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Plans set out for new flat-rate pension

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The Government has published its proposals for a new universal state pension.

Under the proposals, which appeared in a Green Paper, existing means tested arrangements would be replaced by a weekly flat-rate pension of £140, a figure likely to rise to £155 by 2015 once inflation has been taken into account.

This would be paid to anyone with 30 years of national insurance contributions.

Currently, the state pension is £97.65 a week, although this can be topped up to £132.60 using pension credits.

The aim is to simplify the present system and to incentivise personal savings since the flat rate would mean that everyone who retires will know exactly how much they will be receiving from the state.

No specific date has been set for the introduction of the new system, but the Government appears to be looking at a five-year timetable.

Announcing the proposals, Steve Webb, the Pensions Minister, said: “Tomorrow’s pensioners do face a very different world.

“They will, on average, be working for a lot longer, they will be retired for longer, they won’t on the whole have final salary guaranteed pensions in the way that perhaps their parents did. We therefore need a simpler, clearer foundation because more of them will now be asked to save for their retirement.”

Work and Pensions Secretary, Iain Duncan Smith added: “We have to send out a clear message across both the welfare and pension system: you will be better off in work than on benefits and you will be better off in retirement if you save.”

Another option outlined in the Green Paper would see the state second pension replaced with a payment of £1.60 for each qualifying year. In other words, given the current level of state pension provision, someone backed by 30 years of national insurance contributions would be paid a basic £97 weekly along with 30 times £1.60 in supplementary payments.

Those who have spent time caring for children or an elderly relative or dependant would be able to count those years as qualifying in the same way as if they had been in employment.

Were the flat rate route to be adopted, the pension will only be available for new pensioners rather than existing pensioners.

The basic state pension will rise each year in line with average earnings, the Consumer Prices Index measure of inflation, or 2.5 per cent, whichever is the greater.

Although the state second pension would be scrapped, the Government would honour contributions that had already been made ahead of the change.

Those with less than seven years of national insurance contributions would not be entitled to the flat rate pension.

The reform would also probably involve the end of ‘contracting out’, whereby someone faces lower national insurance charges because their state second pension has been assigned to a final salary pension scheme.

One consequence is that some people could see a hike in their national insurance contributions, a rise in costs that would be compensated for by an increase in their state pension payments.

Employers who provide final salary schemes would experience a rise in their national insurance contributions, too, as a result.

Joanne Segars, of the National Association of Pension Funds, commented: “The end of contracting out by defined benefit pension schemes is an inevitable part of simplification.

“But the government must make an early promise that it will make it simpler for schemes to contract back in. It must not load extra costs and red tape on these pension schemes, which are under severe pressure.”

Additionally, the Green Paper will ask for views on a mechanism that would automatically increase the state pension age in line with average life expectancy, rather than the system of pensionable age being set by ministers.

Mr Webb argued that reform is essential given that the government is to introduce auto-enrolment for workplace pensions.

The Minister said: “That is focusing the issue. This is not techy marginal stuff. This is 10 million people of working age over the next five or six years. It is a kind of social revolution.

“They will be free to opt out, but their employer will put money in, they will put money in, tax relief goes in and they will have to decide whether to stay in the scheme or not. This is a huge opportunity for us to get people saving, but we will blow it if they take one look and think it is too baffling, they don’t know what they will get or think ‘why should I bother because the state will pick me up’.”

He described the present system, which includes NI contributory years, Serps and second state pension (S2P), and pension and savings credits, as confused. A flat-rate regime would give everyone certainty.

With the state second pension and the savings part of the pension credit abolished, Mr Webb insisted that “a year bringing up your kids or looking after an elderly relative is going to be just as good as a year spent running a multinational company”.

He added: “There will be no difference in terms of state pension in terms of these two activities. So while the state system at present reinforces the inequality in wages, the new system will become flat rate. That will radically shift the relative position of women in the state system.”

Second state pension and SRP benefits already accrued will not be lost, the Minister maintained: “I’m not taking any money away. We will honour everything that has been accrued to date.”

By way of a safety net, the guaranteed part of the pension credit, worth up to £35 a week, will stay in place for those who fail to accumulate the qualifying years of NI contributions or credits.

Welcoming the proposals, Katja Hall, the CBI’s chief policy director, nevertheless warned that employers should not be burdened with extra costs.

Ms Hall said: “Simplifying the state pension is good news, as people will get their pension without the bureaucracy of a two-tier system and means testing.

“One major hurdle the Government must overcome is the increase in cost to employers of providing final salary pensions to employees, as a result of abolishing the contracting out rebate in defined benefit schemes.

“The Government is right to be consulting on the state pension age. With increasing life expectancy, we will need to work for longer to pay for our retirements.”