£144 is not enough to realise the benefits of a simple state pension
The Pensions Bill will have its second reading in the House of Commons today. I’ve already written about various aspects of the Bill on this blog, but the most important is of course the creation of a ‘single tier’ state pension in 2016. The government is embarking on a radical reform of the state pension system that will merge the basic and second state pensions (BSP and S2P).
Of course, most people who have not yet retired do not understand state pensions, so will hardly notice the difference. In my view, what will matter to them when they reach state pension age, as for pensioners today, is the weekly amount they will receive. On this, the proposed starting rate for single tier, £144 per week in 2012/13 terms, falls significantly short of providing for a decent and sustainable state pension.
A state pension of £144 is inadequate in terms of four specific criteria – all of which have been claimed, by the government, as reasons we need a single tier state pension in the first place.
We can take the first two together: eliminating poverty and establishing a simpler state pension system. We know that single tier will not eliminate poverty because many pensioners will remain entitled to means-tested benefits. The government expects eligibility for Pension Credit (which guarantees a minimum income) to fall, but around 1 in 20 future pensioners will still need to claim it because they will not receive a full single-tier pension, which will require 35 NICs qualifying years.
Absurdly, missing only one of those 35 years will mean a means-tested top-up is necessary. Under the original green paper proposals in 2011, the government suggested a single tier starting rate which was almost 6 per cent higher than the then minimum income guarantee for pensioners; the rate now specified is less than 1 per cent above the guarantee.
Worse, most pensioners receiving the guarantee element of Pensions Credit are ‘passported’ onto other means-tested benefits like Council Tax Benefit and Housing Benefit – this is the current system’s recognition that £142.70 (the 2012/13 guarantee) was nowhere near enough to cover pensioner living costs up to a subsistence standard. One in twenty pensioners will therefore still be entitled to an array of benefits in addition to some single tier. Furthermore, those pensioners receiving only £144 in single tier with little or no income from other sources will avoid the Pensions Credit claims process, but will be required to claim separately for Council Tax Benefit and Housing Benefit – both of which are currently undergoing reform.
Single tier not only fails to eradicate the complexity of pensioner benefits (which led to very low take-up rates, exacerbating pensioner poverty) – set at such a low, it actually succeeds in making the system more complex.
Of course, merging BSP and S2P enhances simplicity, and on that basis has been welcomed by many. Yet even here, not everything is as it appears. Compared to BSP, S2P is very complex, because outcomes relate to earnings rather than simply years of paying NICs. However, S2P is only partially being replaced by single tier (which operates like BSP). With single tier set at such a low level, individuals will have to save more privately to ensure their retirement income is at least what they could have got from BSP and S2P.
The great virtue of S2P was that it was a ‘defined benefit’ system – the formula for determining outcomes was complex, but if you knew the formula, you could at least in theory determine roughly what you would get based on what you earned. In the future, in contrast, private saving will be mainly in ‘defined contribution’ pension schemes. Working out what you will get from defined contribution schemes is anything but simple (in fact it is impossible), because outcomes are ultimately determined by investment returns and annuity rates available when you retire. (There is of course also an important point here the opaque practices of financial service providers.)
This does not necessarily mean we should salvage S2P – but only by setting single tier at a higher level can the potential benefits of simplicity be realised.
The third criterion which a single tier pension of £144 fails to fulfil is its ability to incentivise private saving. For the government, it is by producing a simpler state pension that private saving will be incentivised, because state pensions will then provide a solid platform for private pensions. The failure to fully eliminate means-tested pensioner benefits means this objective is already compromised – as in the current system, many pensioners will still be punished through lost benefits for any private income they have. (In fact the new system will arguably be more punitive, because of the abolition of the Savings Credit element of Pension Credit.)
In a more general sense, as Nigel Stanley and I argue in Third Time Lucky, a state pension set at a low level will make people more risk averse in terms of private saving. Their retirement income will be more dependent on private saving, but this means that in terms of standard of living in later life, they will have more to lose – loss aversion is one of the key behavioural barriers to pensions saving. If single tier was set at a higher level, people would have more certainty that they can secure a decent retirement income from the state, and therefore take more risks privately by contributing greater amounts to a workplace pension.
The final failure of a £144 state pension relates to the fairness of the reforms. We know that many women approaching retirement with poor entitlements to S2P, due to time spent away from the labour market, or a lifetime of low earnings, will benefit from single tier in the short term. So will those pensioners entitled to Pension Credit who do not claim it. But there are two caveats to this. Firstly, many in this group will also be immediate losers through the abolition of Savings Credit in 2016, noted above. The government’s guarantee that nobody retiring with some state pension accrued in the old system will get less under single tier only applies to state pension, so excludes the vital income top-up they could have got from Savings Credit.
Secondly, although it is absolutely right that the government does more for this group in the short-term, in the long-term women in these circumstances are going to be worse off under single tier. S2P was only introduced in 2003. It is a far more inclusive and progressive benefit than its predecessor SERPS, meaning that for people unable to work due to caring responsibilities or with very low earnings, would actually be much better off with BSP plus S2P than single tier at a starting rate of £144. S2P is being abolished before it has really had a chance to do the job it was set up to do. A higher rate single tier would replicate S2P’s impact – £144 per week would not.
This indicates the main unfairness associated with a single tier state pension of £144 per week – under the current system, as the Institute for Fiscal Studies tells us, the vast majority of future pensioners could have expected to get BSP plus S2P above this level. It is unfair to exploit the lack of understanding of pensions among today’s young people to significantly reduce their state pension entitlements. They will be paying the same rate of National Insurance as they would under the current system, but getting less in return.
This loss will be experience by even the lowest earners, assuming a typical working life with pay progression. Somebody earning around £10,000 today will get between around £10-20 less per week from single tier than the current system if they reach state pension age in the 2030s, or £20-30 less if they reach state pension age in the 2040s. These figures are £20-25 and £25-35 for people today earning £20,000.
This impact is indicated by DWP’s impact assessment, but obscured because the numbers of losers are presented only in cumulative terms, that is, everyone retiring between 2016 and 2060 – those retiring later are more likely to lose out, and to lose more.
As a structure for state pensions, single tier has many positive elements. But by setting single tier at such a low starting rate, the government is actually undermining many of the new system’s advantages – as well as condemning many future pensioners to poverty-level income, or a potentially unsustainable over-dependence on risky private pensions.