Yesterday, Towers Watson reacted to the Budget’s announcement that the Pensions Regulator would be given a new objective. Our thoughts on some of the other pensions-related announcements are below.
State Pension reform and the ‘fair deal’ for contracted-out employees
The Government confirmed earlier this week that the new single-tier State Pension would be introduced from 2016. Members of contracted-out defined benefit schemes and their employers will start paying higher National Insurance Contributions from that point. In 2012/13, the National Insurance rebates that will be withdrawn are worth up to £483 for employees and £1,172 for employers – in both cases for people earning over £40,040. These figures should be slightly smaller by 2016.
As the Government first announced in January 2013, it has changed its original plans and now plans to allow people who were contracted-out in the past to build up extra State Pension in cases where people who were contracted in cannot. Today, the Chancellor said that “someone who is 40 years old when the single tier pension is introduced, and who has always been contracted out, will pay an extra £6,000 in national insurance over the rest of their working life – and in return get an extra £24,000 in state pension over the course of their retirement. That’s a fair deal. “
Graham Everness, a senior consultant at Towers Watson, said: “The Chancellor is right that most of the people still paying reduced rate National Insurance today can expect to get back more in retirement than they will have to pay after 2016. This amounts to rather more than a fair deal for a group of people who typically have good pension provision through their employers. At the same time, older workers who have spent most of their careers contracted in must continue paying National Insurance at the full rate but will stop earning any State Pension in return.
“In the long-term, the main impact of the single tier reforms will be to cut State Pensions. For any number of years in employment (not self-employment) or looking after young children under the rules that were introduced in 2002, people could expect bigger pensions under the current system. The previous Government’s State Pension reforms added significantly to long-term spending on pensioner benefits just before the financial crisis broke, so it’s unsurprising that a slightly cheaper system is now on the cards. If cutbacks are required, windfalls for particular groups such as this are harder to understand. However, a change of heart from the Government may be less likely now that the Chancellor has personally described this element of the reforms as fair.
“How good a return people who are still contracted out can expect to get on their compulsory investment in the State Pension system depends on how old they are, how long they have been contracted out for, how much they earn and whether they must only pay higher National Insurance themselves or also shoulder the cost of the rise in their employer’s National Insurance bill. The Government has said that the loss of employers’ rebates will not be passed on to public sector employees through changes to their pension schemes, so public sector employees will do particularly well – at least before any indirect impact on their wages is taken into account. This is especially true for older workers who have been contracted out for a long time. The smaller number of private sector employees who are still contracted out will not gain as much if their employers pass on the costs of their extra National Insurance Contributions. It is generally larger employers who provide defined benefit pensions, so these costs will not be offset by the flat £2,000-per-employer reduction in National Insurance which the Government is using the rebate money to fund and which mostly benefits small firms.”
For further details of how different groups are affected by the State Pension reforms, see Towers Watson’s evidence to the House of Commons Work and Pensions Committee (which begins on p151).
State Pension reform and incentives to save
The Chancellor said that under the single tier pension ‘any one pound you save will be a pound you can keep’.
Graham Everness said: “The impact of the single-tier pension on saving incentives will be mixed. Some people with less than a full State Pension face losing a full pound of benefit, rather than 40p as at present, for every pound of private pension income. This means that the point where Pension Credit entitlement is exhausted altogether will be reached more quickly, so people with a full State Pension will not lose any more because they have some private savings. Some of these people will, however, need to save more because they can now expect less from the State.”
Personal tax allowance and automatic enrolment
The Chancellor announced that the personal tax allowance will again rise faster than inflation and will be £10,000 from April 2014. The earnings threshold at which people become eligible for automatic enrolment into workplace pensions is currently aligned with the personal tax allowance. Under legislation, the personal allowance is just one factor that must officially be taken into account when the Government reviews the earnings trigger for automatic enrolment.
Rudi Smith, a senior consultant at Towers Watson, said: “The Government can set the earnings trigger for automatic enrolment where it wants but seems likely to keep it aligned with the personal tax allowance for the time being. It knew the personal allowance was being raised to £10,000 by 2015 when it first signalled this approach, so getting to £10,000 a year earlier seems unlikely to change its mind. Any change without a proper notice period would also be opposed by employers who want to keep their payroll processes as simple as possible.
“Whereas the largest employers had to enrol existing staff earning more than £8,105, the threshold will be £10,000 for employers with fewer than 160 employees. Employers with 160-349 individuals in their PAYE scheme can increase the threshold above which they must enrol people from £9,440 to £10,000 by postponing automatic enrolment for three months.”
Public sector pay reforms – potential impact on pensions liabilities
The Budget announced that the Government would seek substantial savings through reform to public sector “progression pay” in the period covered by the next Spending Review.
David Robbins, a senior consultant at Towers Watson, said: “Even after the Hutton reforms, the public sector pensions that employees have already built up remain linked to their final salary. Holding down public sector employees’ salary growth could therefore lead to long-term savings on pensions as well as short-term savings on pay.”
Inflation target still based on CPI - less chance of using CPIH for pensions?
The Budget reaffirmed that the Bank of England’s inflation target will continue to be based on CPI inflation.
David Robbins said: “In 2010, the Government cited consistency with the measure used by the Bank of England as one reason for basing some future pension increases on CPI rather than RPI inflation. As long as the Bank’s target remains linked to CPI it may therefore be less likely that pension increases are switched to the new CPIH measure, which is currently lower. The Government has said that it will consider using CPIH for pensions, but perhaps it will now wait until CPIH is officially designated a National Statistic – which is expected to happen in the summer – before giving this much attention.”
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