The Government is consulting on its intention to simplify the State pension system by one of two means:
a)bringing forward the date that the (currently earnings-related in part) State Second Pension (S2P) becomes flat-rate or
b) combining the Basic State Pension (BSP) and S2P into a flat-rate state pension of about £140 per week in today’s prices, above the level of means-tested Pension Credit.
Option (a) would still leave two elements to the State pension, possibly increasing at different rates, so is not as simple as option (b). However, option (a) would also allow the continuation of contracting out (of S2P) through defined benefit pension schemes. It is intended that the reform will not increase public spending on State pensions in any year.
Option (a)
Under current legislation S2P will become flat-rate in the early 2030s, at which point it will provide £1.60 per week for each year that NI contributions have been paid. Option (a) aims to bring forward the time S2P becomes flat-rate, to 2020. A 30-year NI contribution record will give rise to S2P of 30 x £1.60 = £48 per week. Those who have been contracted-out of S2P will receive part of this from their contracted-out pension arrangement rather than from the State (as under the current system). A longer contribution record will give rise to more S2P but not to more Basic State Pension, since the full BSP is paid to all who have a 30-year NI contribution record.
Basic State Pension would be increased in payment each year in line with the “triple guarantee” introduced last year by the Coalition Government: by the highest of the increase in the RPI, the increase in National Average Earnings and 2.5%. S2P would be increased in line with the increase in the CPI, meaning that over time it would become less valuable as a proportion of salary at retirement and as a proportion of the overall State pension. The self-employed would, as now, not be eligible for S2P.
It would be possible to bring the self-employed into the scope of S2P, and to harmonise the rates of increase in the two elements of State pension. However, this would have to be paid for by reducing the rate of S2P in order to achieve the Government’s objective of cost-neutrality.
It would continue to be possible to contract out of S2P and the levels of NI rebate would be reviewed to reflect the cost of S2P being given up.
Option (b)
Option (b) would combine the BSP and S2P as a single flat-rate pension for future pensioners, probably from 2016. The combined pension would be increased each year in line with the “triple guarantee”. Individuals’ NI contribution records will still determine their eligibility for the State pension. As is currently the case, a full State pension would be paid if 30 qualifying years of NI contributions have been made, with a minimum NI payment record of seven years. Moreover, both the employed and self-employed would be eligible.
Inevitably, there will be winners as well as losers. The latter include those with a full NI record, who currently receive a combined Basic State Pension and S2P of around £200 per week. However, there may be a transition period during which these additional years of NI contributions are recognized by an addition to the flat-rate pension.
Those who have been contracted out of S2P would receive less from the State, with the balance coming from their contracted-out pension arrangement. The Government estimates that about 50% of people will have an offset to their flat-rate pension by 2050 to reflect periods of contracted-out service. Since S2P will cease to exist, contracting out will no longer be available for the future, so all individuals and their employers will have to pay the full rate of NI contributions. This would mean additional costs of 1.4% of earnings between £5,304 and £40,040 for members of defined benefit schemes and 3.4% of the same band of earnings for their employers. Employers could, of course, amend the benefit structure of their schemes in recognition of the additional State pension that members would receive but there is no straightforward method of adjustment that would reflect each member’s individual situation.
The Chancellor announced also that the Government is looking into making future increases in State Pension Age automatic, based either on a pre-determined formula or on periodic independent reviews of longevity.