The incentive effects of means tested UK retirement benefits — has the Pension Credit gone too far?

Pub. Date
27 November, 2006
Pub. Type

Means testing plays and important role in state provided retirement benefits in the UK. Although it is well known that the behavioural incentives associated with means testing are theoretically ambiguous, little work has been conducted to infer the behavioural effects of contemporary means tested retirement benefits. This study uses a carefully calibrated structural model to explore labour supply, savings, and welfare effects for UK households of a revenue neutral shift from a state pension system based on a 40% withdrawal rate -- reflecting the current policy environment -- to a 70% withdrawal-rate -- which is mid-way between the current policy environment, and the 100% rate that was applied prior to October 2003. The analysis suggests that the policy counterfactual would have little effect on savings or retirement from a macro perspective, but would have some important distributional implications. Furthermore, the welfare analysis suggests that it would be preferable, from a lifetime perspective, to increase the withdrawal rate on means tested retirement benefits above the 40% rate that is currently applied.