The Pension Credit
Means-testing
gone mad
Until
recently, around 2.5 million out of Britain’s 11 million pensioners were
eligible for means-tested benefit, which raised their basic state pension to
the Income Support level. But, on 6
October, with the introduction of the Pension Credit, this figure increased to
around 50% of the total, that is, well over 5 million, and this is set to rise
further if, as expected, the gap between the basic pension and the Income
Support level increases.
The Pension Credit is the latest
attempt by Gordon Brown to patch up a pension system, which is in need of a
drastic overhaul. The fundamental
problem is that it is possible for employees to retire after a full working
life (44 years for a man, 39 for a woman) with state pension entitlements well
below the Income Support level. And if
the basic pension continues to rise in line with prices while Income Support
rises with earnings, this gap will increase as the years go by.
In the 1970s, under the last Old Labour
Government, Barbara Castle established for the first time a formula for the
annual uprating of the basic pension: it was to be increased every year in line
with prices or average earnings, whichever was the greater (historically, this
has nearly always been average earnings).
But when the Thatcher Government came to power in 1979, she abolished
the link with earnings, and the basic pension was raised annually in line with
prices under the Conservatives.
When New Labour came to power in
1997, instead of restoring the link with earnings, Gordon Brown determined to
focus assistance on the poorest pensioners through the Income Support system,
which for pensioners was renamed the Minimum Income Guarantee (MIG). Since 1997, he has raised Income Support levels
for pensioners dramatically, from under £70 a week for a single person in 1997
to around a £100 a week now, by raising the pensioner premiums, that is, the
extra Income Support paid at age 60.
Income Support levels for
pensioners have been rising in line with earnings or better and the Chancellor
has promised that this will continue until the end of the current
Parliament. On the other hand, the
basic pension has risen in line with prices, apart from special increases
before the 2001 election. As a
consequence of this the gap between the basic pension for a single person who
has had a full working life has risen dramatically, and is now over £20 a week
for a single person.
On the face of it, concentrating
help on the poorest pensioners sounds like a good strategy. But it necessarily involves means-testing,
and as with all means-tested benefits take-up is much less than 100%. Out of the 11 million pensioners in the UK
today, approximately 1.7 million receive Income Support, but it is estimated
that about 670,000 more are entitled to Income Support but do not apply.
Also, like all means-tested
benefits, Income Support produces perverse incentives. Pensioners with modest savings or additional
pensions may be excluded from Income Support altogether (assuming they declare
them), or may have their Income Support entitlement reduced compared with a
pensioner with no savings or additional pension. This naturally causes resentment among pensioners with modest
savings or additional pensions, since it penalises their past prudence.
Before the introduction of the
Pension Credit, small additional pensions, which didn’t bridge the gap between
the basic state pension and the MIG could be literally worthless, and even if
they did bridge the gap they are worth much less than their face value. So, why should people put money into an
additional pension if the end result after many years of contributing is either
no extra income, or very little extra income, on retirement above the MIG?
Today, as we have said, the
difference between a full basic pension and the MIG for a single pensioner is
over £20 a week. For nearly a million
people who haven’t worked a full working life and therefore do not receive a
full basic pension, the gap is larger.
What is more, the gap is scheduled to grow at least until the end of
this Parliament – because the basic pension will rise in line with prices,
whereas the MIG will rise in line with earnings.
If uprating continues to be done
on these bases, the gap will continue to grow (so that by 2040 the basic
pension will be less than half the MIG).
Consequently, individuals will need larger and larger additional
pensions to bridge it – and remember that even if an additional pension is
sufficient to bridge it on retirement, 20 years later the gap will have grown
and that may no longer be the case.
Against this background, the best
advice to people with below average earnings would seem to be: aim to rely on
the MIG on retirement, don’t bother saving (or if you do, hide your savings or
dispose of them on retirement) and don’t bother taking out a private pension
either.
The latter has got its own special
uncertainties, the benefit on retirement being dependent on stock market
performance over many years, and the rate of interest at the time of
retirement. These uncertainties have
become all too evident as world stock markets have plummeted. Small wonder then that the Chancellor’s
attempt to persuade lower paid workers to invest in his new Stakeholder private
pension has been a failure.
It is essentially the MIG plus a
credit of 60p in the £1 on income, other than income from the basic pension, up
to a certain, rather low, limit. The
idea is to reward pensioners a little for having the foresight to save or take
out an additional pension (but it also applies to any SERPS income, even though
SERPS wasn’t a voluntary option). They
will get the MIG plus a bit (maximum £13.80), whereas pensioners with no
savings and no additional pension will just get the MIG,
It is inconceivable that this
fiendishly complicated system will lessen the disincentive to saving that is
inherent in using the Income Support system to top up the basic pension. For any incentive to be effective, it has to
be understood. It will be hard enough
to explain to today’s pensioners how it will affect them, let alone trying to convince
someone who is 20 years from retirement that its introduction is going to make
it worthwhile to save or pay into a private pension for the next 20 years. It’s a fair bet that the Pension Credit
won’t even be around in 20 years time.
People on low incomes know that
they their basic pension will be topped up with Income Support when they
retire. They also know that having
savings or another pension merely reduces the amount of Income Support they can
get. There is therefore little
incentive to save or take out a private pension, even if they have sufficient
disposable income to do so. The
introduction of the Pension Credit will not change that.
There is a straightforward
alternative to this complex morass, which would encourage people to save for
their retirement. The fundamental
principle of it is that people retiring after a full working life have a state
pension at or above the MIG, and that this pension be earnings related, so that
pensioner incomes keep pace with the earnings in the rest of the society.
This would mean that if people
choose to save by whatever means during their working lives, they would get the
full benefit of their savings in retirement.
The uncertainty inherent in taking out private pension would remain, but
at least an individual who chose to take out a private pension would get to
keep all of it on retirement. Likewise,
for any other form of savings. And
there would be no need for the monstrously complicated Pension Credit.
It may even be possible to do away
with the requirement that people must buy an annuity with their pension fund on
retirement, which removes one of the uncertainties in private pension
schemes. In order to encourage people
to provide for themselves in retirement, successive governments have given tax
relief on pension contributions, and allowed people to take 25% of their
pension fund as a tax-free lump sum on retirement. But they have insisted that people buy an annuity with the rest,
the aim being to reduce or eliminate their dependency on state support in
retirement. If the vast majority of
people retire on income above the MIG, then the requirement to buy an annuity
can be eliminated or at least greatly relaxed.
Almost all means testing of
pensioners would be eliminated, even if the MIG continued to be uprated in line
with earnings. Only people who have not
had a full working life would need to have their income in retirement assessed
and topped up to the MIG.
Until recently, it would have been
impossible to imagine that this obvious solution coming about. But, now, even some of New Labour’s best
friends, for example, the IPPR, have come to the conclusion that the pension
regime they have put in place since coming to power in 1997 is a complicated mess,
that this is going to get dramatically worse with the introduction of the
Pension Credit, and that the only solution is an earnings related basic state
pension at or above the MIG.
Significantly, also, private
pension providers have realised that they are not going to be able to sell to
people on below average income while the present complicated system
exists. Standard Life and Norwich
Union, the two biggest providers in Britain, are now saying publicly (Guardian,
30 September) that the entire state pension system should be replaced with a
single flat-rate pension for all at the level of Income Support, so that
pensioner means-testing would be greatly reduced, if not abolished. Then, and only then, will they have a hope
of selling pensions to people on below average incomes.
And as this is written, the
Conservatives have announced a manifesto commitment to raising the basic
pension in line with earnings like the MIG, reversing what Margaret Thatcher
did in 1980. They appear to be also proposing
increases in the basic pension, which would close the gap between the basic
pension and the MIG, and should therefore reduce pensioner means-testing. But it appears to be only a modest step on
the road. Over the years have
constantly deplored the growth of means-testing under New Labour, but this is
the first time they have proposed something concrete to reduce it.
Labour & Trade Union Review
October 2003