Simplified state pension reform reveals challenges of providing adequate retirement income

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The Department for Work and Pensions has recently published its White [aper on reform of the state pension. The key changes, following an announcement in the Budget, will commence in April 2016:

  • There will be a single Tier state pension set at £144 a week in today's money – this will be uprated over time.
  • This will replace the current basic state pension of £107 and the various “top-ups” which individuals can qualify for.
  • An individual will need 35 years of qualifying contributions, up from the current 30.
  • Anyone with less than 10 years of contributions will not receive a pension.
  • Pension credit and “contracting-out” will be abolished.

The aim of state pension reform is to provide clarity and allow individuals to know what they will receive in retirement.

This, in turn, it is hoped will drive greater private saving as it is clear that the state pension will not provide a generous income in retirement.

When the proposal was modelled by the DWP, it became clear that the numbers who would qualify for the single Tier would be significantly less than Government intended. By 2060, only just over 60% of the population would qualify the new single Tier state pension without further change. The DWP has therefore sought to speed up this transition in a number of ways, all basically intended to draw in as many people as possible.

The self-employed, for example, will be fully brought into the new system. This means that they will in effect be credited for the past years where they paid only a very small NI contribution. Some will therefore be significant winners.Similarly, for those in public sector schemes, who have paid a lower NI contribution as a result of having been contracted out, they too will in effect be credited for the years when their contributions were lower.

The result of these changes is that by 2050, 90% of pensioners will receive the full single tier pension, but some will have paid less in contributions than would otherwise be required.

The ending of contracting out will have a significant impact for employers who have or at some point had a Defined Benefit pension scheme. Any employee who was at one time enrolled in a DB scheme will have contracted out of the second state pension, which was at one time known as SERPS. These employees will have then paid a reduced NI contribution, as will have their employers.

With the abolition of the second state pension, there will no longer be anything to contract out of and these employers and employees will now have to pay the full applicable national insurance contributions. This will mean an increase in the NI contribution of employers of 3.4% of relevant earnings.

For contracted out employees, they will be fully brought back in to the state system and pay the full NI contribution, which is an increase of 1.4% of relevant earnings.

Clearly, these are significant amounts. Government wishes to ensure that amounts built up in schemes until the point that the new single tier pensions implemented continue to be paid, but also ensure that the future of the remaining DB schemes is not undermined.

Government has announced that there will be a statutory exemption or override for affected employers that would allow them to offset the cost of the additional NI contributions by reducing future pension benefits or increasing employee contribution rates. These changes would necessitate a change to pension scheme rules, which in some cases will require the consent of the trustees.

The Government therefore proposed to give employers limited powers to change scheme rules for these purposes without trustee consent but after consulting with scheme members.

This is a significant concession to employers, but is intended to allow employers to still have DB schemes to continue to support them.

On the whole, the changes represent a significant simplification of the current state pension, but also highlight the challenges of providing an adequate retirement income.

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Media Team 020 7654 1576

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