John Hutton, the work and pensions secretary, revealed the long-awaited proposals for the overhaul of Britain’s pension system in a white paper on Thursday. The government has accepted most of the proposals suggested by Lord Turner’s Pensions Commission.
The state pension will rise in line with earnings from 2012 at the earliest, although we will have to work longer in return, and millions of workers who are not currently saving into a company pension will automatically be enrolled into a national pension savings scheme with compulsory employer contributions.
But while the plans were welcomed by consumer groups and the pensions industry, there are fears middle-income families will end up shouldering the cost of the reforms.
Labour insists its proposals will not require large tax rises because it will be able to meet the costs by increasing the state pension age. However, Matthew Wakefield of the Institute for Fiscal Studies said: “Despite the planned increase in the state pension age, increased borrowing or taxation is expected to be required to finance these proposals.”
The Conservatives have pointed out there is already a stealth tax on the middle classes hidden in the proposals. Under the plans, an increasing number of people will pay national insurance contributions (Nics) for which they will receive no pension benefit in return.
The key change relates to the state second pension (S2P), a top-up to the basic state pension formerly known as Serps. At present the amount you receive from S2P is linked to earnings, so the more you earn the more you receive, up to a limit.
But the government wants to put a cap on S2P so that by 2030 everyone will receive the same amount. Many people will see the amount of S2P they receive plunge in value without enjoying an equivalent reduction in Nics. A higher-rate taxpayer will in effect be overpaying by £2,119 a year.
Pensions experts are also concerned that the reforms could leave millions of people in generous company schemes worse off in retirement.
At present, firms pay an average of 6% of salaries into money purchase schemes and even more into final-salary plans. They will have to pay only 3% into the national pension scheme, however, and there are fears existing plans will downgrade to that level.
The proposals could be watered down before they become law, however. The reforms won’t be introduced for at least four years, leaving plenty of time for government tinkering. Assuming they go ahead, we explain how the measures will affect you.
What does it mean for my state pension?
The government wants to reintroduce the link between the state pension and earnings, which was severed by Margaret Thatcher in 1980.
The state pension currently rises in line with inflation. Because incomes usually rise faster than prices, this means it will become more generous in future. The government estimates that by 2050 it will result in a total state pension at retirement, including the S2P, of nearly £135 a week in today’s terms. If it were to remain linked to prices, it would be worth between £90 and £100 a week.
Ministers said the increase in the basic state pension will lift more of us out of the means-tested net. Under the current system about half of all pensioners are subject to means-testing. By 2050 that will fall to a third.
But the restoration of the link to earnings will not take place for many years, meaning it will do nothing to help those who have already retired.
The government hopes to introduce it by 2012, but the date may be pushed back, to 2015 at the latest. In the meantime, pensioners’ incomes compared with those of the working population will continue to fall.
When will I get my state pension?
The government says there is a trade-off if we want a bigger state pension — we will have to work longer. The age at which men and women qualify for the state pension will go up from 65 to 66 from 2024, to 67 from 2034 and 68 from 2044.
People who are now in their twenties will have to work until they are 68 before they collect their state pension. Workers in their thirties will be able to retire at 67 and those under 47 will have to work until 66. Workers aged 47 or over are unaffected.
The state pension age for women is already due to rise from 60 to 65 between 2010 and 2020.
But there will be nothing to stop you retiring earlier if you have alternative means. At present, you can take benefits from a private pension at 50. From 2010 that will rise to 55.
What’s in the proposals for women and carers?
Under the current rules only one in three women is entitled to a full basic state pension, compared with 85% of men.
The amount of state pension you get is based on average Nics over your working life. Taking time off to care for children or relatives eats into that average.
The government wants to make it easier for women and carers to build up a decent pension, so from 2010 it will reduce the number of years needed to qualify for the full basic state pension to 30 years. At present women need to work for 39 years and men for 44.
Ministers said that when the changes are introduced after 2010, seven out of ten women will become entitled to a full basic state pension. However, millions of women aged 57 or over will not benefit.
Will I lose out from the reform of the state second pension?
About 20m people pay into S2P, formerly known as Serps. It pays a top-up according to your income and the number of years you have worked and paid Nics.
Someone with a full employment record earning £33,000 or more a year receives up to £110 a week. But the government wants to turn S2P into a flat-rate payment worth about £60 in today’s terms by 2030. Insurer Aegon estimates that anyone earning £18,000 or more will see the amount of S2P they get slashed.
Millions of people have opted out of the state second pension to make their own provision, either through a company pension or a personal plan. They get a rebate of their Nics that is paid directly to their pension company. But from 2012 individuals in money- purchase company schemes will be forced back into the state scheme. However, they will not be forced to pay back any rebates they have already received. Members of final- salary schemes will still be able to opt out.
My company does not pay into a pension on my behalf. Will that change?
From 2012 everybody in a job who is not already in a company pension plan will be automatically enrolled in the national scheme from the age of 22, with the right to opt out.
If you stayed in you would have to contribute a minimum of 4% of your post-tax earnings between £5,000 and £33,000 a year — about £93 a month if you are earning £33,000 or more. The government will contribute tax relief of 1% while your employer will have to pay another 3% — a total of 8%, or about £187 a month.
Contributions are expected to be collected through payroll and, along with the employer’s contribution, transferred into your own individual pension pot, which could move with you if you change jobs. You will also be able to make additional contributions. However, the government is vague about the details of how it will work.
So will an 8% contribution be sufficient to leave me better off in retirement?
Almost certainly not. Many people aim to retire on about two-thirds of their salary. To achieve that, people on average earnings and their employers would have to make total contributions of about 16%.
Where will the money paid into the national plan be invested?
Labour hasn’t made this clear but it is likely your money will be invested with an insurance company or fund manager.
I already have a company pension scheme. How will the national plan affect me?
If your company already offers a pension scheme and its contributions are 3% or more it will not have to offer the national scheme.
If its contributions are less than 3% it will have to raise them to this level or offer the national plan as well. Most contributions made to company schemes are in excess of the minimum.
However, some commentators fear firms will be tempted to close their plans and fall back on the national scheme to cut costs.
Standard Life, the insurer, estimates that if all employers cut back contributions to just 3%, workers will be £14 billion to £15 billion worse off in retirement.
KEY POINTS OF THE PENSIONS REFORM
It will be easier for women who stop work to raise children or care for relatives to qualify for the full basic state pension. Anyone who retires after 2010 will receive the full pension if they have made national insurance contributions (Nics) for 30 years. At present, women have to pay Nics for 39 years and men for 44 years.
FIRED UP
DOMINIC WESLEY, 23, a firefighter at Wolverhampton Business Airport, will be one of the winners from the government’s pensions reforms.
‘I am currently saving into a personal pension because my firm doesn’t contribute to a company scheme,’ he said. ‘In future my employer will have to make contributions to a pension on my behalf which should boost my retirement savings.’
However, his parents — Pat, 60, and Paul, 52 — are underwhelmed by the proposals.
For Pat, any reforms to the state pension will come too late. Like millions of women she took time off to bring up children, so she doesn’t qualify for a full state pension.
The government has proposed changes to make it easier to earn a full pension — but not until 2010. Women like Pat who are already collecting the pension won’t benefit.
Her husband, Paul, is saving into his employer’s final-salary pension scheme and is largely unaffected by the government’s proposals.
