Radical Reforms to the State Pension Here s what the upcoming White Paper is all about

Transcription

1 Radical Reforms to the State Pension Here s what the upcoming White Paper is all about The Department for Work and Pensions will shortly release a White Paper outlining Government proposals for a radical reform of UK state pensions. I have prepared this note to help explain what may be announced. Of course it may not be exact, we need to see the actual details when they are published. Nevertheless, this should help answer many of the burning questions likely to be on people s minds and help people to better understand the changes once they are announced. In brief: What is expected from the White Paper The White Paper will propose a new state pension system, eventually paying just one state pension of 140 a week (in 2010 prices) to anyone with a full 30 year National Insurance record The new pension will eventually replace Basic State Pension and all Additional State Pensions with one payment The 140 a week will be around 160 a week by the time the new scheme starts in 2016 This will only apply to men born after April 1951 and women born after April 1953 It will not be a citizen's pension - it will be based on contributions and age The new state pension will be just above the current Pension Credit means-test level, so those with private pensions, savings or earnings will not be penalised by the state pension Women, the self employed and pensioners on modest incomes with private savings will be winners. 60% of women would be entitled to less than the 140 a week so these women will all get higher state pensions under the new system. It will exclude existing pensioners. This new system will reduce - but not eliminate - pensioner means-testing. Future pensioners who do not have a full 30 year NI record, or those who may get Housing Benefit or Council Tax Benefit may still be means-tested. Anyone already entitled to over 140 a week will still receive the higher amounts, so there will be years of transition to the full new scheme when benefits from the past system will still be honoured The new system will be cost-neutral, it will just spend money differently. The cost of the higher state pension will be offset by savings from increasing the state pension age, abolishing the Savings Credit and money saved by paying zero pension to those with less than around 5 years of contributions. There will be no more contracting out of the state pension system, private schemes will be allowed to reduce their benefit structure in recognition of no longer having to replace the Additional State Pension. Public sector pension schemes may not do this as a result of the recent 25 year reform deal. Ending contracting out will mean workers and employers in contracted out pension schemes can no longer pay reduced national insurance rates. 1

2 Section 1: The old system - the current state pension system is not fit for purpose Too much tinkering and tweaking leaves a complex mess: The UK National Insurance pension system is the most complex in the world and successive Governments have tinkered with parts of the system over the years, leaving most people with a range of different entitlements to different bits of pension, depending on what year they contributed their National Insurance, how much they earned that year and what private pension arrangements they had in place at the time! It is too complex, pays inadequate state pensions to millions, relies on mass means-testing and is unfair to women. Women lose out: Women have tended to lose out significantly in terms of their state pension entitlements. Official figures show that women are entitled to much less state pension than men. The self employed also have lower state pension entitlements as they paid much lower NI. State pension payments from three different parts: The UK Government offers pensioners a bewildering array of various benefits in retirement and the system can perhaps best be understood by breaking it down into three separate parts: 1. The Basic State Pension 2. An Additional State Pension - paid by the state or can be paid by a private scheme instead 3. Pension Credit, pensioner benefits and other means-tested benefits 1. The Basic State Pension based on National Insurance contributions: This is probably the easiest part to understand. This is a flat-rate state pension payment which is paid in full to anyone who has a 30-year national insurance contribution record. In 2012/13, the full Basic State Pension is If someone has less than thirty years contributions, their Basic State Pension is reduced proportionately so, for example, anyone with 15 years contributions will be paid half the full Basic State Pension. Any year in which someone paid Married Women s Stamp, or those who earn less than the National Insurance Lower Earnings Limit will not accrue National Insurance entitlements. Far more women than men have less than a full Basic State Pension entitlement. In 2010, over half of women retirees had less than the full Basic State Pension. 2. Additional State Pension based on National Insurance contributions: This part of the state pension is earnings-related and was originally introduced by the Government to help workers without an employer final salary pension to accumulate extra pension in the state pension system. This part of their state pension would be related to their earnings, just as company schemes were. GRAD, SERPS, S2P: The additional pension has changed over the years. It started in 1961 as the Graduated Pension Scheme, then in 1978 the Government introduced the State Earnings-Related State Pension or SERPS- instead, and in 2002 this became the State Second Pension or S2P. Additional State Pension can be paid by a private scheme instead of the State if 'contracted-out': The Additional State Pension can be paid by an employer or private pension scheme instead of through the National Insurance system. As the original purpose of the Additional State pension was to help workers who did not have a company earnings-related pension scheme to build up an earnings related pension, it was decided that anyone who did have such a scheme would not really need this part of the state pension and could therefore be taken out of this part of the National Insurance pension. This was called contracting-out and is unique to the UK. Instead of receiving the Additional Pension (SERPS/S2P) from the state in retirement, anyone in a contracted-out private pension scheme will receive what was called a Guaranteed Minimum Pension or Protected Rights or their scheme must have passed a 'Reference Scheme Test', so that their private scheme will replace their state pension rights. Workers pay 1.4% lower national insurance contributions and employers pay 3.4% lower NI, in exchange for taking responsibility for the Additional 2

3 Pension away from future taxpayers. So, those who were contracted-out of this part of the National Insurance pension would have part of their state pension rights paid by their private pension scheme. In order to be allowed to contract-out, the scheme had to satisfy the Government Actuary's requirements that ensured it should be able to pay the replacement for the Additional State pension in the future. For any year that someone was contracted-out of the Additional State Pension, their State Pension Statement shows that year's entitlement as a contracted-out deduction or COD because this part of their State Pension will be paid elsewhere. Millions of people get part of their state pension from a private occupational or personal pension scheme. Of course they did not pay NI contributions for that bit of state pension. Confusing entitlement rules: Entitlement to the Additional State Pension depends on which year each National Insurance contribution was made and how much the person earned or whether they received protection when not working (such as mothers looking after young children). Most people will be unable to work out how much Additional State Pension they are entitled to, due to the complexity of all the rules and different qualification and revaluation criteria. Amount of Additional State Pension can be an extra 162 a week: The Additional State pension can be a very large amount, especially for anyone who has been in the state pension system for many years and paid into SERPS when it was originally introduced, since it was unusually generous at first. In fact, the DWP estimates that a higher earner (earning around 41,000pa) could receive an Additional State Pension worth an extra 162 per week, on top of the Basic State Pension of (A lower earner on around 20,500 a year could get an Additional State Pension of around 75 a week and a medium earner on around 29,000 a year could have an Additional Pension of 111). 3. Pension Credit and other benefits - based on age, not National Insurance contributions: The current UK State Pension system also includes a significant element of means-testing. Because the Basic State Pension is so low (and has been cut in relative terms over the years) and because millions of people do not have entitlement to the Additional State Pension, or have not built up a full National Insurance record, the Government had to introduce an extra layer of benefits to top up those pensioners without enough money. But, rather than increasing the state pension for all, in 2003 the Government decided to pay more only to the poorest pensioners, by means-testing the extra payments to bring people up to a minimum socially acceptable level. Only those without much private pension or other income can claim Pension Credit, so entitlement is determined by age and income level, not by contributions. There are also other means-tested benefits such as Housing Benefit and Council Tax benefits, as well as pensioner benefits like Winter Fuel Allowances, free TV licences, free bus passes, prescriptions and so on. Section 2: The New System in Future - what, when, who? What are the new State Pension Reforms expected to do? The White Paper will propose merging together Basic and Additional State Pensions into one flat-rate payment in future, around the Pension Credit level. Eventually, there will be one state pension amount, rather than different entitlements depending on previous earnings and year of contribution. The aim is to pay a flat-rate state pension payment of 140 a week (in 2010 prices, which will be around 160 a week by the time it comes in). This is designed to be just above the level of the Pension Credit Guarantee Credit, so that most future pensioners with a full National Insurance record would be clear of pension credit means-testing. 3

4 When will the reforms start? It is expected that the new state pension will start to be paid to people reaching state pension age after April 2016, i.e. it will apply to men born after April 1951 and women born after around April Who will benefit? Women will be the biggest beneficiaries. The self-employed will also benefit. These are the groups who are most likely to have less than the 140 a week state pension under the current system. People who have saved modest amounts in private pensions, and who would otherwise have been entitled to pension credit because their state pension is less than 140 a week should also benefit because their private pension or earnings or other income will not be penalised by pension credit. What about existing pensioners or people retiring between now and April 2016? All existing pensioners and anyone reaching state pension age before the new scheme starts will not be included. So men born before April 1951 and women born before about April 1953 will stay on the old system which this Government inherited. Will everyone get this 140 a week then in future? No. The entitlement for the full 140 a week new flat rate state pension depends on having paid full National Insurance contributions or having received credits for 30 years. So it is based on contributions and age, not just age. Someone with less than 30 years contributions will get less than the full amount. For example if their contribution record is 15 years, they will get half the full rate. So this is not a citizen s pension. It will still be a National Insurance pension which people have to contribute to. It will not be means-tested. In addition, if people have paid less than a minimum number of years of contributions (perhaps 5 years or 7 years) they will not get any state pension at all. People who did not pay full National Insurance contributions - including those who paid lower NI as a result of being 'contracted-out' of the state pension, will have part of their 140 a week paid by their contracted-out pension scheme. What about people who are already entitled to more than the 140 a week? There will be a period of transition, where past rights from the current pension system will be protected. The DWP has said past rights will be respected, and those who have accumulated a State Pension entitlement above the minimum 140 a week level will still receive the higher amount. They will not be reduced down to the minimum level, so those worrying that they will lose SERPS or S2P entitlements that have taken them above the new flat-rate state pension need not be concerned. Will many people already have built up entitlement to more than the 140 a week? Yes, mostly men. Government figures (Pension Trends Chapter 5, October 2011) show that the majority of women (60%) reaching pension age around 2016 will have a state pension entitlement below 140 a week (in 2010 prices terms), so many women will be increased to that amount. Around 30% of men are on track for a state pension below the 140 level and will also potentially have their State pension increased under the new regime. Of course, in the current system, men generally have much higher state pensions than women. In fact, the official figures also show that around 28% of men (only 9% of women) will actually have state pension entitlements above 180 a week. What about women who paid Married Women s Stamp? Many older women paid a lower rate of National Insurance when they were younger (known as the Married Women s Stamp ). After 1977, women could no longer choose to pay this lower stamp when they got married, but those who were already paying it could continue to do so. These women have accrued no entitlement to State Pensions for the years in which they paid this Married Women s Stamp therefore, even if they reach pension age after April 2016, they will not get the new state pension. 4

5 Will people who have delayed drawing their state pension be allowed into the new arrangements? I don t think so. The Government wants to make eligibility for the new State Pension dependent on when a person reaches state pension age, not when they start taking their state pension. Delaying the state pension is therefore unlikely to allow people to qualify for the higher new scheme. Won't this cost much more, how can the Government afford it? The Government insists this new system will not cost any extra money. The savings made from increasing state pension age, abolishing pension credit and not paying those with less than around 7 years contributions will offset the cost of paying higher pensions to those not already entitled to as much as the new full rate. Section 3: What will happen to Pension Credit and means-testing? What will happen to Pension Credit in future? Pension Credit will remain in place. It will provide a meanstested retirement benefit for any existing and future pensioners who receive less than the 140 a week full state pension and have little other income. What about the Pension Credit Savings Credit? The Government consultation on the new flat rate state pension suggested that Savings Credit would be abolished in future. I assume it will be retained for existing pensioners, but that has not been confirmed. Part of the costs of the new pension will be funded by abolition of Savings Credit. This will, of course, be an extra penalty for low income pensioners with some savings but without a full 30 years state pension entitlement. Does that mean there will be no more means-testing for pensioners? No, although there will be far fewer pensioners on means-testing in future. Existing pensioners will stay on Pension Credit and future pensioners with less than the full 30-year record may claim too. In addition, a significant minority will be entitled to other means-tested benefits such as Housing Benefit or Council Tax benefit. So, means-testing will affect far fewer future pensioners, but the new system will not get rid of means-testing altogether. So some people will still lose part or all their private pension when claiming means-tested benefits in retirement. Section 4: What might happen in practice? What is likely to happen in practical terms in April 2016? It is hard to know exactly how this new system will be introduced, but I expect that some time in advance of the new regime starting, everyone in the country will receive a state pension statement that shows what their state pension entitlement is at the point where the new state pension scheme starts. It will show how much of a full state pension entitlement they have built up in It will also itemise their Basic and Additional State pension entitlements which have been accrued up to that point and this will form the base on which new State pension rights will be built for the future. For example, if someone has 24 years NI contributions, they will have 80% of the full state pension already accrued. So if they then contribute for a further 6 years, they will qualify for an extra 20% of the 140, which equals 28 a week under the new system, to be added to their 2016 entitlement when they retire. Even if their state pension at 2016 is already worth over 140 a week, due to high additional state pension rights, these will still be honoured, presumably uprated for inflation until state pension age, and the entitlement under the new system will start accruing on top of this from

6 If someone has 12 years of NI contributions in 2016, then their statement will show that they have so far accrued the equivalent of 40% of their full new state pension. By contributing a further 18 years, they will build up rights to 60% of the 140 a week under the new system, thus giving them an extra 84 a week, on top of whatever state pension rights they already have in the old system in 2016 (please remember all figures will of course be uprated by future earnings or price inflation). Will some people with 30 full years of NI contributions still receive less than the 140 a week? People with 30 years of contributions could receive less than 140 a week from the state in future if they were 'contracted-out' of the state system in the past. If someone has already accrued 30 years of NI pension contributions in April 2016 then, if they were contracted-out for some or all of the time, they will receive 140 less the amount of their Contracted-Out Deduction as at April 2016, with this COD itself being due from their private scheme. So what happens to pension entitlements before and after the new system? BEFORE: In March 2016, under the current system, a person reaching State Pension Age with full 30 year NI record but no additional state pension rights would have the following entitlement: Basic State Pension 30 years (plus uprating each year) Additional State Pension 0 years 0 Contracted-out deduction 0 TOTAL STATE PENSION pw (in 2012 terms) This person will receive a week state pension throughout their retirement, with the usual upratings each year for earnings or price inflation. If this person has no other income they will be able to claim Pension Credit to top them up to nearly 140 a week (this is in 2010 terms). Of course, claiming Pension Credit will penalise their private pension, earnings or other income. FUTURE: In April 2016, under the new system, someone with full 30 years NI record and no previous entitlement to additional pension will receive: Basic State Pension Additional State Pension 30 years 0 years Contracted-out deduction 0 NEW STATE PENSION 30 years 140pw This will be the their state pension in future and they will not need to claim means-tested pension credit, so their private pension income or earnings or other income will not count against them. 6

7 Section 5: What about contracting-out? What about people who are contracted-out of the Additional State pension? From 2016 onwards, it is likely that the complex system of contracting-out will end, so that everyone in future will earn their state pension rights in the state pension system only and not have part of their state rights transferred into another pension scheme. This means that people will no longer pay the lower contracted-out rate of national insurance (which is currently 10.6% of salary instead of 12%) and their National Insurance contributions will rise to reflect the fact that their state pension rights are potentially higher. They will no longer accrue state pension entitlements outside the state pension system all their future state pension will be in one place. What happens to contracted-out rights built up before 2016? People who contracted-out will receive some of their state pension from a private pension scheme, instead of from the state because they opted out of the Additional State Pension. So the state pension statement these people receive ahead of the 2016 start date for the new scheme are likely to show how much of their state pension entitlement has been accrued outside the state system. This 'contracted-out deduction, or COD', will show how much weekly pension is due to come from a private scheme. For example, if someone was contracted-out of the state pension system all their working life, they would only be entitled to the Basic State Pension and no additional pension from the state. If they were to be suddenly put onto a full 140 a week state pension they would have a significant advantage relative to those workers who paid the full rate of National Insurance in the past, as they would be effectively getting something they had opted out of. What will happen to contracted-out pension schemes? The system of contracting-out will end once the new state pension system starts. Contracting-out only applies to defined benefit schemes (contracting-out was already abolished for defined contribution schemes in 2012). Therefore, workers and employers in defined benefit schemes after April 2016 will no longer be able to pay lower National Insurance contributions than everyone else. Workers National Insurance payments will rise by 1.4%, to reflect the higher state pension in future. Employers National Insurance will rise by 3.4% of salary. Once contracting-out ends, however, employers will no longer have to replace the Additional State Pension through their company pension scheme. That will mean private sector employers will need to be allowed to change the benefit structure of their defined benefit pension schemes, to strip out the state rights that their contracted-out status had required them to include. So the White Paper will presumably propose giving employers the right to reduce their pension scheme benefits to remove the replacement state pension. This will help offset the extra NI contributions employers will pay once their pension scheme is no longer contracted-out. What about public sector pension schemes? The situation may be less easy for public sector pension schemes - which are all contracted-out of the state pension system - because the recent changes to public sector pensions propose there will be no more changes for 25 years. This may mean that public sector pension schemes cannot remove the equivalent of the state pension rights from their benefit structure, even though they are no longer contracted-out, and even though private sector employers will be allowed to do so. Public sector pensions could therefore become even more generous relative to private sector schemes as a result of the state pension reforms. Members of these public sector pension schemes would be accruing the equivalent of the Additional State pension twice! Once in their public sector occupational pension scheme structure and again in the new state pension system's 140 a week pension. 7

8 Section 6: Advantages of the new state system Why is the 140 a week flat rate state pension such a good idea? There are several reasons why a radically reformed state pension would be so beneficial for the future these can be summed up as simplicity, fairness, adequacy and suitability. Simplicity: The current state pension system is so complex and has been tinkered with and tweaked so much over the years, that it is not fit for purpose. Nobody really understands it, nor can they work out how much they will actually receive from the state when they retire. Fairness: A simple state pension, which pays just a flat amount that people will understand and that does not discriminate against low earners or women, will be far fairer and will help people know what their state income in retirement is likely to be. Adequacy: It will also provide a more adequate minimum level, without means-testing. People can then plan to build private savings or other income on top of that minimum state payment. The state pension will then be like the original social welfare idea of pensions, where the state provides a basic minimum safety net for those deemed too old to work. It will then be clearer that there is a very separate aspect of pensions - which is long-term savings. By separating the social welfare function of pensions from the private savings element, people will clearly be able to see that, if they don t have other income, they will just have that minimum 140 a week level from the state and that s it. If they want more than that, they will need to do something about it. Suitability: Currently, the state pension undermines incentives to save in a private pension, because of the penalties imposed on private pension income by the means-testing in Pension Credit. This is particularly problematic for the lower and middle income workers who are most likely to end up on means-tested benefits in retirement as it makes private pensions a potentially unsuitable investment for many low or moderate earners. As we are starting to automatically enrol millions of workers into private pension arrangements, it is vital that government ends the mass means-testing in the current state pension system. Why is the new pension system so much better for women? Women have consistently lost out in terms of the state pension system and the worst affected are the older generations coming up to retirement or already retired. Most recently retired male pensioners receive close to or above the 140 a week level, but most women do not! In fact, around 30% of women retiring in 2010 actually had entitlement to less than 60% of the full Basic State Pension (compared with only 2% of men). In 2010, the median Additional State Pension entitlement for those reaching State Pension Age was 28 a week for men (which makes close to 140 a week when added to the Basic State Pension), but only 12 a week for women, which will leave them well below the new 140 a week state pension. 8

9 Section 7: What about existing pensioners? Are existing pensioners excluded? Yes - and this is likely to be the big problem with the new system - it only applies for future pensioners. Existing pensioners who are receiving less than 140 a week state pension will feel very aggrieved about being left out. Most women born before April 1953 will have pension entitlements below the new level. The average pension for men is already around the new level and many have far more than 140 a week, so they will be relatively unaffected. But older women already past state pension age will be much worse off than newly retiring women or men. Pensioners already on pension credit are less badly affected, since the new full state pension has been chosen to be just above the Pension Credit Guarantee Credit level. Why is the Government leaving out existing pensioners? It boils down to money. The Government faced a very difficult situation. It knew it had to reform the state pension system as it is not fit for purpose the current system is far too complex, leaves too many people without an adequate base of income and penalises private savings or earnings. But the extreme fiscal constraints meant finding a way to improve the state pension without extra cost. It decided to leave existing pensioners on the old system, so they would not be worse off than before, and start a new system for future retirees. It decided that a good starting date would be to coincide with the very unpopular second rise in women s state pension age that the Coalition introduced last year. Therefore, newly retiring women will be on the new pension, as compensation for waiting longer for their pension to be paid. Will the government have to make concessions to existing pensioners? It may be difficult for the Government to leave out existing pensioners altogether. There could be uproar from middle income pensioners who feel they have already been hurt by Coalition policies. Might the Government consider paying the new pension to older pensioners (perhaps those over 75 or 80?) even if not to all? As the oldest pensioners are already often entitled to pension credit anyway, the cost would be lower than including all pensioners. Might the Government consider a tiered introduction of the new system, rather than a sharp cliffedge. That might assuage some of the feelings of unfairness that are likely to arise, particularly for women whose pension age has already increased after 2010 under arrangements put in place by the 1995 Pension Act. What about pensioner benefits such as Winter Fuel Payments, TV licences, bus passes etc? If the Government needs extra revenue, it may consider either taxing pensioner benefits or rolling them into a new higher state pension payment. Again, this is fraught with political dangers, but if there is a big backlash against the Government s policies it may need to find more money for pensions. Section 8: What about the politics of all this? It is hard to see cross-party consensus. A big question, of course, is what will the Opposition say in response to the new pension proposals? Pensioners are a powerful political force and all parties will be nervous about upsetting older voters. Therefore, Labour will look for an opportunity to capitalise on disgruntlement among older generations, particularly older women who are left out of the new system. Labour will try to appeal to existing pensioners who are not included in the new system and demonstrate that they would look after them better. Labour may also take the opportunity to criticise the Coalition's pensions policies so far. For example, the cut in pensions uprating from rpi down to cpi has made state pensions less generous than they might have been under a Labour administration. As earnings inflation has been lower than rpi in recent years, the 9

10 Government s triple lock has still left today's pensioners with lower pensions than they would have had under just a simple rpi link. What could the Coalition say in response to Labour's criticisms? Presumably, the Government can claim that it would love to have been able to include existing pensioners in the new system, but it simply cannot afford to do so, given the deficit it inherited from Labour. It could say that Labour would be hypocritical to criticise leaving existing pensioners with the current system, while moving new pensioners onto a better one, because the policy for existing pensioners is the one this Government inherited from Labour, so Labour can hardly complain that it is not fit for purpose, since they designed much of it! The Coalition will also claim that it had to introduce a new system because the mass means-testing of the existing system was not compatible with automatically enrolling millions of low and moderate earners into workplace pension schemes, due to the risk of their private pension income being penalised by the means-test of Pension Credit. Labour will find it hard to oppose the reduction in means-testing that the new system entails, since it strongly supports auto-enrolment. 10

11 Section 9: Conclusion The White Paper' proposals are likely to cause controversy and, although widely welcomed by most of the pensions industry and younger age groups, the measures will infuriate many older people, especially women, who will feel they are being treated as 'second class' citizens because they are left out of the new system. Leaving out existing pensioners carries significant political risks. The ending of contracting-out may cause some consternation for public sector workers, but they could be protected by the recent 25-year deal that may prevent Government from changing their pension scheme benefits as private sector employers will need to. So, public sector workers could be even better off under the new state pension system, although they will no longer be allowed to pay the lower rate of National Insurance. The new pension system is far better for women, fairer and simpler than the current arrangements and should ensure much-reduced means testing. It is a long overdue and much-needed change. Examples of people who may feel worried about new state pension - and are they right to worry? Worried - already entitled to over 140 a week Anyone already entitled to over 140 a week State Pension from both Basic and Additional Pensions may fear being cut back to 140 Worried - state pension below 140 due to being contracted-out: Existing pensioners who get less than 140 a week state pension because of their contractedout pension rights may think that they would get the full 140 under the new arrangements and therefore feel hard done by Worried - existing pensioners below 140 a week Existing pensioners receiving less than 140 a week because their Basic plus Additional State Pension is not enough to reach 140 Worried - people entitled to savings credit People who would be eligible for Pension Credit and Savings Credit under the current pension scheme may be worried that they will get less under the new arrangements in future concerns probably not valid: No. Such people are likely to be protected under the new arrangements as the Government will not take away past entitlements concerns probably not valid: No. People in this position would not get the 140 a week under the new arrangements anyway, so their concerns are not valid. They will be no worse off since under the new system as part of their state pension rights will still come from their contracted-out scheme as now concerns probably valid: Yes, these people would be better off under the new arrangements but will miss out because they reach state pension age before the scheme starts. They will not lose money, but would have been better off if they had been born later! concerns probably valid: Yes, it is possible that people with savings, who would have qualified for both Pension Credit and Savings Credit under the old system, taking them above 140 a week in total state payments, may end up losing out on their Savings Credit. 11