The Pension Credit

Means-testing gone mad


Until recently, around 2.5 million out of Britainís 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.


Earnings link

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.


Good strategy?

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 didnít 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 havenít 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 Ė 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 Ė 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.


Rely on MIG

Against this background, the best advice to people with below average earnings would seem to be: aim to rely on the MIG on retirement, donít bother saving (or if you do, hide your savings or dispose of them on retirement) and donít 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 Chancellorís attempt to persuade lower paid workers to invest in his new Stakeholder private pension has been a failure.


Nothing daunted, the Chancellor has now applied another twist Ė the Pension Credit Ė to an already complicated system in an attempt to moderate the penalty paid by pensioners with modest savings or a modest additional pension, and by so doing encourage todayís earners to save.This is an extraordinarily complicated benefit, the introduction of which will result in a massive extension of means-testing for pensioners.


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 wasnít 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 todayís 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.Itís a fair bet that the Pension Credit wonít 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.


Straightforward alternative

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.


Will it happen?

Until recently, it would have been impossible to imagine that this obvious solution coming about.But, now, even some of New Labourís 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