The reforms aim to simplify the state pension system, helping to create more certain and more equal state pension payments, and ultimately to help boost private pension saving. If it can achieve all these, then the answer is yes. But does it achieve these aims?
Much of the attention has so far focused on who gains and who loses. This is inextricably linked with the way in which the single-tier state pension will be implemented, and how it interacts with the old system.
One piece of good news is that the transition between the old and new systems, while complex in itself, is much faster than had previously been expected. So state pension outcomes become more certain pretty quickly – by 2030 around three-quarters of people reaching state pension age are expected to receive the full single-tier pension.
This is achieved by making the system generous to people who have been contracted-out in the past. One of the innovations in the White Paper is allowing people who been contracted-out the chance to build up rights in the single-tier state pension, so that they can receive a full single-tier pension as well as keeping the private pensions they have earned through contracting-out.
But this generosity comes with a cost, and the new state pension system still has the very strict constraint of costing no more overall than the current system. So to offset this gain for those who have been contracted-out, other changes have been made to the single-tier proposals.
For example, it will be harder to qualify for a full pension than it is for a full basic state pension, with 35 years of national insurance contributions needed to receive a full single-tier state pension, compared to 30 years for the basic state pension. And a minimum of somewhere between seven and 10 years of NI contributions are needed to get any pension, whereas at the moment any qualifying year provides some basic state pension.
The need to keep costs down – the new single-tier pension has to cost the same overall as the current state pension system would have cost – means that the level of the pension is only just above the level of the pension credit, and not as high as it might otherwise have been.
This affects who gains and loses from the single-tier state pension. In the short term, the more generous transition means that not only do the people who would be expected to gain from a single-tier state pension – women who have missed out on the state earnings-related pension scheme and the state second pension in the past, the self-employed – but so too can people who have contracted-out in the past.
In the longer term, the lower level of the pension means that the reformed single-tier state pension actually costs less than the current system – by 2060 the single-tier system is expected to cost 8.1 per cent of GDP, compared to 8.6 per cent of GDP in the current system. This means that more people are likely to have lower state pensions under the single-tier system, at least at the start of their retirement.
But overall, the new proposals would achieve a relatively simple and certain state pension system, relatively quickly. The important question is: will this help to boost private pension saving?
Another important outcome from the single-tier state pension point is less reliance on the pension credit. Currently 2.5m pensioners currently receive pension credit, and more than a million do not claim what they are entitled to. Removing the savings credit for people reaching state pension age under the single-tier pension system, and setting the single-tier state pension level above the level of the guarantee credit should mean far fewer future pensioners would be entitled to pension credit – an estimated 5 per cent of pensioners in 2060, compared to almost 40 per cent today. Many might still be eligible for housing benefit and council tax benefit, so means-testing will not disappear, but it should be less pervasive.
Allied to simplicity and certainty, the reduction in the extent of means-testing for retirement income should make the value of pension saving clearer – it will be more obvious what the outcome would be from not saving, and there is some reassurance that any money saved will increase the amount of income that people have in retirement.
Less certain is the impact on existing contracted-out defined benefit schemes, where the contracted-out rebate will be lost. On the downside for scheme members, they will in future pay higher NI contributions, but they will also accrue more state pension, and may well benefit from being able to build up a full single-tier state pension as well as keeping previous contracted-out rights.
Employers will also pay higher NI contributions, and would still have to meet the obligations of their existing schemes. Inevitably, many will therefore change the terms of the scheme, or the employee contribution levels. The government intends to make it easier for scheme sponsors to do this, but some sponsors may still close schemes entirely.
The overall impact of the introduction of the single-tier state pension on private pension saving therefore remains uncertain.
The reforms will definitely lead to a simpler, more certain system, with less means-testing and so allow people to more easily understand how much (or how little) the state will provide. Auto- enrolment will make sure that the vast majority of employees will be saving in a workplace pension scheme.
However, there are still challenges to get people to save enough (more than the minimum contributions) and to help them get the most from their saving by keeping charges at appropriate levels, ensuring value for small pension pots, making good decisions about how they draw down their pensions and even encouraging employers to provide defined ambition schemes. These issues will need to be addressed if the single-tier state pension is to be successful in increasing private pension saving, and ultimately boosting retirement incomes.
Chris Curry is research director of Pensions Policy Institute
Key Points:
* The department for work and pensions’ White Paper considers the validity of a new single-tier state pension.
* The proposals looks to achieve a relatively simple and certain state pension system, relatively quickly.
* The overall impact of the introduction of the single-tier state pension on private pension saving remains uncertain.
