The long-awaited consultation on state pension reform finally appeared in early April. This paper offers two options but which one is best?
Option one accelerates what is happening to the state second pension anyway.
For lower-earners, there is currently a higher accrual rate of 40 per cent based on assumed earnings of £14,400, as long as you earn at least £5,304. Rules made in 2007 freeze the upper accrual point at £40,000, above which S2P accruals stop. Inflation will gradually eat this figure away. The bottom limit might catch up with this upper point by about 2030, after which S2P would become flat rate.
The new option one suggests accelerating this process by cutting the £40,000 so that it equals the £14,400 by 2020.
This does not feel part-icularly radical and we are still left with all of the legacy Serps and S2P earned up until 2020. That will not disappear out of the system until after 2070.
The thought of living with LEL, LET, UET, UAP, UEL and a host of other unnecessary acronyms for the rest of my life does not fill me with joy. The average UK citizen has no idea how this stuff works and is one of the reasons why they switch off at the mere mention of the p-word.
Option two proposes paying one flat-rate pension, combining the basic state pension and S2P, from the date of introduction. In today’s money, the rate would be around £140 a week.
People who had already built up more than £140 in state pensions would have their entitlement protected and people who had been contracted out would face a deduction from the £140, at roughly £1 a week for every year they were contracted out.
This choice looks like a no-brainer but there is a fly in the ointment. Contracting out for defined-benefit schemes would cease, meaning about eight million workers, mostly in the public sector, would have to pay higher National Insurance contributions.
Their DB schemes, no longer partially funded with NIC rebates would also require a haircut. Think 60ths falling to 80ths and 80ths to 100ths.
Sympathy may be in short supply but option two, with its 1.6 per cent tax rise and cut in accrual rate, will meet with much resistance as it follows hot on the Hutton heels of a move to career average and a 3 per cent contribution rise.
Labour relations will require strong but fair management but the prize of a single, simple state pension is worth the difficulty of the journey.
If option two does go ahead, advisers will have a simple message to convey, every £1 you save is yours and if you do not save, all you will get is £140. It does not get much simpler than that.
John Lawson is head of pensions policy at Standard Life