Pensions revolution won't help current pensioners

The government's proposal for a massive pensions shake-up is good in many ways, but it won't help anyone over the age of 61.

Earlier this month, the government published proposals for a massive pensions shake-up. The heart of the plan is that most pensioners will receive a flat State Pension of £140 a week. This will replace the current basic State Pension which pays £102.15 a week. This is a good idea in many ways. The trouble is, not everyone will benefit.

Now I should stress that these are just proposals at the moment and the government is now asking for feedback. In fact, the government has asked for feedback on two different proposals. The first proposal – known as 'Option 1' – is a fairly limited tweak of the current system whereas the second proposal – 'Option 2' – is much more radical.

Option 2 is the one that boosts the state pension to £140 a week and is the most likely to be implemented. So in this article, I’m going to focus on the more radical Option 2.

What happens now

Currently most pensioners receive the basic state pension which pays £102.15 a week. On top of that, many poorer pensioners claim Pension Credit which can take their income up to around £140 a week.

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Even if they don’t qualify for Pension Credit, some other pensioners get a higher income because they’re eligible for a State Second Pension. The Second Pension has allowed many people to get a higher pension in return for National Insurance contributions made through their working life.

Just to make things even more complicated, some people have ‘opted out’ of the State Second Pension (also known as SERPS) and, as a result, some of their National Insurance contributions have been paid to a private pension provider. The private provider can then pay out a higher pension during the person’s retirement.

The current system is complicated and also discourages prudent saving. That’s because a pensioner with a £20,000 savings pot won’t be eligible for Pension Credit whereas someone who hasn't saved at all can get Pension Credit.

The plan

The new proposal will make saving more attractive. If the proposal is implemented, most newly retired pensioners will receive £140 a week from 2015 onwards. (That’s in today’s money.) It won’t matter how much you have or haven’t saved, you’ll just get the £140. That will make things much simpler.

However, when you look at the State Second Pension, things are still quite complex. The aim is to eventually merge the Second Pension into the normal £140 state pension, but that process will take many years to complete.

Take a look at this example:

Barry is a 54-year old man who is planning to retire aged 66 in 2023. He has contributed a fair bit to the State Second Pension over the years and, under the current system, he can expect to receive around £70 a week in addition to his basic state pension. In total, he should get around £170 a week. Now if simplicity was the only thing that mattered, you’d just say, Barry gets £140 a week - like everyone else. However, that wouldn’t be fair, so Barry will still get his £170.

But things will change for younger folk. People at the beginning of their careers won’t be making any contributions to the Second Pension, so the Second Pension will eventually die. It’ll just take a long time.

Importantly, the new scheme will only affect people who become pensioners in 2015 or later.

Winners and losers

Let’s now look at some of the winners from Option 2:

I think the biggest winners will be people on modest incomes who nonetheless want to save for their retirement. If they save a small sum, they can keep their money when they retire and still receive £140 a week.

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The scheme is also good news for the self-employed. Currently the self-employed aren’t eligible for the State Second Pension, but they’ll get the full £140 under the new plan.

However, there are also some losers.

Firstly, there’s people who haven’t paid much National Insurance. To receive the full £140 pension, you need to have paid National Insurance for at least 30 years. If you’ve paid 20 years' worth of contributions, you’ll get around £92, but if you’ve only paid 5 years of contributions, you’ll get nothing! The minimum level is 7 years of contributions. So if you haven’t paid much National Insurance over your life, you’ll either have to rely on your own savings or claim means-tested benefits.

Secondly, members of private sector final salary schemes are even more likely to find that their final salary scheme is wound up sooner or later. That’s because many final salary schemes have been boosted by National Insurance contributions from ‘opted out’ employees. Now that ‘opt outs’ will no longer be possible, I suspect that some employers will decide that this is the final straw and close down final salary schemes.

The biggest losers will be current pensioners. People who are already receiving the State Pension aren’t going to get any benefit from these changes. I reckon this will create a lot of resentment amongst people who are pensioners now.

Some pensioners will wonder why they have to go through the indignity of claiming a means-tested benefit while younger folk just get the money with no questions asked. Others will be annoyed that they’re penalised for saving while younger people get to keep all the money they have saved for their retirement.

Overall, I support the proposed pensions shake-up, but I think the government needs to think carefully about how it can keep current pensioners relatively happy. Otherwise we’ll just get more resentment and bitterness between the generations.

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