Workers see red over flat-rate state pension proposals

Higher earners and employees with long working lives are set to be the biggest losers under proposed reforms to the state pension unveiled this week.

The potential impact on these individuals was highlighted as the government announced its far-reaching plans for a “simpler, fairer state pension for the 21st century”.

In the green paper, published on Monday, two options were put forward for reforming a state pension system described as “dogged by complexity and confusion”.

Women, lower earners, and the disabled will all gain under the proposals – but the government concedes that the trade-off is that some people will be likely to pay more national insurance (NI) or receive less pension for what they pay in.

Currently, the state pension is made up of three elements: the basic state pension of £97 per week; a means-tested pension credit; and the state second pension (S2P), which allows working individuals to top up their basic pension entitlement.

The first option for reform in the green paper would speed up the transition towards a simpler, flat-rate two-tier state pension by phasing out the earnings-related component of the S2P more quickly – by 2020 instead of the mid-2030s. Under this option, in the longer term, people with 30 years of NI contributions in both the basic state pension and the S2P could expect to retire on a state pension of about £145 a week.

A second, more radical, option – believed to be favoured by the government – would see the state pension and the S2P combined to create a single-tier state pension for future pensioners set at £140 per week.

This would be an £8 uplift from the standard minimum guarantee provided by the pension credit, currently £132 per week.

“This radical redesign, still based around the contributory principle, would over time lift millions out of means testing,” says the government. “It would also put an end to inequalities in the current system that penalise women, low earners and the self-employed.”

However, some will not get an uplift from the proposals.

In its green paper, the government acknowledges that those who could expect to build up more significant amounts of S2P, such as those with longer working lives and higher salaries, would not be able to do so.

Currently, people can build up an earnings-related S2P on earnings between about £14,000 and £40,000. This enables some individuals with long working lives to boost their state pension to about £200 per week.

“The trade-off for the greater simplicity and clarity provided by giving everyone with a full contribution record a set flat-rate amount is that the amount of state pension would be capped at 30 qualifying years,” explains the green paper.

“In practice, this means that people who build up NI contributions or credits for additional years would not receive more than the flat-rate payment.”

Pension analysts say the proposal means that those contributing beyond 30 years will not get any extra benefit. 1.58m people now get over £150 in state pension a week.

“Presently, people who are working more than 30 years end up with a higher state second pension, of up to £200 a week, to reflect their ongoing and additional contributions,” says John Ralfe, independent pensions consultant.

“Under a single tier pension, the most these future pensioners can expect is £140 per week, so they will be worse off.”

A single-tier pension would also have a knock-on effect for millions of workers in final-salary schemes who have contracted out of contributions into the S2P.

These workers have been paying lower rates of NI, because they have been contracted out – but they will see their tax bill rise by 1.4 percentage points if contracting out ended, as proposed by the government.

“Unless employers make further changes to their defined-benefit schemes, they will face extra costs and scheme members will see their pay-packets hit with extra tax/NI charges,” says Bob Scott, senior partner at LCP, the pensions consultants. “In total, these amount to 5.3 per cent of relevant salaries, or around £105 a month for someone on average earnings.”

The government does not indicate in the green paper when either option would be implemented. But it gives an assurance that “any contributions accrued by people under the current pension system would be honoured”.

While many welcomed the proposed reform, particularly the second option, there was concern that it would only apply to future pensioners. “So none of today’s pensioners will get less than now, but they will not receive the new benefits,” says Ros Altman, director- general of Saga Group, the specialist financial adviser for over-50s.

“This is a big drawback to the proposals and it would be good if the government could find a way to deal with the anger of today’s pensioners,” she adds.