Pensions - Articles - Radical state pension reform expected to be announced today

 By Dr Ros Altmann, Director General of Saga

 Flat-rate, simple state pension about £145 a week expected for future
 This reform vital to make it safer to pay into private pensions with auto-enrolment

 At last we are about to see it. The long-awaited White Paper, showing the Government's proposals for radical reform of the state pension is being released.

 Executive Summary

 
•   The White Paper will propose a new state pension system, paying just one state pension of around £145 a week to anyone with a full National Insurance record
 
•   The new pension will start after 2016-2017 and eventually replace Basic State Pension and all Additional State Pensions with one simple payment
 
•   The age at which the pension will be paid will rise in future, as life expectancy rises. It will rise to age 66 in 2020 and age 67 by 2028, then further thereafter
 
•   The new state pension will be just above the current Pension Credit Guarantee Credit means-test level, to make it safer for people to save
 
•   Women, the self employed and future pensioners (not existing pensioners) on modest incomes with private savings will be winners.
 
•   This new system will reduce - but not eliminate - pensioner means-testing. Future pensioners who do not have a full NI record, or those who may get Housing Benefit or Council Tax Benefit may still be means-tested.
 
•   Anyone already entitled to over £145 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, for example state pension age will rise and savings credit and contracting out will be abolished
 
•   There will be no more contracting out of the state pension system and private schemes will need to change their benefit structure in recognition of no longer having to replace the Additional State Pension.

 These are brave proposals, but are long overdue in order to improve pension provision for our ageing population. Despite years of tinkering, we still have a state pension system that is not fit for purpose. It is creaking at the seams. It has been patched up so many times and is now just a complex web of different parts that almost nobody understands. With these proposals, however, future pensioners should eventually have a system that is simple, clear and understandable. They will know the deal. It will take time to get there, but we will be on the right path.

 What is the Government proposing?

 The state pension will pay a basic minimum of around £145 a week. The White Paper will propose merging together Basic and any 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. If people want or need more income in later life, they will have to either plan to save more or keep working if they can, to supplement what the state can afford.

 What is wrong with the current state pension?

 It is horrendously complex. In fact, Britain has by far the most complex pension system in the world. The DWP itself has admitted that it cannot provide accurate forecasts of many people's state pension entitlements because the calculations are so complicated! At the moment, the state pension paid can consist of the following parts:

 
•   Basic State Pension (BSP)
 
•   Second State Pension (S2P)
 
•   State Earnings Related Pension (SERPS)
 
•   Graduated Pension

 and then, if all those are not enough they can also receive the

 
•   Pension Credit, which can consist of
 
•   Guarantee Credit and
 
•   Savings Credit.

 All these elements of the state pension have different qualification criteria and different rules. Nobody really understands the system and its complexity makes it impossible to plan properly for retirement because people do not know what they will receive from the state.

 In fact, the State Pension system actually undermines private pensions, because anyone who ends up on means-tested benefits in retirement will find that their private pension savings are penalised. Even on the Government's own figures, at least one in 20 retirees in future will not get value from their private pensions. And the proportion of low to moderate earners who lose out, will be much higher than this average.

 Why is the flat-rate pension such a good idea?

 At last, we would have a state pension that people could understand. The current system is so confusing that most people do not know what they will get from the state and nearly half of pensioners end up needing means-tested benefits to avoid poverty. This is because our Basic state pension is about the lowest in the developed world. The new flat-rate state pension would be simpler and more generous, it would be understandable, would avoid mass-means-testing and would mean people could plan to build on top of the basic minimum state pension if they want more than the £145 a week in retirement.

 Will all pensioners get this £145 a week in future?

 No. Unfortunately, the complexity of the current system leaves us with enormous legacy issues that will mean there has to be a transition period over a number of years which leaves pensioners with some entitlements from the old system, while also being part of the new state pension, but eventually those who have contributed for the required number of years will get the full new flat-rate pension. The low paid, women, carers, the self-employed and disabled will be less likely to lose out as they have done in the current state pension system.

 Will this be a citizen's pension?

 No, this pension will only be paid to those with a full National Insurance (NI) record either from working and paying NI, or being credited while not working.

 Why around £145 a week?

 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. The current Basic State Pension is just over £107 a week (rising to £110.15 a week from April 2013). However, anyone without much extra income can then claim means-tested Pension Credit which will give a Guarantee Credit income of at least £142.70 now, rising to £145.40 in April 2013. Therefore, many people with a full Basic State Pension will still be below the Pension Credit level and people over pension age with no NI contribution record at all can be paid £145.40 anyway. However, people who have some extra private savings or private income could find this income merely replaces state benefits and will be penalised for their private retirement provision. This means it is not safe to encourage everyone to contribute to a pension scheme, so the Government needs to lift the Basic State Pension to at least the Pension Credit means-test level.

 Why do we need to introduce this now?

 Because the Government has started requiring all employers to automatically enrol workers into a workplace pension scheme. Without this state pension reform, many lower or moderate earners, people nearing retirement or those do not own their own homes will be at risk of losing much or all their private pension. We have to make it safer for people to save.

 What about people already entitled to more than £145 state pension - will they be reduced to the £145?

 No. The Government will protect their extra payments and therefore this £145 a week pension is a minimum, not a maximum. Some people could be receiving over £200 a week from state pensions (with Basic State Pension, SERPS and S2P) and they will continue to do so. Over time, however, there will be no additional state pension accruing and future generations will have just the flat-rate state pension. It is not sensible for the state to pay a higher state pension to higher earners - a flat-rate makes more sense and is far fairer.

 Won't this cost a huge amount of money?

 No, the Government says that this proposal is actually cost-neutral. The increased state pension age, adjustments to savings credit and introducing a de minimis number of years to qualify will fund the costs of increasing payments.

 At what age will this new state pension be paid?

 The Government plans to increase the State Pension Age to recognise the fact that people are living longer and healthier lives, so they will be able to keep working longer in future. In view of these trends, the DWP says it will be looking at continuing an ongoing process of pension age rises for the future and will seek to tie the state pension age to longevity rises. This will mean that younger people cannot be sure at what exact age they will start receiving a state pension. This is an important idea. We need to get away from the notion that there is one fixed age beyond which people are no longer fit to work and therefore must receive a state pension. Of course, there are limits to how far and how fast the state pension age can rise, and there is a concern that the most immediate changes are being made to quickly. Far better to indicate to future generations that the state pension age will rise after, say, 2020 or 2030, rather than suddenly imposing huge changes, especially on women who have no private pension resources.

 What about existing pensioners?

 The Government's plan is that only those who reach state pension age after these new measures start will actually benefit from the change. Therefore, existing pensioners will stay on the current system, while all new pensioners will move over to the new system. So none of today's pensioners will get less, but they will not receive the new benefits.

 Why are today's pensioners not being given this better pension?

 It would be too expensive. The Government argues that it simply cannot afford to pay a much higher state pension to all of today's pensioners. It knows, however, that it has to sort out the state pension system for future generations. Therefore, it has taken the decision to change the system going forward. It had a choice. It could leave things as they are, continuing to tinker with the current system that is not fit for purpose, for fear of upsetting existing pensioners, or it could take the difficult decision to set up a new system for the future in order to put us on a sustainable path.

 What will happen to contracting-out?

 Contracting out will be abolished. There will be no additional state pension to contract out into! In future, all national insurance pension accruals will go towards just one payment - the state pension - and as long as people have a full contribution record they will get the full state pension.

 What about people who do not have a full National Insurance record?

 Those who do not have a full NI record will not get the full £145 a week and there will be some residual means-testing in the system to make sure they are still eligible for the equivalent of the Pension Credit, alongside existing pensioners.

 Conclusion:

 Too few middle income workers are rewarded for working and saving for retirement, and our current system generates unequal outcomes for men and women. A radically reformed state pension will reward people who work and save, clarify the deal for future pensioners, and simplify the role the state plays in providing a clear and solid foundation on which to save for old age. The introduction of auto-enrolment has added urgency to the need to tackle means testing. The aim is to deliver a simple, decent state pension for future pensioners, which is easy to understand, makes it safe to save and is affordable.