The move to a fixed state pension provides a welcome simplification, but the overall long-term effect is not generous
The government yesterday unveiled its plans to radically overhaul the state pension, which have been welcomed by some and criticised by others. On the one hand, the proposed system would be a welcome simplification relative to the current complex miscellany of rules, and would give individuals much greater clarity over what state pension income they could expect in retirement. Anyone with 35 years of qualifying activities would receive a fixed pension of £144 a week. Employment, seeking work, looking after young children and caring for sick or disabled adults would all count as equally creditable activities.
On the other hand, there will be many people who will get a lower state pension income as a result of these changes, so we should be careful not to overstate the benefits.
The one group of significant winners from yesterday’s proposals is those who have long periods in self-employment. Those who spend their whole working lives in self-employment could earn up to £144 a week of state pension, compared with only just over £107 under the current system. However, extending pension entitlement in this way would weaken the case for the self-employed paying lower national insurance contributions than employees; therefore, the government may decide to offset this benefit by demanding higher NI payments from them.
Anyone reaching state pension age before 2017 will be entirely unaffected by the proposed changes. Among those reaching state pension age shortly after 2017, there will be some winners, in addition to the self-employed. In particular, those who have 30 years of contributions to the basic state pension, but who are entitled to a total state pension (including the state second pension) of less than £144 per week could see their final pension income increased. This group will include some low earners and people who took time out of the labour market to care for young children or disabled adults prior to 2002. But this group will also include those who contracted out of the second tier state pension – that is, they chose to give up their rights to the state second pension in return for lower national insurance contributions (or a refund of NI contributions). This latter group will, on average, consist of higher earners.
The size of this group of winners will, however, decline rapidly over time. As a result of reforms implemented in 2002, the range of activities credited towards both tiers of the current state pension system (which includes those in employment, job seeking and looking after young children or disabled adults) is almost as broad as under the proposed system. This means that anyone carrying out one of these activities at the moment not only earns entitlement towards the basic state pension (which is worth a maximum of £107.45 per week) but will also be earning an extra entitlement on top from the state second pension.
Taken together, these will provide many people who are currently working or caring with more than the £144 a week promised by the new pension system. In fact, anyone who has spent more than 30 years in creditable activities since 2002 – which is anyone born in 1986 or later and, arguably, those born from around 1970 onwards – would be financially better off under the current system.
Overall, the proposed system is a welcome simplification. It is important to be clear though that, in the long run, the proposed changes would in fact reduce state pension income for almost everyone (the exception being the self-employed); a fact that was far from clear in the government’s rhetoric yesterday. Of course, this reduction in generosity will have the advantage of increasing the long-run sustainability of the public finances.