State pensions are in a mess – radical reform urgently required
by Dr. Ros Altmann
(All material on this page is subject to copyright and must not be reproduced without the author’s permission.)
Dramatic interest rate cuts are part of the Government’s range of panic measures to save our banking system and engineer economic recovery. But policymakers seem oblivious to the dreadful impact this has on pensioners living on their savings. Nobody would recommend cutting state pensions as a way out of the crisis, but rate cuts have similar effects as they reduce savings income! Such ‘collateral damage’ is being ignored but maybe it could be offset somewhat by introducing proper state pension reform.
British pensioners are currently treated appallingly. Despite being one of the richest nations in the world, we have just about the lowest state pension. Moreover, it is so complex that nobody really understands it. Disgracefully, the latest state pension reform package does nothing for today’s pensioners and is little more than giving with one hand, while taking back with the other – a classic hallmark of this Government’s policies.
Let me try and explain the problem and suggest a solution.
At the moment, the state pension has three major parts, each of which has different rules, different qualification criteria and will have different reforms.
Firstly, the Basic State Pension, pays around £90 a week to those with a full contribution record (now 39 years for women and 44 years for men, soon changing to 30 years for everyone). This main plank of the state pension has fallen hugely in value since the Tories broke its link to earnings increases in 1980, tying its value only to prices. The Government plans to restore the earnings link between 2012 and 2015, by when the Basic Pension will be still lower than now. It will not even be back to today’s level by 2020.
Secondly, the State Second Pension (S2P, which used to be called SERPS) was originally earnings-related but has been constantly cut since its introduction in 1978. This is currently more generous to lower earners, but by 2030 it will become flat-rate and only tied to prices. Unlike any other country, we allow people to ‘contract out’ of this part of the state pension. Employers and employees can pay lower national insurance as long as their private pension scheme will replace the second state pension on retirement, supposedly saving costs for future taxpayers. Contracting-out has added unbelievable layers of complexity to our pension system. It also allows public sector workers to pay lower national insurance, even though future taxpayers will still have to pay their pensions anyway. Abolishing contracting out could save Government £6billion a year.
Thirdly, there is the means-tested Pension Credit. Anyone over 60 can get around £130 a week without any National Insurance record, as long as they have not bothered to save much and don’t keep working. This makes a mockery of our national insurance contribution system because the over 60’s can get at least £130 a week without ever paying national insurance but at most £90 Basic Pension with a full lifetime’s contributions!
Pension Credit was Gordon Brown’s ‘big idea’ for improving state pensions while controlling costs. Rather than increasing payments for all pensioners, he decided to ‘target’ spending on the poorest. This sounds good in theory, but is awful in practice. Nearly half of all pensioners are entitled to this horribly complex benefit, it costs a fortune in administration, while a million do not claim it and remain in poverty. It also entails dreadful disincentives. Any earnings over £5 a week and any private savings or pension are effectively taxed at between 40% and 100% by the Pension Credit means-test, so pensioners are penalised for saving or working part-time. Even more disgracefully, despite recent rate cuts, the Pension Credit calculation still assumes pensioners are earning 10% (yes, 10%!) interest on their savings, so many of them are wrongly denied pension credit payments.
The state pension reforms are a con-trick. They tinker with the current system, raise the pension age for everyone, but still retain mind-boggling complexity, contracting-out, unfairness to many women, huge administration costs and poverty. Basic State Pensions will be tied to earnings instead of prices, State Second Pensions tied to prices instead of earnings, and Pension Credit less generous. The stated aim is to increase state pension income to 30% of median earnings by 2050 (equivalent to around £135 a week in today’s terms). However, if the earnings link had been maintained since 1980, Basic State Pensions would now be above £140 a week. So even by 2050, the Government’s complex reforms will still leave pensioners worse off than 1980!
We could do so much better. When advising the Government on pensions policy, I recommended introducing a Basic Pension of around £140 per week, without means-testing, for all residents over age 75 – finally providing a fair, simple system that everyone could understand, ending means-testing penalties on savings, pensions or earnings and removing the need to force people to buy annuities.
At the time, I was told this is unaffordable. It was not true then and is not true now – especially in light of the billions that have been wasted on such things as cutting VAT which will not help our economy long-term at all! Just ending contracting-out would give enough money to pay £140 weekly state pension immediately.
With a rapidly ageing population, radical pension reform is essential. A simple Basic Pension, lifting the elderly out of poverty, recognising women in their own right, abandoning mass means-testing would move pensions into the 21st Century. I urge the Government offset the damaging effects of crisis interest rate cuts by radically reforming state pensions and finally treating pensioners with the dignity they deserve.