Will 9 out of 10 be better off under the Government's pension reforms?
"Ministers are expected to insist that at least nine in 10 people will be better off under the reforms." The Telegraph, January 13, 2012
"Economists are forecasting a 25 per cent rise in the value of annuities. Currently £100,000 buys an income of £5,690 a year. If annuity returns improved by 25 per cent, this would increase to £7,113. With the average time spent in retirement now 20 years, that means an extra £28,000." The Express, January 14, 2013
"Most Britons will lose out in pension shake-up: New flat-rate payouts will mean majority get less, say experts. Biggest reform of the state pension since it was created. People will have to make 35 years of National Insurance contributions to qualify for the more generous retirement payments. By 2060 half of pensioners will be worse off." The Daily Mail , January 15, 2013
When the Old Age Pension Act was first introduced in 1908, nearly 600,000 over 70s with an income less than 8 shillings a week queued up to collect their weekly five shillings. Reduced amounts were paid to those with higher incomes. Since then, this system has been reformed at least twenty times.
The new White Paper on pensions was published yesterday. The Minister for State and Pensions Steve Webb has been doing the media rounds to introduce the new single-tier system. Full Fact has looked at the main features of the plan as it was reported in the media.
Currently, 12.7 million people receive a pension in England and Wales. According to the latest ONS release on Pension Trends, in 2010/11, pensioner couples received an average income of £610 per week, compared with £345 per week for single men of pensionable age and £279 per week for single eligible women. This includes occupational pensions - those accrued privately through workplace schemes - as well as state pensions.
Will they earn more from the new system?
How the current pension system works
The current system is composed of three elements:
1. A Basic State Pension of £107.45 per week is awarded to anyone who has worked for over 30 years. It can be topped up to £142.70 a week with means-tested credits called Pensions Credit.
2. The State Second Pension was introduced in 2002 and is awarded in line with earnings, subject to a different set of qualifying criteria. In average it's worth about £18 a week but it can contribute an extra sum of up to £100 each week.
According to Steve Webb, it doesn't make sense for the state to run a pension scheme based on earnings at the same time as employers run their own pension schemes.
3. People who receive Company Pensions get tax relief and, by contracting out of the second state pension, boost their savings by paying less national insurance.
New system
All these elements will be repleced with a flat rate - higher than the present basic pension - which in today's money will be equivalent to £144 p/w. Means-tested top ups are being eliminated. If the law passes, the new system will be implemented from 2017.
To qualify for a state pension, the total number of years of work (or other qualifying activities, such as caring for children or disabled relatives) will jump from 30 to 35. But it's worth bearing in mind that prior to 2010, the number of years work necessary to qualify was 39 for women and 44 for men reaching pensionable age.
The annual rise in pensions will be indexed to what is known as the triple lock: this means the amount paid out will rise in line with either earnings, CPI or 2.5% - whichever is the highest.
Will nine in 10 people will be better off under the reforms?
The Institute for Fiscal Studies has argued this is highly unlikely. For the IFS, the proposals "imply a cut in pension entitlements for most people in the long run." This is because:
"In 2017—18, most low earners and non-workers will under the current system accrue £5.05 (£3.59 plus £1.46) of additional weekly state pension rights for 'contributing' for one extra year, provided they have not already accrued 30 years of contributions at that stage (those who already have 30 years, would accrue £1.46 of additional weekly pension). Higher earners would accrue £5.81 a week of state pension (or £2.22 if they already had 30 years of contributions). In the proposed new system, these same people would accrue £4.11 of additional weekly state pension (or nothing if they had already accrued 35 years of contributions). The key point is that £4.11 is less than £5.05 (what most lower earners would accrue under the current system) and the gap for high earners is, of course, even greater.
Therefore, in the long run, the reform will not increase pension accrual for part time workers and women who take time out to care for children. In fact, in common with almost everyone else, these groups would end up with a lower pension at the state pension age under the new system than they would do under the current system."
Who will lose out?
Steve Webb told The World At One that the number one loser will be the "Aussie backpacker"; in other words people who work and contribute to National Insurance for less than 10 years won't receive a penny in retirement payments from the state.
High earners will lose out from the extra earnings they would have piled up through the Second State pensions, which was tied to earnings.
5.3 million public sector employees and 1.6 million private sector employees who were active members of contracted-out Defined Benefit pensions schemes (see element 3) in 2011 (source: Department for Work and Pensions White Paper, p.38) were, under the current system, allowed to opt out of higher national insurance payments. That opt out will end under the new reforms, as a result they will face a rise of 1.4% in National Insurance contributions.
How much will the system cost?
Steve Webb wrote in the Telegraph that "the overall cost of the new system will be the same as the one it replaces." On the Radio 4 programme The World At One, he specified that this would be effective "for the next couple fo decades or so. After that the bill will go down."
This is confirmed in the DWP White Paper (p. 12), though the authors hasten to add "long-term expenditure forecasts are highly uncertain."
Criticisms
Critics - amongst them the National Pensioners Convention - agree with the IFS that overall people will lose out. They pointed out that somebody retiring today would earn £150; their earnings would go down to £144 a week in 2018. People will have to pay more in National Insurance contributions, work longer and get less.
Self-employed people paying the same rate of NI will not end up paying more, under current proposals. The IFS says this may change.
Though critics are concerned about overall higher National Insurance contributions, Steve Webb has claimed that these would be "more than offset" by the higher state pension workers will receive.
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Image courtesy of 401(K) 2013