If there is one issue in pensions that the Government wishes would just go away, it must be means-testing.
The Government would love to be able to say, hand on heart, that anyone saving for retirement will definitely gain from it. Such a message would also be very welcome for everyone involved in selling or advising on pensions. Unfortunately, we are quite a long way from it.
Means-testing is a thorny issue for any adviser giving guidance to someone relatively late in their career who has little or no pension provision, with the spectre of misselling hanging over an adviser who gets it wrong.
Under the pension credit, what means-testing involves for most people is that they could potentially lose up to 40p of means-tested income for every £1 of personal income they have managed to accumulate. It currently affects individuals with incomes of up to about £159 a week. A 40 per cent reduction in means-tested benefit is unwelcome, especially since most will only have received 22 per cent tax relief, but arguably the difference in living standards justifies saving.
The real problem is with people who are not entitled to the full basic state pension and also have no state second pension entitlement. For them, some or all of the income from their savings will result in a pound-for-pound reduction in pension credit. In other words, they get absolutely nothing extra from their savings.
The Government is trying to tackle the means-testing issue through its reforms, which will ultimately lead to the Pensions Act 2007. It is making it much easier for those who spend time out of the workforce caring for others to qualify for the full basic state pension.
For example, the full basic state pension will be available to those with at least 30 years of National Insurance contributions or credits compared with the current 39 years for women and 44 years for men. The Government is also indexing the basic state pension to earnings – probably from 2012 – which will stop the gap between the basic state pension and the guaranteed income under pension credit from growing further. Changing to a flat-rate S2P will mean that most employees will end up with an income that takes them well clear of means-testing.
However, there is one group whose position will be worse following the changes. This is the self-employed, particularly those on low incomes. As they have no access to S2P, the means-testing trap will become even more of an issue than it is now.
The reason for this is a technical change to the savings credit, which is the part of the system that gives the extra 60p total income for every £1 of savings. At present, the savings credit applies to all income on top of the basic state pension, which is £84.25 a week for a single person. From April 2008, there will be a gap between the basic state pension and the point at which savings credit kicks in and that gap will grow over time. What this means is that for anyone who is not entitled to S2P, there will be a portion of their personal income on which they will lose means-tested benefit pound for pound.
Scottish Widows recently published a report with the Equal Opportunities Commission where we examined how different women might fare following pension reform and one of the case studies showed how dramatic the means-testing effect could be.
Maya is a low-earning self-employed woman – perhaps a childminder or hairdresser – who pays 5 per cent of her band earnings into a personal account from age 22 until she retires at 65. She pays in the same amount as an employed person would but without any employer contribution. Based on modelling by the Pensions Policy Institute, Maya might have a personal account income of £23 a week in today’s terms at her state pension age of 68 but she could lose £23 of means-tested pension, meaning she receives nothing from a lifetime of saving.
Minister for pension reform James Purnell attended the launch of our report and is acutely aware of this issue but resolving it is very difficult. One option might be to increase the trivial commutation limit so people like Maya have the option of taking their pension fund as a lump sum although that is not problem-free either.
Pension reform goes a long way towards resolving many of the means-testing issues and is particularly beneficial to women. It would be very disappointing if some of those who often already face poverty in retirement – the low-paid self-employed – were disadvantaged by the reforms. If you have any ideas on how this issue could be removed, Purnell would welcome them. You could even be part of his blog at www.dwp.gov.uk/ pensionsreform/weblog.
Ian Naismith is head of pensions market development at Scottish Widows