Pensions - Articles - Towers Watson reveiws pensions after CPI fall

 State Pensions
 Basic State Pension – ‘triple locked’

  

 Legislation requires the Basic State Pension to increase at least in line with national average earnings growth. However, the Government has promised to maintain the ‘triple lock’, at least until 2020. Under the triple lock, the Basic State Pension rises each year by the fastest of earnings, prices or 2.5%.

  

 The measure of earnings growth that the Government must use is not prescribed in legislation but it has historically used whole economy average earnings growth, comparing average wages in the three months to July to those in the same three months a year earlier. The ONS’s provisional estimate of this is 2.9%. A revised estimate will be published tomorrow.

  

 A 2.9% increase would take the full Basic State Pension for a single pensioner from £115.95 a week to £119.30 in April 2016 (increases are rounded to the nearest 5p). If estimates of wage growth are revised down enough for the 2.5% underpin to bite, the full Basic State Pension will rise to £118.85.

  

 The New (‘single-tier’) State Pension
 The New State Pension (sometimes called the ‘single-tier State Pension’) is being introduced for people reaching State Pension Age from 6 April 2016. The Government has said that its starting level will be above the Pension Credit Standard Minimum Guarantee (a means-tested minimum income level); it has used an illustrative value of 5p/week above the SMG.

  

 The SMG for a single pensioner is currently £151.20 a week. Under legislation, it must rise at least in line with national average earnings growth. If earnings growth in the three months to July were confirmed as 2.9%, the SMG would rise to £155.60 in April.

  

 The New State Pension would then be at least £155.65, though the Government could contemplate setting it at a higher level as part of the Spending Review decisions to be announced on 25 November.

  

 People reaching State Pension Age from April 2016 can get more than the full New State Pension if they have built up higher entitlements under the existing system. Most of those reaching State Pension Age in the first few years will get less than the full State Pension – often because periods when they were contracted out and paid lower National Insurance Contributions mean that they get replacement benefits from occupational or personal pensions.

  

 In recent years, when earnings growth was subdued, the Government ensured that the cash increase in the SMG was the same as the cash increase in the Basic State Pension. It has not said whether this underpin will apply to the April 2016 increase – but the issue will only arise if the final earnings growth number is revised down to 1.9% or less. If this did happen, and the Government matched the cash increase in the triple locked Basic State Pension, the SMG would rise to £154.10. The New State Pension would then be at least £154.15.

  

 Like the Basic State Pension, current legislation says that the New State Pension must rise at least in line with average earnings and the Government has committed to increase it in line with the triple lock for at least the remainder of this Parliament.

  

 David Robbins, a senior consultant at Towers Watson, said:

 “When the Government first proposed a flat-rate State Pension in 2011, it suggested that this could be £7.40 a week above the means-tested minimum income for pensioners. Even if the Chancellor does find some more money in the Spending Review, the gap will not be anything like that big – though it will widen over time if the New State Pension remains triple-locked.

  

 “One reason why the starting level of the New State Pension will now be lower is that the Government chose to spend some money on giving generous State Pension top-ups to older workers who have been contracted out in the past and continue paying NICs after 2016.”

  

 Additional State Pension – linked to CPI
 Payments of the additional State Pension (SERPS, State Second Pension) rise each April based on CPI inflation in the year to the previous September. When inflation is negative, benefits are frozen in cash terms.

  

 Private sector defined benefit pensions
 Most defined benefit pensions in the private sector still rise with RPI inflation rather than CPI inflation: the DWP has previously estimated that three quarters of schemes have rules that stipulate an RPI link. RPI inflation in the year to September was +0.8% (but some schemes use different months for increases).

  

 Where the wording of scheme rules means that pensions now rise with September CPI, pensions will stay flat rather than being cut in cash terms.

  

 Most schemes use CPI to revalue pensions between the time when a member stops building up new benefits and when they start claiming their pension. Here, it is CPI inflation over the whole period of deferral that matters. Where the revaluation period is one year, the statutory revaluation order is expected to specify a zero increase rather than a negative one.

  

 David Robbins said:

 “Where pensions are linked to September CPI, negative inflation represents a small real terms transfer of resources from sponsoring employers to pensioners.

  

 “If there were a sustained period of low inflation, this may reduce the value that people approaching retirement attach to inflation-linked pensions. Some may be more tempted to swap a final salary pension for defined contribution pot or to exchange future increases for a higher starting pension. However, most people tend to stick with what they have got and inflation expectations will only be one factor in their decision.”

  

 Public sector pensions
 In 2010, the Government changed the measure of inflation used to uprate pension payments for former public sector employees from RPI to CPI. Public sector pensions increase each April based on inflation over the year to the previous September. With CPI inflation negative, payments will be frozen in cash terms, representing a small real terms transfer of resources from taxpayers to public sector pensioners.

  

 David Robbins said:

 “For the Exchequer, the shift to CPI inflation is a gift that keeps on giving – the gap between what is actually paid out and what would have been paid out gets wider more or less every year. A public sector pension that was £10,000 a year in 2010 would have reached £12,060 in 2016 if it had remained linked to the RPI. With a CPI link, it will be £11,521.”