14 Jan 2013

The new state pension – the key questions

A flat-rate pension, equivalent to about £144 in today’s money, is being introduced from 2017. But there are more losers than winners in the new system, according to the Institute for Fiscal Studies.

The new pension will be “fair”, according to David Cameron, but is described as a “con trick” by the National Pensioners Convention.

The Institute for Fiscal Studies (IFS) says the government’s plans are a “welcome simplification”, but that “they also imply a reduction in the state pensions that most people born after around 1970 can expect to receive from the state”.

There are more losers than winners, according to the IFS, and the under-40s are hit harder than older people.

What happens at the moment?

Currently, the basic state pension is £107.34 a week. This can be topped up to £142.70 by the state second pension and pension credit.

Why is the government making changes?

Ministers argue that the current pension system is too complicated, with people unclear about how much money they will receive from the state when they retire.

There are thought to be more than 1.5 million people who are not claiming the means-tested pension credit to which they are entitled.

The government also says the system is unfair to women who have a broken national insurance (NI) contributions record because they have taken time out of the workplace to care for children.

The other losers at the moment are the self-employed, who, like women who give up work, often receive a lower pension.

What are the changes?

From 2017, there will be a flat-rate pension of £144 a week (in today’s money) that everyone will receive as long as they have paid enough NI.

At the moment, people build up a full contributions record for the basic state pension after working for 30 years. In future, they will have to work for 35 years to qualify for the new single-tier pension, but it will be more generous.

Those with fewer than 35 years on their NI record will receive a reduced pension, while people with a contributions record of under 10 years will not be entitled to a pension.

Women who take a break from the workplace will not be penalised as long as they have a full NI contributions record.

This does not mean they have to be in paid work for 35 years. Like now, if women are entitled to child benefit and are not earning, their NI contribution towards the basic state pension and state second pension is paid by the state until the child reaches the age of 12.

Women do not have to work full time to receive an NI credit; they just have to earn £107 a week or more.

The self-employed, who do not currently receive the state second pension, will also be entitled to a full pension if they have paid enough NI.

What happens to people with occupational pensions?

The seven million people with defined benefit/final salary pension schemes provided by their employers are usually contracted out of the state second pension and pay reduced NI contributions.

This is coming to an end and these people, and their employers, will have to pay higher contributions in future.

Of these seven million people, five million work in the public sector.

The GMB union says employees will have to pay an extra 1.4 per cent of salary, while the effect on employers will make these schemes “unaffordable” unless changes are made.

Who has welcomed the changes?

The Chartered Institute of Personnel and Development (CIPD) says the new flat-rate system is an improvement because it will give people a clearer idea of what they will receive from the state when they give up work and encourage them to boost their future retirement incomes.

The CIPD says people contributing to final salary pension schemes will have to pay more NI, but will benefit from an enhanced state pension.

The National Association of Pension Funds, which is also in favour, says: “For the first time in a generation, people will know that it pays to save, and that whatever they put aside won’t be eroded by means-testing when they retire.”

Who has criticised the changes?

The National Pensioners Covention (NPC), Britain’s biggest pension organisation, says the government is perpetrating a “con trick”.

It says people with a full NI contributions record receive about £150 a week from the state pension and state second pension, while in future they will be expected to pay NI for an extra five years to qualify for £144.

The NPC is also angry that existing pensioners will be excluded from the changes, including the hundreds of thousands of people who do not claim pension credit despite being entitled to it.

What is happening to the state pension age?

The state pension age is rising to 66 for men and women by 2020. It will go up to 67 after 2026.

Who are the winners?

According to the government, women are among the biggest winners because they are more likely to have time away from the workplace, usually to bring up children, than men.

The Department of Work and Pensions (DWP) says 2.8 million women receive a state pension of under £80 a week, compared to only 474,000 men.

It also says 750,000 women who reach pension age in the decade after changes are made will on average receive an extra £9 a week. The IFS agrees that these women will be some of the biggest gainers from the reforms.

What women will receive depends on their age and how many years they have contributed to the state second pension.

The self-employed, who currently pay less NI and do not qualify for the state second pension, also benefit.

According to the government, 4.2 million self-employed do not receive a full pension.

These changes will take decades to filter through. By the 2040s, the government says more than 80 per cent of people reaching the state pension age will receive a full pension.

The IFS says that one group that will benefit “in the short run” are people retiring after 2017 with a 30-year NI contributions record who would not be entitled to £144 under the current system, but will be under the new system.

Those in final salary pension schemes will have to pay higher NI contributions when contracting out comes to an end, but will also receive a more generous state pension.

Who are the losers?

The government is keener to talk about winners than losers, but others have filled the gap.

Those who fail to make NI contributions for 10 years or more will lose their right to a pension.

Tom McPhail, from Hargreaves Lansdown, has told Channel 4 News that people in their 20s and 30s on good salaries are also likely to lose out.

This is because these people could expect to receive a state pension under the current system (because of their contributions to the state second pension) that is considerably higher than £144.

Niki Cleal, director of the Pensions Policy Institute, agrees with this analysis, arguing that “those who lose out are likely to be consistently higher earners who would have built up considerable rights to the state second pension”.

More dramatically, the IFS says that although several groups benefit in the short term, “these proposals imply a cut in pension entitlements for most people in the long run”.

The explanation for this is that accrual rates will be lower in future. “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.”

The IFS says the government’s plans “imply a reduction in the state pensions that most people born after around 1970 can expect to receive from the state”.

In a nutshell, there are more losers than winners and those under 40 are hit harder than older people.