The Government has just released a summary of the responses to its consultation on reforming the State Pension. The overwhelming majority of responses supported a flat rate state pension of around £140 a week (in today's money) which would remove the mass means-testing of future pensioners and finally make it safe for most people on moderate incomes to save in a pension scheme.
The DWP will now be working on its own response to the consultation, as it decides how to proceed with state pension reform. I would expect a Green or White Paper later this year or early 2012 and it seems clear that, with overwhelming support for the most radical option, we are likely to get meaningful reform proposals. Of course, as always with pensions, the devil will be in the detail and we will have to see what is actually finally decided, but Steve Webb has been in favour of a flat-rate state pension for many years, so I would expect that to be the new future for state pensions. It will be vital also to see how the Government proposes to tackle the transition from our current system, to a new system. This will not be easy, but politicians - and even the Pensions Commission - have ducked such much-needed reform for far too long and it is fantastic that this Government seems determined to finally get to grips with the scale of required reforms.
Saga submitted a response to this Consultation and our comments feature heavily throughout the document. We highlighted the long overdue need for radical reform of our state pension system, which is far too complex and which undermines private pension saving. [Saga's response is in the notes to this release].
The Government identified four guiding principles for state pensions that are fit for the 21st century. They were fairness, simplicity, affordability/sustainability and encouraging personal responsibility. It is only the flat rate simple state pension that will achieve these objectives in the future. Any other system that retains or tinkers with the current pension system without radical overhaul, will not be simple, will not be sustainable, will not encourage personal responsibility and will retain many unfairnesses such as the unfair system of 'contracting out' of state pensions which allows some workers to pay far less national insurance than others even in publicly funded, unfunded, pension schemes. Ending contracting out could save large amounts of money.
Our major concerns about the reform proposals revolve around the fact that this new pension system will not apply to existing pensioners, only to those in the future, however it is of course welcome that future state pensions will be far better for the disadvantaged groups and easier to understand than the current complex mess, which almost nobody comprehends.
NOTES TO EDITORS:
1. The consultation document can be accessed on the link below
2. This is Saga's Response to the Consultation:
Response to Consultation ‘A state pension for the 21st century'
Question 1: Would the current state pension, if left unchanged, meet the Government’s principles for reform and provide an effective foundation for saving?
The present system does not encourage personal responsibility. For example, our state pension system is a major disincentive to pension saving – especially for lower income groups who are most likely to be at risk of ending up eligible for pension credit in retirement. If they do save in a pension scheme, they risk losing much or all of their pension if they claim pension credit. In addition, the state pension at the moment is so fiendishly complex that people do not know in advance what they will receive from the state (even the DWP itself often does not know their pension until they are about to reach state pension age). If people do not know what they will receive, they cannot plan to supplement a particular amount, so financial planning is not easily achieved.
The present system is not fair, in that it penalises women and those who have very low paid jobs (for example people who have a series of part time jobs each paying below the NI threshold) will not have any state pension entitlement.
The system is by far the most complex pension system in the world and almost nobody actually understands all its intricacies, including calculating contracting out benefits, GMPs, different entitlements from past contribution periods etc.
The system is probably affordable, as long as pension ages continue to rise.
Question 2: To what extent would fast flat rating meet the principles for reform and improve savings incentives?
Faster flat-rating would not really achieve the objectives of reform, nor improve savings incentives. To the extent that the state pension would be lower under faster flat-rating than the current system, it could even mean more people end up entitled to pension credit, thereby actually reducing savings incentives even more. The system would remain complex, would retain mass means-testing and hinder personal responsibility.
Question 3: What further reforms might be required to the State Second Pension, such as crediting arrangements and uprating of pensions in payment, to better meet the Government’s principles, recognising that there is a trade-off between coverage and the potential level of any combined, two-tier flat-rate pension?
Further reforms of S2P seem to me to be pointless and retaining a two-tier flat-rate pension merely adds to confusion and complexity. Indeed, new crediting arrangements would also add to complexity and just serve to confuse people, which has been one of the problems entailed with past pension reforms. Tinkering with the system is not what we need. We need a new approach.
Question 4: To what extent would a single-tier pension meet the Government’s principles for reform and improve savings incentives?
A single-tier pension would definitely help personal responsibility because it would help people realise what the state will pay, so they can plan to provide more for themselves if they want it. Reducing mass means-testing will reduce the disincentives that the current pension credit system entails for private pension savings. A single-tier pension would be far fairer and much simpler (particularly after the transition period once we have removed the remnants of the current complex system). The single-tier pension would allow women to have the same pension as men, as long as they had sufficient contributions or credits - although there will still be a possible problem for women who have several jobs each paying below the NI threshold and a way needs to be found to cope with this small minority.
The major problem of this single-tier pension proposal, as currently constructed, is that existing pensioners are all excluded and that will feel very unfair to millions of today’s retired people. They will be very angry at the perceived unfairness.
Question 5: Which of these two options would act as the best complement for automatic enrolment.
The only option that would complement auto-enrolment is Option 2. If we do not get rid of mass means-testing and the disincentives and penalties that pension credit imposes on private pensions, then I do not believe it is safe to actually proceed with auto-enrolment. We already know that 1 in 20 of all those enrolled risk not even getting the value of their contributions back on retirement, so they will have wasted their money. This equates to hundreds of thousands of people. It is irresponsible of Government to proceed to auto-enrol lower earners most at risk of losing out, and particularly lower earners already in their fifties, because they may come back in future years and claim compensation on the basis that Government failed to properly warn them of the risks and that Government itself devised a pension system that penalised their private pensions.
Question 6: Government would be interested in hearing views on other reform options that would meet the Government’s principles for reform.
My favoured option for reform would be to introduce the flat-rate state pension, as currently proposed, but for all pensioners, both existing and future pensioners. The modelling work will need to be done to see from what age this new pension could be paid and still be affordable and I assume it would be perhaps from age 72 or 75 or so. However, there will not then be the problem of existing pensioners being so much worse off than new pensioners and there will still be an age beyond which mass means-testing disappears.
Question 7: What would be the impact of ending contracting out, as implied by any single-tier model?
Contracting out is the most complex part of our pension system and should have been abandoned many years ago in my view. The rebates given for contracting out are not sufficient to replace the state pension benefits given up in most cases. If contracting out was abolished, it would have several advantages, for example:
It would improve employer defined benefit scheme funding in the longer term, as long as the schemes could drop responsibility for replacing contracted out benefits within the scheme benefit structure. The rebates are insufficient to meet the costs of providing replacement benefits, therefore by removing both the rebate and the associated liability, scheme funding would improve.
It would bring in billions of pounds of much needed extra revenue to the Exchequer
It would simplify the pensions system so people could understand it better and the state would just provide a basic social welfare minimum pension payment, clearly separate from any private savings.
It would end the anomalous hidden subsidy to public sector employment which the current contracting out system entails, whereby unfunded public sector pension schemes are still contracted out, even though future taxpayers will have to fund these benefits fully.
The disadvantages of ending contracting out would include:
Workers and employers in contracted out schemes would have to pay higher NI contributions.
Someone who believed they could invest their rebate cleverly and make huge returns may end up not being able to do so.
Overall, I believe that it is very important for us to end contracting out in order to simplify the pension system and remove some of the differential between private and public sector pensions.
Question 8: If the decision is taken to end contracting out, how could the process be best managed so as to minimise any adverse impacts on employers and individuals?
If this decision is taken, perhaps it could be phased out, but it will also be important to explain the reasons for needing to do this.
Question 9: In conjunction with the reforms outlined in Chapter 2 are there ways we can change the means-testing system for future pensioners to make it more simple, reduce disincentives and encourage personal responsibility while continuing to help pensioners avoid poverty?
It would be worth thinking about how to avoid the continued means-testing penalties that will be imposed by housing and council tax benefits for those who do not own their own home or still have low incomes. The best way to alleviate poverty is to raise pensioner incomes and encouraging more private saving in future should help that. Improving incentives for saving, better public information and so on.
Question 10: What mechanism should be used to determine future increases in State Pension age?
I believe there is merit in tying future increases to future life expectancy, but the best way would be to establish an independent commission to monitor and recommend any changes over time.
Question 11: How should the Government respond to the frequent revisions in life expectancy projections while giving individuals sufficient time to prepare?
At the moment, people need at least ten years’ notice of a change in their expected pension age, so they can plan for this. Pension planning now is a long-term exercise and cannot be done at short notice.
In future, however, life expectancy may keep rising and the age at which a pension starts should also increase. But pension planning should be different from the current practice, where people aim at one date. It will be helpful to help people think about part-time work in later life, so that retirement is not one specific date they aim at after which they stop all work. They should not think about planning for one date beyond which they are ‘past it’ and on the scrap heap work-wise.
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