costs of Pension Provision" (draft, The Pensions Institute, London, January 1998), p. 8.

29. Blake, "Pension Choices and Pension Policy in the United Kingdom," Table 10.B6.

30. Disney, "Comment," pp. 131-132.

31. Blake and Orszag, "Towards a Universal Funded Second Pension," Tables 3.2 and 3.3.


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