Briefing note on new flat rate state pension proposals
Some hopefully helpful Q&A to clarify what may happen
I thought it might be helpful to compile a list of the questions that people are asking, to help provide answers to those who are not sure how the new proposed flat-rate state pension system will work, who it will affect and how they will be impacted. The Draft Bill and Regulatory Impact Assessment for the new single tier flat rate state pension should be published imminently but it is important to note that these proposals are only in White Paper format and have yet to pass through Parliamentary scrutiny, so some of the detail may change.
Here is a Q&A based on my interpretation of the Government’s announcements so far.
What is the main aim of the new system?
To simplify the state pension in order to encourage private saving and offer a firm foundation on which to plan more later life income than is paid by the state.
What’s wrong with the current state pension?
It’s far too complex, made up of so many different parts that nobody understands it. It is also inadequate to lift people above means-testing and therefore undermines private retirement provision. It currently comprises:
Basic State Pension (up to £107-45 pw)
+ 3 types of earnings related pension, each with different qualification criteria depending on when contributions were made and how much people earned:
State Earnings Related Pension
State Second Pension
+ means tested top-up (to which 40% of pensions are entitled) which increases income up to minimum £142-70pw with
Pension Credit which has two parts:
Guarantee Credit (£142-70pw)
Savings Credit (up to £18-54pw)
Entitlement to some of the earnings related state pensions could be contracted out to employer schemes in exchange for paying lower National Insurance.
The whole system is so complicated, most people have no idea what they will actually get from the state and nobody can give a precise figure of what later life income they will receive. The worst aspect is that the state pension itself is so inadequate that it leaves 40 per cent of pensioners entitled to the means-tested pension credit, which then takes away much or all of any private pensions or earnings they have. Thus, the state pension undermines self-reliance, especially among lower or middle earners who are most likely to end up with lower state pensions in later life. Since the Government is automatically enrolling all workers into a workplace pension scheme, without any risk warnings about the means-testing in the state system, it is vital that the risk of loss is mitigated with radical state pension reform.
When will the new system start?
April 2017 (one year later than originally proposed in the Green Paper that was issued in 2011). Anyone reaching state pension after that date will be put onto the new system.
Who will qualify?
All women born after 6 July 1953 and all men born after 6 April 1952 will be included in the new system.
How will people qualify?
With a 35 year National Insurance contribution record. Anyone reaching state pension age after April 2017 who has a full National Insurance record or credits will receive the £144pw. The White Paper proposes raising the number of years for a full pension from 30 in the current system, to 35 for the new arrangements.
What does the Government propose to pay?
Eventually, there will be one flat-rate state pension, which the White Paper says will be £144 a week (in today’s money terms). The new state pension will be designed to roll together the Basic State Pension (currently £107-45 a week) and all the additional state pension entitlements (SERPS, State Second Pension and Graduated Pension, which will vary depending on people’s previous income). Of course, it will take some time to actually get fully onto the new arrangements and, because of the crazy complexity of the current state system, there will be many years of transitioning.
So the new pension will lift pensioners above the Pension Credit means test. The reason for choosing £144 in the White Paper is that this is above the means-tested Pension Credit Guarantee Credit level. The vital principle of this reform is that the new state pension must lift people above the means-test level of Pension Credit. Currently, the Guarantee Credit level is £142-70pw, and the White Paper sets the new state pension at £1-30 pw above that.
Will the £144 be uprated in line with Pension Credit between now and 2017?
Not necessarily. The only commitment is to make the new state pension higher than the then Guarantee Credit level, but not by a particular amount. The differential of £1-30 does not need to be uplifted in line with Pension Credit between now and 2017. It could be just 1p above. Obviously, a lower differential will save costs in future.
How will the new flat-rate pension be protected against inflation?
It will be uprated at least in line with average earnings. The Government proposes that the new state pension will be increased at least in line with earnings and initially it suggests the ‘triple lock’ should apply – in other words the higher of earnings, cpi inflation or 2.5%.
At what age will the new state pension be paid?
In 2017, state pension age for women will be over 64 and for men it will be 65. In 2018, state pension age for both men and women will be 65 and then it will increase to 66 by 2020 and then to 67 by 2028. The White Paper has also announced that the state pension age will be kept under review and that an independent body will be appointed to oversee this, alongside the Government Actuary’s Department and will report at least every 5 years. Any future changes to state pension age will be announced with at least ten years’ notice.
Will carers and other non-workers be included?
Yes. Carers should be credited as now. People who have been credited into the National Insurance system, perhaps because they were caring for children or adults, or were seeking work, or are disabled will earn qualifying years as if they were working.
What about existing pensioners?
They are excluded. Nobody who reaches state pension age before April 2017 will be included, so there will be a sharp cut-off between those born just before or just after the new scheme starts. I have already had many angry emails from pensioners concerned about the unfairness of this divide. I certainly understand such feelings, but the Government has been determined to proceed with the policy, so that at least future generations can have a sustainable, simple system, which they can understand and plan for.
Why are existing pensioners being left out?
It would cost too much to include them. Because of the constraints on public spending, the Government had to design a system that was ‘cost neutral’. This has meant that many people will not benefit from the new pension.
Can people qualify for the new system by delaying taking their state pension until after April 2017?
No. I’m afraid the Government will not allow this, because the new system is dependent on when people actually reach state pension age, not by the age at which they start taking the pension.
Will people still be able to defer taking their state pension in future, as they can now?
Yes, but on much less generous terms. It looks as if the rates for deferring state pension (currently an extra 10.4% a year is added to the state pension for each year of deferral) will be reduced in future as it is considered too generous. Also, there will be no facility to receive past years’ payments as a lump sum as is currently offered.
What about those who are already entitled to more than £144 a week, will they lose that?
No, but it will be probably be uprated less generously. Many of today’s pensioners and future pensioners already have more than the £144 a week state pension, from a combination of the Basic and Additional state pension accruals. They will not lose their extra as the Government has promised that it will protect state pension rights that exceed the new state pension level. However, the Government proposes that the £144 a week pension increases at least in line with earnings or has the ‘triple lock’ applied, while the additional amounts above that will be uprated in line with just cpi. These details have yet to be confirmed and will evolve over time.
Won’t millions of pensioners be furious at being left out?
Probably! Although most men with a full working career already have a state pension entitlement higher than £144 a week, although most women have less than this. Men with a full working career in the state pension system, who did not contract out into a private pension, would already be above the new state pension level. Those who were contracted out for many years might have less but they also paid lower national insurance and will get the other part of their state pension from their private scheme.
Why are women said to be doing so well in the new system?
Because their current state pension entitlements are usually below the £144 a week, so they will get more in future. The average state pension entitlement for women in 2016 is expected to be around £130 a week, so many women after 2017 will get more state pension.
Will all women benefit?
No. A particular group of women is being treated very harshly. Those who reach pension age between April 2016 and April 2017 were hit by the Coalition’s decision to increase women’s state pension age a second time, with only around 4-5 years’ notice. The original Green Paper proposed that the new state pension would start from April 2016, but the latest White Paper proposals delay the start date by one year. Therefore, although in future the new system should be very beneficial for many women, and brings forward the date at which men and women’s state pension entitlement will be equalised, about 400,000 women before 2017 will face a sharp increase in state pension age but still stay on the old system, even though men of the same age will get the new system. If the new state pension had started in April 2016, as previously envisaged, these women would have benefited from the new system, but the current proposals mean that they have lost out twice.
Why are the self-employed doing well out of the new system?
Because they have always paid lower National Insurance and been excluded from the Additional State Pensions, but will be put onto the new higher state pension in future. The self-employed will be big beneficiaries because they are currently only eligible for the £107-45 pw Basic State Pension and none of the Additional Pensions like State Second Pension. In future, they will be treated the same as other workers and can expect the new £144pw higher pension.
Will the self employed have to pay higher NI in future to reflect higher state pension?
We do not yet know, these details are up to the Treasury, not the DWP.
What if people have already retired and have only 30 years contributions now?
They will receive 30/35ths of the new £144pw pension, which will be around £123 a week – which is higher than the £107-45 for the full Basic State Pension now. This assumes they have no contracted out rights and were in the state pension system all the time. So 30 years in new scheme is better than 30 years in old system.
What can people do if they have 30 years and want to get 35 for full pension?
They can try to buy missing years, or work longer or be credited for a further 5 years. It is possible to buy back missing years or obtain credits for National Insurance between now and 2017, although there are only 4 years’ notice of a 5 year increase. Some people have written to me concerned that they have already retired and made sure that they have 30 years National Insurance contributions in order to qualify for a full state pension, but their record will now be 5 years short. Those reaching state pension age after April 2017 will not get the full £144 a week unless they can make 5 extra years of contributions. These people will generally have a choice. If they do not want to make extra contributions, then they will be entitled to 30/35ths of the £144 a week (assuming they have not been contracted out of the state system), giving them a state pension of £123-40 a week, which is still much better than the current full Basic State Pension of £107-45. However, they could also decide to contribute for an extra five years, either by buying back contributions, or by going back to work. This would allow them to build up to the full £144 a week.
How much will it cost to buy back missing years to top up to 35?
Anyone who has not contributed to National Insurance for the years since 2006 can buy back National Insurance credits for the missing years. However, if they missed years before 2006, this buyback option is not available. The cost of buying back the missing years is supposed to be set at the rate that applied during that year. This will be around under £350 for each year, and will buy an extra years’ worth of the new state pension. This extra year’s pension is worth £214 every year on the state pension (1/35th of the annual new pension). So for under£350 paid now, people can buy an index-linked state guaranteed pension of over £200 for every year they live. AS this seems such a good deal, I think many people will want to have the option to buy back any missing years that relate to periods before 2006 if they need to. I wonder whether any pressure will be put on the Government to allow this during the transition period to help those who retired with 30 years contributions.
Will people be able to buy any missing years after the new system starts?
Yes, up to 2023. It seems the Treasury is proposing that anyone who does not have a complete 35 year National Insurance record will be able to buy back missing years after the new system starts, as long as they reach state pension age before 2023. This cut-off point may change as the Bill goes through Parliament, as it seems very generous to allow people six years to decide to buy missing years.
Is Pension Credit being abolished?
No. Pension Credit will remain in place for those who do not qualify for the full £144 a week state pension, and it will of course also remain for existing pensioners.
Is the Savings Credit being abolished?
Yes. Savings Credit will not be paid to anyone reaching pension age after April 2017. This will save significant sums to the public purse and is part of the mechanism for offsetting extra costs of paying the new higher state pension in future. However, there will be a 5 year transition to help people who would have qualified for savings Credit with their housing costs if they need it.
What about those who are entitled to disability payments with their Pension Credit?
The Government says those who would have been entitled to extra disability payments under the current system if they claimed pension credit will still receive that extra money on a means-tested basis if they require it.
What is happening to the 25p pw extra pension for those over age 80?
They are being abolished for future pensioners. Currently, anyone reaching age 80 is paid an extra 25p per week as an ‘age addition’ to their state pension. This sum has not changed for decades and the Government is abolishing it for people reaching pension age after April 2017.
What will happen to Category ‘D’ pensions?
It is being abolished for future pensioners. At the moment, anyone over age 80, whatever their National Insurance record, is entitled to a ‘citizen’s pension’ called a ‘Category D’ pension, which pays around £65 a week. This anachronism of the current system will be abolished in future.
What about married women’s stamp?
There will be some transitional protection for women who paid married women’s stamp. These women have paid lower National Insurance but then do not qualify for a state pension in their own right. They need to claim on their husband’s pension. As the new system will be for each individual, the option to claim on a partner’s pension will gradually phase out, but there will be transitional protections.
What about widows inheriting husbands’ pensions?
There will be some transitional protection for some women who would always have expected to inherit their husband’s pension and cannot now make up for the loss of this right. More details will be revealed as the Bill goes through Parliamentary scrutiny.
Why do we have to wait to 2017?
Because the pensions industry says employers need time to adjust defined benefits. The Government says it has delayed the start of the new flat rate state pension to 2017, instead of the 2016 originally expected, because the private pensions industry says that employers will need more time to adjust the scheme benefits for Defined Benefit pension schemes to cope with the ending of contracting out. It does seem most unfair that many women will lose out so heavily in order to help employers who provide their workers with very good private pensions.
What will happen to contracting out?
It is being abolished. The UK has run a system of ‘contracting out’ of the add-on parts of the state pension and allowed people to export their state pension rights to a private or employer pension scheme instead. In exchange for giving up these state pension rights, they and their employers were allowed to pay lower National Insurance. Now, however, there will only be one state pension and no earnings related elements, so there will be nothing to contract out of. Everyone will, therefore, in future pay the same rate of National Insurance to accrue the same portion of the flat rate state pension and there will be a clear separation of state and private pensions.
Why must contracting out end?
There will be nothing to contract out of and is far too complex. State provision should focus on a flat-rate, rather than earning-linked, state pension in future. Contracting out is the most complex part of our whole pension system. It has been a very messy ‘loose end’ that makes no sense at all in the new flat-rate pension world. In a new system where the state pension is just one flat-rate payment, which is what we need and should have happened long ago, contracting-out makes no sense.
What about people in contracted out pension schemes?
They will pay the same National Insurance as everyone else. They and their employers will no longer pay lower National Insurance contributions than everyone else. Only defined benefit pension schemes can be contracted out now, the ability for defined contribution schemes and personal pensions to contract out was removed last year. There are currently two rates of National Insurance for employees – the normal rate and a reduced ‘contracted out’ rate which allows workers to pay 1.4% lower NI than the normal rate and employers to pay 3.4% lower NI than other employers.
So many workers will need to pay 1.4% extra NI?
Yes. They will pay the normal rate of NI, instead of a reduced rate and will be getting a much higher state pension from this. Paying an extra 1.4% National Insurance will mean those who are currently in contracted out pension schemes pay the normal rate, rather than a reduced rate as at present. The maximum increase in National Insurance that will be payable by workers, will be around an extra £500 a year for the higher earners.
What about employers who have to pay extra 3.4% NI?
They will be allowed to reduce the pension benefits if they wish to. It is only employers who are still running open contracted out defined benefit pension schemes who will be affected by an increase in NI contributions. Most of these schemes in the private sector are now closed to new members and many are closed to all, so the issue affects fewer employers over time. The reason they pay lower NI is to reflect the fact that they have committed to replacing the earnings related part of the state pension for their workers and that is reflected in their pension scheme benefits. In future, they will no longer have to replace the state pension benefits as the state will join the earnings-related and Basic State Pensions together in the new flat rate system. Therefore, employers will have to pay the same rate of NI as all other employers. However, it would not be right to force them to still replace state pension rights that are reflected in the benefit structure of their scheme. Therefore, the Government plans to allow employers who want to strip the replacement for state pension out of their defined benefit scheme promises, to do so, even if trustees try to object. This is only fair, since the employer would otherwise be paying double for the same benefit. There will ultimately be lower costs to employers, but in the short-term the costs will rise as a result of higher National Insurance and the costs of organising changes to the scheme benefit structures.
How will the new entitlements be calculated?
A complex calculation will need to be performed that assesses the value of each person’s state pension entitlement as at April 2017 when the new scheme begins. The Government will look at each person’s accrued National Insurance record and calculate how much state pension they are already entitled to. This is called the Foundation Amount. This will then be compared with what they would get under the new state pension system. If their present entitlement is greater than their accrued portion of the £144 a week, they will keep the higher amount. If their current entitlement is less than the portion of the new £144 a week, their Foundation Amount will be the entitlement under the new system.
What is the ‘contracted out deduction’?
Anyone who was in a contracted out pension scheme for part of their working career will have given up some of their state pension rights and the amount they have given up will depend on the years in which they were contracted out and their earnings. The amount of state pension which they relinquished entitlement to is shown on their state pension forecast as a ‘contracted out deduction’ or ‘COD’.
What happens with the Contracted out Deduction?
It will be deducted from the £144 flat rate state pension when calculating the Foundation Amount in 2017. A statement will be prepared for everyone as at April 2017 to check what pension entitlement they have under the existing system and compare it with what they will receive under the new system. Millions of people have some contracted out rights from time when they contributed to a private or employer pension scheme. Their state pension forecast will show a ‘contracted out deduction’ which is the amount of state pension they gave up when they were contracted out into the private pension that will replace these state benefits. This contracted out deduction needs to be deducted from their £144 a week state pension entitlement.
What is the ‘rebate derived payment’?
From 1997 to 2002 there was no contracted out deduction, even though people paid lower National Insurance if they were in a contracted out scheme. Therefore, the Government will take account of this by reducing the Foundation Amount further than just looking only at the Contracted Out Deduction, to reflect the number of years between 1997 and 2002 and the person was contracted out for.
Overall, this system will eventually be much clearer for future generations. At last the state pension system should better help people prepare for retirement better, however the ludicrous complexity of the current arrangements will continue to add complications for a number of years of transition. They will know that, once they reach state pension age (this age will increase in future, as life expectancy rises and it will be reviewed every five years) the state will pay them £144 a week (in today’s money terms) and that is all. If they want more than that, they will have to find the money somewhere, either from their own private savings, or from working longer, or from other sources. This gives clear incentives for people to save if they can without the fear that so many will be penalised by a Pension Credit means test.
These proposals are certainly not perfect and it is really regrettable that they only apply to future pensioners, but the framework of this new system is so much better than the current unsustainable mess, and they will leave us with a much better state pension system in future. It is also regrettable that the terms of the new pension will be much less generous than originally proposed and that it will not start until 2017.
The legislation will have to go through Parliament in coming months and we will see if there are any changes along the way. But overall, the UK should end up with a much better state pension system in future.