When the UK’s new state pension comes into effect for everyone retiring from April 6, a key part of Iain Duncan Smith’s legacy will become reality. It will “make millions of people better off”, according to the Department for Work and Pensions.
At £155.60 per week it is certainly some £40 higher than the current basic state pension, and also slightly above the existing means-tested level of benefits for pensioners, which is £151.20 per week. The government boasts 75% of retirees will gain in the first 15 years of the reform. Yet even its own estimates suggest the reforms will be cost neutral in the short term, and less expensive in the longer term. If there’s no such thing as a free lunch, what’s going on?
First you need to understand the existing state pension. It’s made up of a basic component of up to £115.95 per week based on the number of years in which the recipient has paid national insurance (NI) contributions; and an additional component based on the amount of NI contributions they have paid on earnings between £6,000 and £40,000 – providing a maximum top-up of £164 per week. Those pensioners with little or no additional component or private savings get their basic pension topped up by means-tested benefits to £151.20 per week.
The new state pension will sweep away these complex elements in favour of the new flat-rate payout, which will be available to everyone with 35 years of NI contributions (anyone with less than ten years’ contributions will get nothing; those with between ten and 35 years will get a proportionate amount; so some are likely to remain reliant on means-tested benefits). It is affordable for the government because the additional top-up entitlement is being removed – without reducing the amount of NI we all have to pay, of course.
There is a clear gain for those unable to earn any or much additional pension – particularly the self-employed, women taking long career breaks, and the very lowest paid. On the other hand, all those people currently eligible for a top-up under the additional component are potentially facing a loss. There is real concern over a widespread lack of awareness concerning what individuals are likely to receive.
The downside won’t actually kick in on April 6. Everyone will start accruing benefits under the new system on that date and when they reach state pension age, the authorities will compare the benefits they accrued under the old and new systems for the period to April 2016 and pay out the higher of the two along with whatever is accrued under the new system from April 2016. This means the loss of the additional state pension component will have little effect on workers retiring in the immediate years after 2016.
This explains how the government can claim 75% of retirees will gain in the first 15 years (by an average of £4 per week). Yet according to the government’s own figures, over 60% of those now in their twenties will find themselves £16 per week worse off on average at today’s prices when they retire. One actuarial firm conservatively estimates that around two-thirds of the current workforce will lose out to the tune of £1,000 a year.
Then there are the millions of workers who were encouraged in the 1970s and 1980s to “contract out” of the additional pension. As a substitute for receiving that top-up on retirement, the government paid a rebate of their NI contributions into employer or personal pensions. Under the new system, they will receive up to £55 a week less than the full new state pension when they retire, to take into account the rebates that they have already received. This has come as a surprise to many who, being entitled to a full basic state pension under the existing system, assumed they would be entitled to a full state pension under the new scheme.
And this isn’t the only communications problem coming out of the transition to the new scheme, as highlighted recently by the House of Commons work and pensions committee. One prominent example is how these reforms interact with changes currently taking place to the women’s state pension age. Many women born after 1950 will miss out on the new state pension for a few years because the government has raised their pensionable age more quickly than previously expected. Women Again State Pension Inequality has been fighting a forceful campaign seeking to remedy what it regards as unfair treatment.
The heart of the matter
These issues with the new state pension are at least partly due to the government’s understandable emphasis on the fact that the basic entitlement is rising. The story of how it is being paid for is more complex and politically inconvenient to tell – including what is being taken away from the millennials.
It comes at a time when the government is exhorting that generation to save more for their retirement through automatic enrolment into a pension scheme and/or through the new lifetime ISA. In many cases, that increased individual saving is unlikely to make up for the loss of the additional state pension. Not for the first time, it leaves the government open to the accusation that it favours the current generation reaching retirement over the next. Iain Duncan Smith may be grateful that he no longer has to justify it.