From the TUC

Flat rate pension – a progressive idea but who’s paying?

04 Apr 2011, by in Pensions & Investment

The government’s much trailed Green Paper proposing a flat rate retirement pension has yet to appear on the DWP website, so it is hard to give a detailed reponse. (Update: it was published at 6pm but has still yet to appear at 6:30).

But we do know that the government is not intending to put any extra money into the system. This is what Pensions Minister Steve Webb said on the Today Programme this morning:

We’re not talking about spending a lot more money … we’re broadly talking about spending the same money but spending it in a simpler way. We take the complicated system – the basic pension, the state second pension, the means-tested – (and) roll them into a single payment.

“Obviously if people have already built up rights above that level we’ll honour them so we’re not taking any money off people.”

The key question therefore is who will lose as there are clear gainers.

As Jackie Ashley says, many women will be winners (though they are also big losers from the rise in the state pension age).

The self-employed are also set to gain, though whether it will still be possible to justify continuing the current difference between National Insurance contributions for the employed and self-employed is an interesting question.

Lifting a big group of poorer pensioners out of means-testing for pensioner benefits will be another bonus, as we know that many pensioners do not claim all to which they are entitled (although council-tax and housing benefit will still be means-tested). It is easy to forget just how much the state “saves” through non take-up of benefits.

I set out the mechanics of how the flat-rate pension is expected to work in a previous post. Essentially the government will abolish the state second pension. This is the least understood and confusing part of state pensions provision as some people qualify and some don’t. It has been earnings related but is moving to a flat rate top-up. Instead of this selective coverage and variable rate, the government will roll it up with the basic state pension into a single pension set just above the current means-testing level.

If you want a thorough costed account of how this might work, the Pensions Policy Institute work fleshing out the NAPF proposals for a foundation pension is the best place to start. They find that the NAPF’s version of a single flat-rate retirement pension would cost £25 billion if introduced in 2017.

I suspect that Steve Webb  would be very happy if the government was announcing full implementation of the NAPF’s plans, but he would never get that past the Treasury. That is why he has had to say that it will be close to cost free.

So how has he got the cost down?

We do not know the full answer – and there will be a lot of detail to go through – but here are two likely losers, on top of those losing from the higher state pension age:

  • current pensioners – We do know that the reforms will only apply to those who hit the state pension age in 2016 – those who have retired already will not benefit from the new system. Strictly speaking you could argue that current pensioners are not losers as their pensions will not go down, but I doubt whether they will see it this way. Unless there are some measures in the Green Paper that have not been briefed in advance it looks as if those who miss out on the reform because they reach the state pension age too early are likely to see the reform as very unfair.
  • current members of defined benefit pension schemes – The state second pension was originally introduced (as SERPS) by Barbara Castle. She wanted to make sure all workers could get a pension based on their earnings on top of their basic state pension. Most workers at that stage were members of good employer schemes, so SERPS was targetted at those who were not. Employer schemes could contract out of SERPS. In return for giving up entitlement to SERPS, both the employee and the employer pay reduced National Insurance payments. But if the state second pension is abolished the rationale for contracting out ends. This means that employers and employees currently in contracted out schemes will face an increase in their NI contributions or what the Conservatives once called a stealth-tax or pensions tax grab.

Ending contracting-out in this way will have two main effects:

  • In the private sector, it will be a further blow to defined benefit schemes. Employers have already closed most such schemes to new members, it is likely that putting this extra cost on employers will lead many to think about closing them to future accruals too.
  • In both the private and public sectors, it will lead to a cut in take-home pay as workers find bigger National Insurance contributions are taken from their pay-packets. This will be a particular blow to public sector pension scheme members, already facing bigger contributions for poorer pension benefits as a result of the government’s decision to raise contributions, the possible impact of the discount rate review, the recommendations of the Hutton review, scheme revaluations and the impact of the cap and share agreement.

A further worry will be how the Treasury accounts for the employer NI element when contracting out ends. There is no net cost to the public sector in employer NI payments, but the Treasury could choose to use the change as a way of reducing spending if it keeps the extra income and does not increase departmental budgets to take account of their higher NI bills.

Finally it is worth reflecting on how this move fits into the history of pensions.

When Barbara Castle introduced SERPS she was saying that pensioners should expect both a basic state pension that increased with earnings and an additional top-up based on providing some continuity with what people used to earn when they were at work.

But the last Conservative government broke the link with earnings for the basic state pension in 1980. This is why so many pensioners now need means-tested benefits.

Another way of looking at today’s reform therefore is to say the government has gone back to where we were before Barbara Castle introduced SERPS. The new flat-rate pension will be at a level not that different from what the basic state pension would be if the earnings link had not been broken. But the state will no longer have a role – other than through auto-enrolment – in providing a pension based on maintaining some continuity with pre-retirement living standards.

2 Responses to Flat rate pension – a progressive idea but who’s paying?

  1. Pauline visits the Annexe in Partick
    Apr 11th 2011, 8:52 pm

    […] Tories are proposing a flat-rate pension scheme, effectively abolishing the State Second Pension/SERPS and winding up related schemes and benefits. […]

  2. The flat-rate pension runs into the sand? | ToUChstone blog: A public policy blog from the TUC
    May 5th 2011, 3:30 pm

    […] to introduce a flat-rate pension will not be introduced in this parliament Lord Taylor of Holbeach has told the House of Lords […]