What’s wrong with the White Paper?
by Dr. Ros Altmann
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The Government’s pension reform proposals will be going through Parliament next session. Unfortunately, they will not deliver a sustainable pension system in future, nor indeed will they help today’s pensioners. These are not the radical reforms required and will still leave us with the most complex state pension in the world, providing woefully inadequate pensioner incomes.
There are two fundamental problems which must be addressed. Firstly, the state pension is too low and secondly the state system undermines private provision, so the whole system is unstable.
The state pension comprises the Basic State Pension (BSP) around £84 per week and the earnings-related second state pension (S2P) that is more generous to lower earners and has different contribution criteria from BSP. These two can be supplemented by claiming means-tested Pension Credit to ensure a weekly income of at least £114. Since 1980, the BSP has been uprated only in line with prices, not earnings, and has become increasingly inadequate to avoid pensioner poverty, thus leaving nearly half of pensioners needing means-tested benefits. The White Paper proposes re-linking BSP to earnings, but not until 2012 at the earliest by which time it will have fallen further from today’s already inadequate level and it will not be back to today’s level before 2020. If the earnings link had remained since 1980 BSP would now be around £136. Although Government claims the state pension will be more generous after the reforms, the overall picture is mixed. Higher BSP is offset by rising state pension age, by cuts in the generosity of S2P and (from 2008) Pension Credit savings credit will become less generous too.
Without the white paper reforms, in future around 80% of pensioners would need means-tested Pension Credit, but even after the reforms, the proportion will still be 40-50%. This over-reliance on mass means-testing in the state pension system (which also does not lift all pensioners out of poverty due to low take-up) penalises private sources of income and is, therefore, a disincentive to save. Those claiming pension credit lose at least 40% of their private pension income and some lose all of it in the means test, so they are little or no better off for having saved. Until the state pension is raised to a decent basic level, without means-testing, private pensions cannot be put on a stable sustainable footing.
So, if the state pension reforms are not as good as they could be, what about the White Paper proposals for improving private pension savings? The Government proposes automatically enrolling all workers into a nationwide system of personal pension accounts. They will contribute 4% of salary, with employers compelled to contribute 3% plus 1% added by tax relief, giving overall contributions around 8% of salary, but individuals can opt out if they wish.
This proposal is, in my view, dangerous. In fact, these personal accounts could damage private pension provision as a whole. Almost all employers who contribute to private pensions currently pay more than 3% of salary, and are bound to be tempted to cut back to this level. 8% of salary is unlikely to provide decent pensions, but people will think this Government ‘approved’ level will be enough. Also, those most likely to opt out are the ones who currently have no pension, so they will still have no provision, while existing pension schemes could worsen. Finally, unless pension credit penalties are removed, the potential for compensation claims against future Governments is significant. Many of those at whom these personal pension accounts are aimed, should not actually contribute but should probably save elsewhere, or pay back debts. The problem with pensions is that the money is locked in and cannot be taken out, even if pension credit is going to take all the pension away. The proposed auto-enrolment system will not have individual advice – in order to keep the charges as low as possible – so people could be put into a scheme that is not suitable for them, no-one will advise them and they may not find out this was unsuitable until it is too late.
A universal resident’s pension paid at the pension credit level of £114 per week, or even higher, without means testing could overcome most of the problems. Government says this is ‘unaffordable’ but that is not true. We spend billions of pounds on pensions each year which could be redeployed to provide a truly simple and fair system, which everyone could understand and upon which they could confidently build to provide additional income for themselves in future. For example, ending contracting out would free up over £10billion a year, with billions more from ending higher rate tax relief. A great opportunity has been missed in the current reforms and far more radical change will be needed in future.