A single-tier pension: what does it really mean? - The Institute For ...

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Executive Summary A significant reform of the UK’s state pension system is currently being enacted. From 2016–17, the basic state pension and state second pension will be replaced by a new single-tier pension for everyone below the state pension age (SPA). This will bring an end to earnings-related state pension accrual in the UK. This marks the latest step on a long, tortuous and rather circular journey – a journey that started in the early 1970s with a basic state pension worth about £145 a week (in current earnings terms) and that has finally ended up in much the same place. The major difference between the 1974 system and the proposed new system is that the new system will be essentially universal, with considerably more extensive crediting of unpaid activities than was available in 1974. Short-run effect of the proposed reform We have been able to use a unique data set combining lifetime National Insurance contribution histories with detailed micro data from the English Longitudinal Study of Ageing to look at who will benefit from these reforms among the first generations of those reaching SPA from 2016. Of those living in England who will hit state pension age between 6 April 2016 and 5 April 2020, we estimate that: • 18% of individuals (6% of men and 44% of women) would gain from the retrospective crediting of activities that, at the time, only gave entitlement to the basic state pension or to a low level of SERPS. This includes periods of self-employment, and periods of caring activities, childcare or low earnings before 2002. • Overall, 35% of men and 61% of women (43% of individuals) would see their pension income at SPA increased as a result of the proposed reform. Many of these individuals will be benefiting from the ability to ‘work off’ previous periods of contracting out. • 19% of individuals (21% of men and 14% of women) will find that the income they can expect at the state pension age under the proposed system is lower than they could have achieved under the current system. • The average change in pension income at SPA across all individuals is an increase of £2.74; 7% of men and 26% of women would see an increase of at least £10 per week. • Gains are largest among those who have spent periods out of the labour market caring for children and those who have had long periods of selfemployment. The average gain among women is £5.23 per week; the average gain among those who have had more than 10 years in self-employment is £7.51 per week. • Taking into account the more generous indexation of the state pension in retirement under the proposed system, 98% of individuals would benefit 1 © Institute for Fiscal Studies
A single-tier pension: what does it really mean? from the proposed reform over the whole of their life beyond SPA. Only 2% would lose; this is confined to those with fewer than 10 years of contributions and those who lose out from the abolition of derived pensions based on a partner’s contribution record. • However, some gains in state pension income will be offset by reductions in means-tested benefit entitlements, including those arising from the abolition of the pension credit savings credit. While 64% of individuals in the lowest wealth quintile would receive higher pension income as a result of the reforms, only 40% of them would find that their household’s net income would be higher after taking into account reductions in means-tested pension credit. Long-run effect of the proposed reforms In the longer term, the new system will be less generous to just about everyone than the system that it is replacing. This certainly includes anyone born in 1986 or later and potentially includes cohorts born as early as 1966. That is because the accrual rate will be lower than the combined accrual rate of the basic state pension and state second pension, and because almost all the same activities create entitlement under the current regime as under the new one. Particularly worse off are those who contribute for longer, whether through paid employment, caring or receiving disability-related benefits. Although the more generous indexation arrangements under the proposed system would narrow the gap between income under the current and the proposed system through retirement, most people would have to live to over 100 to be better off overall. The only significant exceptions will be the long-term self-employed and people who will start to receive credits to the basic state pension (but not the state second pension) under universal credit. However, it remains to be seen whether the self-employed will be asked to pay higher National Insurance contributions, which could offset this gain. Wider implications of the proposed reforms The proposed reform may encourage private saving for three reasons. First, it will result in a reduction in the state pension income most younger individuals can expect, and therefore they may wish to increase their private saving to compensate for this. Second, the reform should also increase clarity about what individuals can expect to get from the state in retirement. This could lead to an increase in private saving either if it enables individuals to better engage with decisions about pension saving or if it makes individuals more aware of how little they can expect from the state. The new system will be cheaper and simpler than the system it is replacing. The Department for Work and Pensions estimates that the new single-tier pension 2
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7. Conclusions Pensions Bill 2013-1
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References Attanasio, O. and Rohwed
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