The rainy day cometh

Before the turn of the 20th century, the safety net in old age was the family. Failing that, the last option was to ‘go on the parish’: a very uncertain form of local charity. In 1908, a limited type of provision was introduced, but it wasn’t until 1946 and the Beverage Report that the British state first offered a universal pension scheme designed to lift ?all pensioners out of poverty.

Since that initial post-war sea change, every successive government has had the unenviable task of attempting to balance the needs of the population and the Treasury. The result is a multi-layered system of breathtaking complexity. Very few people truly understand all of its interlocking aspects.

Now, however, with some fanfare, the government has announced details of the latest attempt to address this troublesome subject. It is arguably the most significant change in a long while because the intention is more than just tinkering with amounts and definitions; instead, it aims to cut through historical structures and establish a new, simple, single-tier national/state pension. From 2017, the pension will be £144 a week (in today’s money) for those with 35 years’ National Insurance (NI) contributions; those with fewer years will receive less. If you have already got over about £144 a week in today’s money, you can keep what you have already built up.

How does this compare with the current ?situation? Well the first thing is that, as highlighted above, a simpler system would be a big advantage ?over the current arrangement, in which people ?receive different amounts depending on their employment history, scheme membership, NI ?record and various other factors.

What about the actual amounts? As it stands, the state pension consists of four parts: the basic state pension (up to £107.45 a week) and three earnings-related pensions (graduated pension, state earnings-related pension scheme and state second pension), which can add another £120 a week. In addition, to protect the poorest, the government guarantees all pensioners a minimum income of £142.70 a week (the means-tested pension credit), regardless of other circumstances.

Winners and losers

The situation is still far from clear and the small print will make interesting reading. We do know that the new arrangement is slated to start in 2017, so anyone who reaches pension age before then won’t be affected. For everyone else, it is worth noting that the government said the changes will be ‘cost neutral’. This means there will be both winners and losers.

The most obvious losers are those (mainly private sector) workers who will no longer accrue in the earnings-related scheme, which was always considered the ‘top-up’ to the basic pension. A person on average earnings could have expected around £200 a week, so the drop to £144 is significant.

On the surface, people whose state pension is currently less than £144 a week will be obvious winners (typically part-time workers, the long-term unemployed and the disabled). However, many of these won’t have a 35-year NI record, so they won’t receive any extra. This particularly affects those who have stayed at home to look after children or elderly parents. The current rules mean many carers can be credited with extra NI years, but this wasn’t the case historically.

Similarly, it is worth noting that the very poorest, that is those with no savings, or private or occupational pensions, would only gain £1.30 per week because the government’s pension credit already guarantees a minimum pension income of £142.70.

The self-employed look set to be winners. They don’t take part in the three earnings-related schemes and only receive the basic state pension (a maximum of £107.45 per week). The new single-tier plan will therefore give them an extra £36.55 per week or £1,900 a year. To be ‘cost neutral’, we can expect to see increases in the self-employed NI rates.

Many final salary scheme members (including around five million in the public sector) will also be winners for similar reasons: currently they pay less NI and receive just the £107.45 pension, not the additional earnings-related schemes. They will be upgraded to the new £144 as well. However, what’s given with one hand will soon be taken with the other: the ‘contracting out’ arrangement giving the lower NI rate is ending, so take-home pay during working life will take a slight hit. For example, a nurse earning £25,000 will see take-home pay reduced by circa £20 a month.

As an aside, the end of the ‘contracting out’ system will mean higher costs for employers who run final salary schemes. Last year saw record rates for closures and, except for politically protected public sector schemes, this extra blow may well be the final nail in the coffin for final salary schemes.

Long-term strategy

While the single-tier pension will be of benefit to many, it’s clear that the opposite is true for others. It is unlikely to be a coincidence that government is introducing this change at the same time as ‘auto-enrolment’ is placing all workers into (almost compulsory) occupational pension schemes. It could be argued that these changes are a strategy to transfer some of the future pension costs of UK retirement from the state and onto employees and employers – effectively a hidden tax rise. Although that strategy might sound cynical and unwelcome, it is worth reflecting on the pressures that underlie it: the magnitude of the UK’s retirement problem.

The state pension was originally seen as no more than a safety net, not an end in itself. Even so, the failure of a wider UK savings culture has meant ?ever-upwards pressure. With the various earnings-related elements, the maximum payment is now as high as £13,250 a year, which for many is almost ?a salary replacement. The burden on the state, ?however, is enormous and increasing. It’s no surprise that a time of national economic pressure has prompted a revised approach.

With the move to just £144 per week, relying solely on the state pension will mean retiring in poverty if at all. The only answer – and it’s an unpalatable truth – is that it’s now more vital than ever to make personal provisions, even if it means making sacrifices. The new auto-enrolment ?pensions will, for the first time, force most people along that road. It’s a good start, but it’s likely that most people will nevertheless need to be encouraged to do more.

In addition to finding the money, the key barriers to pension savings are typically inertia and complexity. As financial advisers, we can go some way to help with the first point. For the latter, it should be our professional duty to help dispel the myths and explain the benefits, wherever and whenever possible.