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Means to an end

The PPI has put forward a range of proposals to reduce means-testing of pensions

The measures put forward in the Pensions Commission report and Government White Paper have provoked differing reactions among the pension community but there is general agreement on one topic – the need to reduce reliance on means-testing. Directing resources to the poorest in society through a system of credits is better than spreading resources more thinly unless such a policy means that more people become dependent on means-testing over time.

The Pensions Commission said there should be less means-testing and that the core function of the state system should be to provide a generous flat-rate pension.

When a less generous state scheme is combined with means-testing, people have to save more to achieve an adequate retirement income but the perceived disincentive to save becomes more pronounced.

The Pensions Commission acknowledged that linking the state pension to prices meant that it was less simple, less generous and more reliant on means-testing than it would be if the system was linked to earnings. However, indexing the state pension in line with earnings will not be enough to get people off means-testing.

The Pensions Policy Institute, an independent research organisation, has just published a paper entitled Transition Trade-offs: Options for State Pension Reform, in which it recommends detailed reforms of the state pension and state second pension aimed at halting the growth of the means-tested pension credit.

It argues that indexing the state pension in line with earnings is the minimum needed to slow down the growth of means-testing.

Although the Pensions Commission’s proposals were more generous than just linking the state pension to earnings, they would not reduce the numbers of people eligible for pension credit from the current level of around 50 per cent. At the same time, many people would continue to doubt the value of personal saving.

The Pensions Commission proposals assumed incremental changes over time to the current complex system consisting of a state pension and state second pension. The danger with this approach is that, in 2030, well-off pensioners will gain more than the poorer pensioners.

The PPI suggests three different ways in which a simple single-tier state pension could be afforded within the same range of costs as the Pension Commission proposals, each giving a better result for the poorer pensioners.

The PPI’s alternatives would also reduce eligibility to pension credit to only 10 per cent of older people, which would overcome the current disincentive to make voluntary pension savings.

The three options are:

  • Increase the state pension to the guarantee credit level in 2010 (currently 114 a week for single persons and 87 a week for individuals) and stop accruals of the state second pension. The proportion eligible for pension credit would reduce to 10 per cent from 2010.
  • Increase the state pension at a faster rate than increases in earnings to reach the guarantee level by 2030 and stop accruals of the state second pension. The proportion eligible for pension credit would reduce to 10 per cent from 2030.
  • Replace accruals to the state pension and state second pension with accruals to a new pension at the guarantee credit level. The proportion eligible for pension credit would reduce to 25 per cent by 2050 and 10 per cent from 2060.

The Government’s pensions proposals have been a long time coming. If they are to be delayed by another few months to consider the PPI’s thinking, we would all benefit.

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