Actuarially fair accrual rates and deferral of the UK state pension

Dagpunar, John (2019) Actuarially fair accrual rates and deferral of the UK state pension

Abstract

Persons who have achieved state pension age (SPA) are entitled to defer taking the pension and instead receive an extra pension on termination of deferral. The Department of Work and Pensions (DWP) asked the UK Government Actuary to advise on an actuarially fair scheme, which is interpreted to mean one that gives on average no pre-tax advantage over a lifetime to the deferrer and consequently remains cost neutral to the Exchequer. After a review of the literature on deferral or early take-up of state pensions in the UK and other countries, this paper argues that the current scheme based upon a uniform accrual rate cannot meet the objectives of fairness. Instead, we
propose a scheme where the accrual rate varies dynamically according to number of years deferred, gender, state pension age, number of years deferred under the existing uniform rates, and real rate of pension uprating. The model, developed in continuous time, is extended to the more complex scenario of a deferrer with partner entitled to inherit deferrer’s extra pension or lump sum. Accrual rate curves are plotted for various scenarios and compared with the current uniform rates of 5.8% and 10.4% that apply to those who attained state pension age after 5 April 2016 or before 6 April 2016 respectively. The 10.4% scheme is shown to be actuarially unfair for a wide range of real pension uprating rates, at cost to the Exchequer. The methodology should be applicable to public pensions in other countries.

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