The Government has published a consultation paper on the reform of the State pension system, and the Citizen’s Income Trust has submitted a response.
Here we print excerpts from the report (in italics), the consultation questions (in bold type), and our responses to those questions (in plain type).
Guiding principles. In terms of pension reform, we have four clear guiding principles:
- personal responsibility – enabling individuals to take responsibility for meeting their retirement aspirations in the context of increased longevity;
- fairness – ensuring an adequate level of support for the most vulnerable, ensuring everyone with a full contribution record should be entitled to a state pension above the standard level of means tested support, [note]This is defined as the level of income provided by the Pension Credit standard minimum income guarantee which in 2010-11 tops up pensioners’ income to £132.60 a week.[/note] and ensuring all groups are treated fairly;
- simplicity – simplifying the state pension so that it is easier for people to plan and save for their retirement; and
- affordability and sustainability – given longer-term pressures on the public finances, any state pension reform must be affordable. Any options for reform must be cost neutral in each and every year to avoid placing an unsustainable burden on future taxpayers. Any proposals will be subject to confirmation, including on affordability, and will reflect the projections set out in the Office for Budget Responsibility’s forthcoming Fiscal Sustainability Report. In addition, changes to State Pension age should ensure the system is sustainable for future generations (p.5).
Would the current state pension, if left unchanged, meet the Government’s principles for reform and provide an effective foundation for saving?
A substantially means-tested system doesn’t encourage people to take responsibility for retirement income because it makes it difficult to predict the effect of savings on net income in retirement.
The current system is not fair, in the sense that different people receive different and often unpredictable amounts from the State. It is surely not fair that someone with a full employment record who saves small amounts during their working life and pays some of their earned income into an occupational pension scheme should receive less from the State for the duration of their retirement than someone else with a full employment record and the same earned income and household structure who hasn’t saved any of their income and who hasn’t paid some of their income into an occupational pension scheme.
The current system is far from simple, mainly because of the too complex means-tested Pension Credit, with its two separately regulated elements of Guarantee Credit and Savings Credit.
The current system could be made affordable and sustainable, but only at the expense of more recipients being brought into the means-tested elements.
Options for reform
Option 1: Faster flat-rating
The Government believes it is necessary to reform the state pension for future pensioners so that it provides a better foundation for saving. This paper seeks views on two broad options for reform to deliver a simple, flat-rate contributory state pension that lifts the majority of future pensioners above the standard means-test:
- Option 1: acceleration of existing reforms so that the state pension evolves into a two-tier flat-rate structure more quickly; or
- Option 2: more radical reform to a single-tier flat-rate pension set above the level of the Pension Credit standard minimum guarantee.
Chapter 2 sets out these options in greater detail and assesses each option against the Government’s principles for reform.
Option 1: Faster flat rating
Currently the basic State Pension is a flat-rate payment worth £97.65 a week and the State Second Pension is partly flat rate and partly linked to earnings, such that higher earners receive a higher state pension. Option one would accelerate the pace of existing reforms so that the State Second Pension would became flat rate by 2020 instead of the early 2030’s. This would give people a clearer idea of the state pension they would get in retirement as they would receive a set amount of pension for each qualifying year. At the end of transition, all those with a full contribution record, for example 30 qualifying years, would build up the same state pension, currently estimated at around £140 a week, albeit through two tiers.
It would be possible to go further by ensuring all earners built up the same pension, better aligning the detailed rules of entitlement between the basic State Pension and State Second Pension, and using the same uprating for the two pensions when in payment. This would further simplify the system and increase the number of people receiving the full pension. The precise value of this combined, flat-rate pension would need to be set at a level that met the affordability principle. Under Option 1 contracting out would continue for members of Defined Benefit schemes (p.7)
To what extent would faster flat rating meet the principles for reform and improve savings incentives?
This option envisages consolidating the calculations of State Basic and Second Pensions and reducing the differences between them, and also envisages reducing the length of the period during which the earnings-related component of State Second Pension will be phased out.
These and other minor adaptations of the State pension system would reduce slightly the uncertainty related to the impact of savings and private and occupational pension provision on net income during retirement. However, they would not by themselves reduce complexity, and thus would not encourage personal responsibility or promote greater fairness. They would not deliver a simple system. It would of course be possible to determine pension levels which could make the system affordable and sustainable, but reductions necessary to achieve this would propel more people into the means-tested safety net. To retain two levels of State Pension in a context of means-testing makes simplification impossible unless the rules of the two levels were to converge to agreement and the pensions were large enough to avoid recipients requiring Pension Credit.
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?
In the cause of simplicity, the State Second Pension regulations should converge towards those of the State Basic Pension.
Option 2: a single-tier state pension. Option 2 would be a more radical approach to state pension reform, combining basic State Pension and State Second Pension into one single-tier state pension. 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.
Under this option, contracting out for Defined Benefit schemes would end. In itself, this could ultimately bring simplification of the personal tax system. The complexity associated with contracting out would, however, continue during transition to the single-tier pension (p.8).
To what extent would a single-tier pension meet the Government’s principles for reform and improve savings incentives?
In the longer term, the principles for reform would be more clearly met by Option 2 than with Option 1. The system would be simpler, and individuals would be treated more fairly. The option would make net income in retirement more predictable for given levels of saving and of occupational and private pensions, and so would encourage personal responsibility.
Far fewer individuals would be in the means-tested part of the system so many more people would reap the full benefit of their savings and occupational and private pension provision. This would be much fairer than the present system.
In the short term, transitional arrangements might create unfair outcomes; but short term problems are no reason for rejecting a scheme which would provide long term improvement.
Automatic enrolment into employer pension schemes: While we are living longer fewer are saving for their retirement. Overall, between 1997 and 2010 the number of jobs in the private sector with any employer sponsored pension provision declined from 46 per cent to 36 per cent. [note]Office for National Statistics, (2010) The Annual Survey of Hours and Earnings 2010. ONS.[/note] The Government is introducing automatic enrolment into workplace pension schemes from 2012 to tackle undersaving (p.8).
Which of these two options would act as the best complement for automatic enrolment?
The fact that contracting out will cease and that only thirty years of contributions will be taken into account under the second option makes automatic enrolment important, particularly for shorter or interrupted working lives.
State Second Pension was posited on the basis of lack of voluntary enrolment in occupational pensions, so its rationale would be diminished by automatic enrolment.
It therefore appears that the second option is the better fit with automatic enrolment.
Government would be interested in hearing views on other reform options that would meet the Government’s principles for reform.
The second option without a contribution record condition would meet the principles of simplicity and personal responsibility. It would be fair in the sense that every individual would be treated in the same way. Those few people who might be thought not to have contributed to society would in any case be receiving a means-tested pension under the current system, so there would be little if any additional cost to including them in a new single tier State pension. Even if the cost of the single tier pension were to be raised by abolishing the contribution record condition, the additional cost would be small and would be offset by administrative savings as contribution records would no longer be required (provided that other contributory benefits received the same treatment).
For 65 years New Zealand has paid a flat-rate and non-withdrawable Citizen’s Pension to everyone aged 65 or over who satisfies a residency requirement, so there would be a working model from which to learn if our own Government ever decided to establish such a Citizen’s Pension in the UK.
The next logical step would be to combine National Insurance Contributions with Income Tax: a process that has already begun with the recent Government announcement of the convergence of their regulations and administrations.
It is important that everyone is protected from poverty in old age by an adequate state pension. A further question is whether the state should subsidise, by tax reliefs or other tax expenditures, the contributions to occupational and personal pensions of those with earnings and with aspirations for a higher standard of living in their retirement than that provided by the State Pension.
Ending contracting out: Where individuals are contracted out of the State Second Pension they and their employers receive a rebate on their National Insurance contributions to reflect the fact they are building up less state pension entitlement. Schemes are obliged to either invest the rebate directly into the scheme on members’ behalf (in Defined Contribution schemes [note]Under Pensions Act 2007, contracting out for Defined Contribution schemes end in 2012[/note] ) or provide members with a minimum level of benefits as set out in legislation for Defined Benefit schemes. The purpose of the contracting-out rebate is, in effect, to compensate members for the additional state pension they have given up.
This chapter has set out two options for state pension reform. Under option 1 (faster flat-rating), contracting out would continue, although the value of the rebate would fall over time. Under option 2 (single tier) contracting out for Defined Benefit schemes would end completely (p.28).
What would be the impact of ending contracting out, as implied by any single-tier model?
Under pressure from lower investment returns and increasing longevity, Defined Benefit Schemes are becoming less sustainable and less generous, causing pension fund trustees to close the schemes to new entrants, reduce the level of pensions paid, and increase the number of years of contributions required to earn a full pension. There is therefore a trend towards employers contracting back into the State Second Pension. This suggests that the ending of contracting out for Defined Benefit Schemes would not be unwelcome, provided the single tier pension remains of sufficient value.
If contracting out were to end, the accrued benefits would need to be taken into account when an individual’s pension is calculated: so that any impact of the change would be slow.
It would be helpful if all contracting out were to end. To separate private, occupational and State pensions clearly from each other would inject greater simplicity and comprehensibility into a currently complex system.
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?
Provided sufficient time is given to enable employers and employees to prepare for the change, a switch to higher National Insurance Contributions, and presumably lower occupational pension contributions, should not be difficult to manage. What people will expect is a realistic level of State pension, and this they should receive under the single tier pension.
The fewer complexities there are in the system, the more individuals will put their financial resources and other assets aside for retirement, and the more they will pay into private and occupational pension schemes, so long as they believe that the stock markets will provide reliable returns.
Whilst transitional periods can be difficult, they are worth the trouble if the new scheme will be beneficial in the longer term, and it is clear that it is possible to get from the current income maintenance system to the new one. These conditions are fulfilled in the case of the consultation paper’s second option, so management of the transition should not be too difficult.
Means-tested Pension Credit: Under each of these proposals the Government will, in due course, give consideration to whether reforms are needed to the current system of means-tested support to ensure that this part of the system delivers on the principles for reform. Just as we have taken steps to rationalise the welfare system to ensure that work pays through introduction of the Universal Credit, we need to ensure that it pays to save for retirement and that complexities in the current system are reduced where possible (pp.8-9).
In conjunction with the reforms outlined [above] 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?
The more individuals there are on the new single flat rate pension, the smaller will be the number on means-tested benefits. A new genuinely universal single pension would remove the need for a means-tested supplement altogether. The vast majority of those not on the full flat rate pension would end up being paid by the State a total income not very far below the level of the State single tier pension. The flat rate pension paid to everyone would not require much additional expenditure and would allow the whole means-tested pension system to be dismantled. One result would be a considerable saving in administrative costs.
The whole system would then be simpler, disincentives would be reduced to zero (in relation to the State single tier pension), and everybody would be encouraged to save for their retirement. Pensioner poverty would be considerably reduced.
(Different housing costs in different regions will of course continue to pose a problem, as they do for any income maintenance system; but this particular complexity should continue to be dealt with separately, and no discussion of this problem should be permitted to confuse the important consultation now taking place on the right structure for the State Pension.)
State Pension Age: The State Pension age plays an important role in ensuring that the state pension remains sustainable and affordable – one of the key principles for future pension reform. The Government has acted quickly to take recent increases in life expectancy into account by setting out proposals to increase the State Pension age to 66 by April 2020.
But these increases in longevity will not end in 2020 and it is only fair that those generations who will benefit from these increases share in the costs. Not to do so would be unfair on the people of working age who would need to bear the burden of this increased longevity. In addition, there are important benefits to the economy and individuals from working longer.
The Government must continue to consider the State Pension age, and the question now is how to build into a future state pensions system a more automatic mechanism for ensuring further revisions in life expectancy are taken into account in a way that is timely and transparent.
The two options are:
- Increasing the State Pension age through a formula linked to life expectancy.
- Increasing the State Pension age through a review.
What mechanism should be used to determine future increases in State Pension age?
We would rather study the question: Should there be a State Pension age?
As longevity increases, it will be important to provide incentives to defer the receipt of occupational and private pensions. A seamless income maintenance architecture would be helpful in this respect. We therefore suggest that a useful mechanism for encouraging people to earn income for longer, and thus to delay until later in life the receipt of their occupational and private pensions, would be a Citizen’s Income: an unconditional, nonwithdrawable income for every citizen, paid for by reducing tax allowances and contributory and other benefits. Such a Citizen’s Income could rise as individuals pass age thresholds, but it would otherwise remain of the same structure from young adulthood to old age. The concept of ‘retirement’ would largely disappear as individuals chose their own income maintenance strategy, reducing earned income and taking private and occupational pensions as best suited them.
A transitional phase could be a ‘mature worker’s income’ for the over 50s, paid for by a reduction in tax allowances and other benefits, with regulations to match those of the State single tier pension. ‘Retirement’ would become far more flexible an experience, to the benefit of employers, the economy, and individual workers.
With this scenario the concept of ‘State Pension age’ would disappear.
How should the Government respond to the frequent revisions in life expectancy projections while giving individuals sufficient time to prepare?
See the answer to question 10.
The Citizen’s Income Trust’s additional comments
a) It is understood, although not explicit in the consultation paper, that the newly structured pension will only be paid to those who reach state pension age at or after its implementation date, reported to be 2015 or 2016. We recognise that the new pension scheme has to be cost neutral and cannot therefore include all existing pensioners from the start, so that a contribution-based, means-tested system will have to continue in parallel for a long time. With rising life expectancy this could extend many decades into the future. We propose that at the inception of the new pension structure every legal resident over 100 should immediately be eligible and that existing pensioners should become eligible on reaching the age of 100. This would mean that two parallel pension schemes might continue until about 2050 but we would expect that considerably earlier than this a future government would decide that everyone should be brought within the scope of the new scheme in order to eliminate the cost of having to administer the existing scheme for a minority as well.
b) Option 2 for a single tiered pension makes a considerable advance towards a Citizen’s Pension paid at the same rate to all legal residents of a qualifying age, and it is welcome that lesser amounts are no longer paid to couples than to two single people. However, it still depends on National Insurance contributions having been paid or credited for a minimum of 30 years. It is appropriate that this should be one way of establishing legal residence and that those who have worked in this country illegally and have not paid income tax or NI contributions should be excluded from entitlement to the State Pension, but other evidence of legal residence, such as inclusion in the electoral register, should be considered when determining eligibility.
Those most likely to be excluded are married women who have not worked, been unemployed or disabled, or had caring responsibilities for long enough and who currently rely on receiving Category B pensions based on their husbands’ contributions. There will also need to be regulations for legal immigrants from other countries who have not been in the UK as long as 30 years. If the UK has a reciprocal arrangement with their country of origin then they should be paid the new pension in full. If not, they should be paid pro rata and be expected to enhance that by claiming the pension to which they became entitled before leaving their country of origin.
c) People should be able to defer the single tier pension and receive it later at a higher rate, as they can now for the basic state pension. If a Citizen’s Pension were to be implemented, then the same could apply. If a Citizen’s Income for all adults were to be implemented then such provision would no longer be appropriate or required.
We would be pleased to receive correspondence relating to our response to the Government’s consultation paper