The road to change

Jonathon Howard takes a look at potential changes to the state pension.

As I read the government’s recent Green Paper entitled A State Pension for the 21st Century it occurred to me that there are people alive now who will be drawing their state pension well into the 22nd century.

What is needed, therefore, is a state pension for the 21st and 22nd centuries.

The government is trying to address the fact that UK pensions have become so bogged down in legislation, inequity and disincentives that the population has largely disengaged.

As far as state pensions go, most people just close their eyes and hope for the best.

According to DWP research, a staggering 71% of respondents felt that ‘sometimes pensions seem so complicated that [they] cannot really understand the best thing to do.

'This is hardly surprising when you consider that even the Department for Work and Pensions cannot always get its figures right'.

The interaction of state pensions and means-tested support is also a potential barrier to full public buy-in.

It has been well reported over the last year or two that, without a significant rethink, NEST could bring about the perverse reality that the worst off would begin replacing their means-tested benefits with personal contributions.

So, do the proposals contained in the Paper adequately address these concerns? The key proposal is that the existing two-tiered state pension should be scrapped, in favour of a single-tier universal payment equivalent to £140 per week in today’s money.

The Paper actually sets out two options, the other being to move the state second pension to a flat rate sooner than scheduled, but I do not believe the government has much appetite for the latter option, despite protestations to the contrary.

The £140 per week will be paid to anyone who has a National Insurance payment/credit record of at least 30 years, with increases backed by the triple guarantee.

The state pension age (SPA) will be formally linked to increases in longevity and payments will depend solely on your own record, without reference to your spouse’s.

Simpler structure

It is clear that moving to a single, flat rate pension will create a much simpler structure and the fact that individuals will earn their own, distinct entitlement means that some of the former inequity will be removed.

The fact that the minimum level has been set above the threshold for pension credit also means that those swept into NEST will not have to worry about losing their benefits. So far, so good.

I also agree that the SPA must be aligned to longevity if the plan is to stand the test of time.

A startling statistic contained in the Green Paper is that it took from 1920 until 1990 for the average life-expectancy in the UK to increase by five years, but it has increased by another five years between 1990 and 2010.

This is a massive acceleration which would give the government of tomorrow a colossal problem if they do not establish a mechanism for increasing the SPA according to future trends.

But as with all well-meaning proposals, there are inevitably some issues. While the new structure is simple to understand, the government wants to honour all existing rights and is planning to make allowances for those who have previously contracted out.

While understandable, if these proposals go ahead there will be a multi-layered state pension for perhaps the next 100 years as all of the quirks work their way through the system.

I seem to remember the A-Day changes were nice and neat until all the various interested parties added their caveats.

It is clear that whatever path the government takes, this is a zero-sum game as far as funding is concerned.

Any increases to benefits will be paid for by a combination of efficiency-savings, a minimum qualification period of seven years and a gradual increase in the SPA.

The efficiency savings are not contentious, and I think the public will just have to accept a rising SPA on the understanding that the trade off is a longer life.

The qualification period of seven years is less fair, but this is clearly the only way the sums balance.

I think that the proposals are therefore reasonable enough and ironically will pave the way for a sustainable state pension for the 22nd century. It is the 21st century that worries me.

Jonathon Howard is head of corporate clients at Courtiers Investment Services