Untangling the web

The challenges of introducing a flat-rate state pension above the level of the means-test are huge. But then so is the prize, says John Greenwood

Momentous pensions announcements seem to be coming along on a regular basis these days. But last month’s leaked proposal to introduce a flat-rate pension of around £140 a week, payable to all and abolishing at a stroke the means-testing mire of Pension Credit, is surely the most
significant yet.

Imposing simplicity on a complex system at zero cost to the Treasury is bound to create winners and losers and pensions experts are filling the time before the publication of more detailed proposals by the DWP, ’towards the end of the year’, trying to figure out how the sums can be made to add up in a way that is as fair as possible.

Initial media reaction to the proposal reflects the scale of the political job the government faces in getting these changes through. The first front pages cheered a £140 pension for all. A day later the Daily Mail was referring to ’pensions apartheid’ between the younger people who will get what is now being described as an unfair handout, and existing pensioners who have been stuffed again.

TUC General Secretary Brendan Barber summed it up well. “Some reports suggested that everyone gains and that the new system will cost less, but unfortunately both cannot be true. The real test will be not just who gains, but who loses.”

Such is the potential benefit of the proposal that any number of other factors could be tweaked to the detriment of pensioners to pay for it. Universal benefits such as the winter fuel allowance and TV licences will surely go, but more fundamental reshaping of the retirement structure could follow.

“This change would provide better justification for a later state pension age,” says Ros Altmann, director general of Saga. “The increase in state pension age, announced in the comprehensive spending review, was supposed to be ’fair’ because it was in exchange for a decent state pension. However, the current proposals for slowly raising the basic state pension each year would not be sufficient to really pay a ’decent’
pension, whereas radically reforming the system would be a far better deal, especially for women.”

Many winners would be created – women and the self-employed would be particularly well-served by the changes, as would expats. Retired couples would also be better off, getting their own income, rather than be calculated together.

But if the project is to be delivered in a tax-neutral framework, there have to be losers, and many experts see future accrual of state second pension as a source of cash for ministers looking to balance the books.

Tom McPhail, head of pensions policy at Hargreaves Lansdown says: “Someone who would have had a full contribution history by the time they
retire could expect to be on combined basic and state second pension of between £8,500 and £10,000 a year. They could in future be getting less.”

Few experts expect anyone to actually lose the state second pension and Serps they have already accrued, although it could be argued they have already lost out at the swipe of a minister’s pen when state pension age was increased and indexation downgraded.

Instead, pensioners would be expected to get at least as much as they currently have. Some argue they would get their S2P benefits to date on top of the £140 a week, although this would prove expensive.

“I think the losers will be those with large state second pension and Serps pots,” says Ian Naismith, head of pensions market development at Scottish Widows.

These people could find they will stop accruing state pension altogether in future if their combined benefits are at or above £140 a week by the time the changes are introduced. That would doubtlessly raise the question in the minds of many why are they continuing to pay National Insurance contributions.

“The Government has to consider the impact on areas such as contracting-out decisions,” says Raj Mody, pensions partner at PwC.

What to do with contracting out will prove a major headache for the government, and could potentially result into a last minute rush to contract out of S2P amongst people who are mistrustful of what the government will do with their benefits in future.

It could be argued that we have already lost out at the swipe of a minister’s pen when state pension age was increased and indexation downgraded

“If the government gives everybody a
flat rate pension of £7,280, that would
leave those who contracted out with
exactly the same pension as those who
did not,” sys McPhail. “It could be that
the government say that the basic state
pension is £7,280 a year, but that is
reduced by a set figure, perhaps £75, for
every year you have been contracted out,
which would reduce the attractiveness of
contracting out now for the last two
years before the practice is outlawed.”

However, different contracted out rebates have been paid at different levels over the years, and everyone’s fund will have performed differently, giving different incomes in retirement. So making deductions could leave some people below the £140 a week level, undermining the simplicity of what the government is trying to do.

Some suggest the proposal could ultimately lead to the abolition of National Insurance altogether, as people will question what it is actually there for if pension is universal. That would lead to savings that would dwarf the already significant cash to be saved by abolishing Pension Credit. Before we get to that point however, the government has to resolve the small issue of successfully introducing a flat-rate state pension payable to all.