Recent Pension Reform Proposals
by Dr. Ros Altmann
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There has been so much news on pensions recently that I thought it might be helpful to give a little round-up of what has happened in the past few weeks.
Reforms of both private and state pensions have been proposed, as well as public sector pensions.
Pensions tax relief:
The Government plans to change the pensions tax relief limits. For top earners, instead of the hugely complex limits that had been imposed, the Government is proposing to limit pension contributions to £50,000 a year and this would attract full tax relief (even at the new top 50 per cent rate apparently); the lifetime limit on total accumulated pension funds is being cut to £1.5million (it is currently £1.8million), but those who have already passed the limit should be protected. These are still generous limits and top rate tax relief is an extremely attractive pension savings incentive.
The Government is proposing abolishing the requirement that everyone must buy an annuity with their pension funds by age 75. For the moment, the age limit has been raised to 77, to allow time for new legislation to be enacted, so anyone reaching age 75 now does not have to buy an annuity. In the meantime the Government has proposed that people will be able to take money out of their pension fund as long as they have sufficient pension income to avoid falling back onto means-tested benefits in later life. These proposed measures would only really benefit the very wealthiest pension savers, but I am hoping that the Government will abolish the mandatory annuity requirement for everyone.
Pension provision has fallen sharply in recent years. Company pension schemes have continued to close, with large deficits and replacement money purchase schemes are much less generous. The Government wants to increase pension coverage so, by 2017, all workers earning over about £7500 a year will have to be automatically enrolled into an employer pension scheme. Employers will have to contribute at least 3% of salary, if the worker is willing to put in 4%.
For those employers who do not want to choose a pension provider, the Government is proceeding with the introduction of the National Employment Savings Trust (NEST), which will be a national basic pension scheme that will cater for all employers. It will charge a relatively high 2% initial charge in the early years, but its annual charges will aim to be just 0.3% a year, which is much lower than most other schemes.
I am very concerned that this scheme may not be suitable for all those automatically enrolled into it and am also fearful that many employers, who currently contribute far more than the 3% minimum (the average employer contribution is over 6%) will cut back to the lower official level, leaving many workers with a worse pension than they would otherwise have had.
Public Sector Pensions:
The Government has asked Lord Hutton to carry out a detailed review of the affordability and sustainability of public sector pensions. He recently released his interim report, which concluded that reform was required because the unfunded public sector pension schemes are too much of a drain on taxpayers. It looks likely that he will recommend an end to final salary schemes in the public sector, as he says that these schemes are ‘inherently unfair’. He may suggest moving to a career average scheme, rather than final salary, which will be less beneficial for high flyers, but which will also be less costly than current final salary arrangements.
He also points out that he believes public sector workers have not paid enough into their schemes, with taxpayers bearing an unfair share of the burden of costs. He is likely to recommend increased contributions for public sector pensions, although he may decide that lowest paid workers should not be asked to contribute more.
The Government is proposing that all future inflation-linked increases to pensions in payment should be in line with rises in the consumer prices index (cpi), instead of the retail prices index (rpi). The justification for this is that the Government considers cpi is a more accurate measure of the inflation rates faced by pensioners, because cpi excludes housing costs such as mortgage interest, which are a major cost element for younger workers, whereas most pensioners have already repaid their mortgages. This justification is not entirely correct, since many pensioners do still have mortgages and the cpi calculation does not properly reflect pensioner spending patterns at all. In reality, this move to cpi is really mostly an effort to save costs, with estimates suggesting that the cpi is so much lower than rpi that the impact on pensions would be to reduce their generosity by between 10 and 15% over a typical retirement. Thus, pensioner incomes could be reduced by quite a substantial amount as a result of this change.
There have been three significant reform proposals for State Pensions, and there are likely to be more still to come.
Basic State Pension to rise faster:
Firstly, the value of the Basic State Pension will rise faster than previously promised, with a ‘triple lock’ guarantee that it will increase by either consumer prices, retail prices, earnings or 2.5%, whichever is the highest each year. This only applies to the Basic State Pension, but additional State Pension entitlements, from Second State Pension – S2P, State Earnings Related Pension – SERPS, and Graduated Pension, will increase in line with cpi.
£140 a week flat-rate pension?:
Secondly, there are rumours of a radical shake up of state pensions, with everyone who has a full National Insurance record being paid at least £140 a week as a flat rate pension. The Basic State Pension and Second State Pension (including SERPS or Graduated Pensions) would be rolled into one payment, anyone entitled to more than £140 would still receive their higher payments, but anyone who would otherwise receive less actually will be increased to this level. This sounds like a fantastic reform, although unfortunately it leaves out existing pensioners due to the problems of the budget deficit. If only it had been done many years ago when the public finances were stronger, our pension crisis could have been averted. However, at least for people reaching pension age in future, there would no longer be mass means-testing in the State pension system and their private pension savings would be theirs to keep, without being penalised by means-testing of Pension Credit.
State Pension Age increases:
Finally, the State Pension Age will rise to 66 for everyone by 2020. Women’s state pension age is already rising from 60 and was due to reach 65 by 2020. That timetable has been in place for years and women have adjusted their plans accordingly. However, suddenly, the same group of women who have already had to change their retirement plans to accommodate one lot of changes, are finding their state pension date changed with very little notice. This will cause significant problems and needs to be reconsidered. It is very unfair to hit the same group of women twice. The idea of equalising men and women’s pension ages makes sense, however the change is being introduced too quickly and very unfairly, with a disproportionate effect on hundreds of thousands of women. Their pension age is being increased, for the second time in recent years, and they do not have enough time to prepare. Having already adjusted to the idea that their pension age would be rising from 60, some women are suddenly being told that in about seven years’ time their pension age will actually rise to 66 instead. For example, a women who will be 63 on 4th April 2016 will retire at 63, but a woman who reaches age 63 on 6th April 2017 will not be able to receive her state pension until age 66!