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Throwing light on the costs of state pensions

We have seen a large number of papers and proposals that will affect pensions over the coming years. These include a new priority order on winding up defined-benefit schemes to provide extra protection for long-serving members.

There are proposals to simplify contracted-out schemes and bring annual savings to employers of up to £16m by allowing them to convert guaranteed minimum pensions to “normal” scheme benefits, provided they are equivalent in actuarial terms.

The publication that is probably the most important is one that has received little comment but which will underpin pensions for many years – the Government Actuary&#39s quinquennial review of the National Insurance Fund. This estimates NI contribution rates in future years (up to 2060/61) to meet the cost of the pay-as-you-go state benefits.

One of the aspects of state pensions of great concern is how they are uprated – should it be linked to changes in retail prices or to the growth in national earnings? The review throws light on the relative costs of these options.

But first, the review gives some interesting statistics. The number of people over pension age is projected to increase by about 40 per cent from 10.6 million in 2001 to 14.8 million in 2060 while the number of people of working age is projected to remain around today&#39s level.

NI contributions of today&#39s workers pay the cost of today&#39s pensions so the number of workers to pensioners is a key factor in the financing of state pensions. The review shows that the pensioner support ratio – the ratio of the number of people at working ages to those over pension age is projected to fall from 3.3 in 2001 to 2.7 in 2030 and 2.4 in 2060.

The projected expenditure from the National Insurance Fund, including the cost of paying out contracted-out rebates in NI contributions and administration as a percentage of gross domestic product is 6.2 per cent, reducing to 5.9 per cent in 2030 and 5.4 per cent in 2060. This assumes real growth in earnings of 1.5 per cent a year and that flat-rate benefit rates and earnings&#39 limits for contributions are uprated in line with prices.

However, if uprating is in line with growth in earnings rather than prices, projected expenditure would increase to 7.9 per cent in 2030 and to 8.9 per cent in 2060.

The projections of NI contributions are interesting. Class 1 NI contribution rates (emp-loyer and employee) required to balance income and expenditure, excluding the contributions allocated to the NHS are shown in Table A at the bottom of the page.

Current Government pol-icy is to increase the basic state pension each year by the greater of the increase in prices or 2.5 per cent.

If this continues and real growth is 2 per cent a year, the class 1 NI rate in 2060/61 would increase to around 16 to 17 per cent.

There are many calls for improvements to state pensions especially the uprating of pensions in line with earnings. However, the costs are instructive as shown in Table B below

Should flat-rate benefits be increased in line with the growth in earnings rather than prices? The information provided in the

Quinquennial Review illustrates the significant costs to governments and taxpayers in paying for the former and the inevitability of going for the cheaper option.

Of course, the cheaper option for state benefits means the individual taxpayer rather than the state has to make up for the income

shortfall during retirement through private means.

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