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Government unveils new state pension details
(Update) The government has released details of a new flat-rate pension of around £140 a week – but probably worth £155 by the time it is introduced in 2015-16.
(Update) Details of a new flat-rate pension of around £140 a week, but probably worth £155 by the time it is expected to be introduced in 2015-16, were unveiled today by pensions ministers Steve Webb and Iain Duncan Smith. It will replace the existing system of a basic pension, currently £102.15 a week for a single person, which can be topped up to £137.35 a week with means-tested pension credit as from 11 April.
Modernising the state pension
The green paper, ‘A state pension for the 21st Century,’ sets out the options on how to simplify the system for future pensioners. ‘Over the years small changes to the state pension system have turned what started as a relatively simple contributory system into a complex mess, leaving people utterly confused as to what the state pension means for them,’ explained secretary of state for Work and Pensions, Iain Duncan Smith. ‘We have to send out a clear message across both the welfare and pension system – you will be better off in work than on benefits and you will be better off in retirement if you save.’
The green paper considers either acceleration of existing reforms so that the state pension evolves into a two-tier flat-rate structure by 2020 rather than the early 2030s, or a more radical reform to a single-tier flat-rate pension set above the level of the pension credit standard minimum guarantee.
The report seems to favour the more radical second option combining basic state pension and state second pension into one single-tier state pension. Under the second option, future pensioners with at least 30 qualifying years would receive the same flat-rate pension currently estimated at £140 a week – with this payment being set above the basic level of support provided by pension credit. There would be a minimum qualification of seven years of national insurance (NI) contributions or credits. Everyone would qualify individually – whether single, married, divorced or widowed and there would be no special rules for marriage, bereavement or divorce. Both options could be designed to impose no extra costs.
Replaces earnings-related pensions
Under the more radical second option, the payment currently estimated at around £140 to all future pensioners would be funded by ending the state second pension, abolishing means-tested savings credit and introducing a seven-year minimum qualifying rule. Contributions to earnings-related, top-up pensions such as the current state second pension (S2P) and earlier state earnings-related pension (Serps) as well as graduated contributions would be honoured until the new flat-rate pension is introduced. Those already in retirement and receiving pensions would remain unaffected by the changes – although they will find any earnings-related pensions will in future increase by the lower consumer price index (CPI) each year, rather than the usually higher retail prices index (RPI). The latest inflation figures for February show CPI hit an annual rate of 4.4% while RPI moved to 5.5%.
A few high earners will be worse off than if they had been able to continue contributing to the top up pensions. Some with the maximum contributions could currently be drawing as much as £150 a week on top of their basic pension of £102.15 in earnings related pension – although to qualify for extra pension at that rate they would have been higher rate taxpayers all their working life and paid the maximum in NI contributions.
But the vast majority of individuals will benefit. Some three million self-employed people will also be better off with a higher flat-rate pension as they are not currently eligible to top up their pension through S2P or earlier earnings-related schemes unless they have previously spent time as an employee.
Integration with Nest
The changes will be introduced to coincide with the roll out of Nest, the new National Employment Savings Trust pension in which all employees will be auto-enrolled – although they currently retain the ability to opt out. This begins to be introduced for the largest companies in 2012 and by 2016 all employees should be enrolled in the scheme. Contributions will be phased in to reach 3% of qualifying earnings paid by the employer, 4% by the employee with a 1% tax rebate by 2017.
The discontinuance of mean-tested benefits for pensioners and replacement with the new flat-rate pension removes most of the incentive to opt out of Nest. Had the reforms not been introduced anyone on average earnings or less would have been no better off by joining Nest. They would simply have started paying for a pension that was no better than means-tested benefits – which are non-contributory and therefore ‘free’. Half of all pensioners are currently eligible for means-tested benefits and a higher flat-rate pension will benefit the estimated 1.6 million pensioners who are currently eligible but do not claim.
The ability to ‘contract out’ of the state earnings-related S2P will also be removed at the same time. Many employees and employers get a rebate on NI contributions because their S2P top-up pension is contracted out to their company final salary pension scheme. However, the removal of the contracted out rebate is likely to mean the end of final salary linked pension schemes in the private sector. They were already proving a drain on companies’ financial resources and many have been closed to new entrants or new contributions and the removal of the rebate will make them even more expensive to provide.
Women and carers to benefit
The new flat-rate pension will be welcomed by most as it is much fairer than the current system which discriminated against women who stay at home to look after children or elderly relatives. Many never qualified for a full pension and were too proud to claim means-tested benefits. The breaks in mothers' and carers’ NI contribution records means the average basic state pension for women currently stands at just £70.26, compared with £83.74 for men. Women's average payment from the state second pension, and Serps, is just £15.50 a week, little more than half the £28.71 paid to men.
Pension reforms will rapidly be followed by increases in the retirement age, due to be equalised at 65 by 2018. On 6 April 2010, the state pension age for women started to increase gradually from 60 to 65, to match men’s by 2018, moving to 66 for everyone between November 2018 and April 2020. It has not yet been announced whether further rises to 67 and 68, that are not due until 2036 and 2046 respectively, will be brought forward but the report envisages regular reviews of state pension age to take account of increased life expectancy.
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