Yesterday (14 January 2013) the DWP published its White Paper, “The single-tier pension: a simple foundation for saving”.  The White Paper sets out the Government’s plans for reform of the state pension system.  This speedbrief looks at the Government’s proposals.

State pension: the current position

There are two elements to the state pension for employees: the basic state pension and the state second pension (S2P).  The amount of an individual’s basic state pension depends on the number of years national insurance contributions which are paid. Currently the maximum basic state pension for a single person is £107.45 per week.  S2P is an earnings related top-up to the basic state pension.

Occupational pension schemes which are contracted-out provide the S2P element from the scheme in place of the state.  Contracted-out scheme members and employers pay reduced national insurance contributions. Contracting-out on a defined contribution basis was abolished from April 2012.

State pension reform: what the Government has done so far

The Government has been keen to reform the state pension system to improve the support for people in retirement and to remove unnecessary complexity.

In the March 2012 Budget, the Chancellor announced that the basic state pension and S2P would be combined into a single-tier pension.  The Queen’s speech in May 2012 announced that there would be a Pensions Bill to legislate for the single-tier pension as well as how state pension age would be increased in light of longevity changes. For more on these developments, please see our speedbriefs:

Eversheds' pensions speedbrief - Two Pensions Bills announced in Queen’s Speech

Eversheds' pensions speedbrief - Budget 2012: the pensions aspects

Eversheds' pensions speedbrief: State pension: possible future developments

State pension reform: White Paper proposals

The Government intends to implement the single-tier pension option in April 2017 at the earliest.  Legislation to achieve this will be introduced at the earliest opportunity, subject to the Parliamentary timetable.

The single-tier pension will:

  • Replace both basic state pension and S2P and be set above the basic level of means tested support.  In current figures this will be a pension of £144 per week.
  • Require 35 qualifying years of national insurance contributions (or credits)(NICs) for the full pension.  Those with an incomplete contribution record will have the pension pro rated subject to a minimum qualifying period of between seven and ten years.
  • Be based on individual qualification: it will not be possible to build a pension entitlement based on a spouse or civil partner’s NICs.
  • Cost no more overall than the current arrangements.  Decisions on the starting amount and the uprating method will be made shortly before implementation.

The White Paper confirms that the single-tier pension will only apply to those who reach state pension age after April 2017.  State pension benefits in excess of the single-tier pension will be protected through transitional provisions.

The introduction of the single-tier pension means that contracting-out will be abolished.  This means that both employers and active members of contracted-out defined benefit schemes will see an increase in their national insurance contributions.

The White Paper confirms that employers will be given a statutory power to offset the costs of the abolition of contracting-out.  The power will allow employers to amend their schemes without consent to increase member contributions or to reduce future service benefits. At the same time, the White Paper makes it clear that there will be no further legislation to remove the ongoing issues with guaranteed minimum pensions (GMPs) which relate to contracting-out between 1978 and 1997 (although there may be changes to the law relating to the conversion of GMPs (into scheme benefits) to make this more workable)

The Government will carry out a review of state pension age every five years starting from the next Parliament.  The first review will take place in the next Parliament with the outcome being published by 7 May 2017.  The White Paper also makes it clear that individuals will be given ten years’ notice of any change to state pension age.

Next steps

The draft pensions reform bill will be published later this week.

Comment

The single-tier pension is designed to simplify state pension provision.  However, as tends to be the case with pension reform, the devil will be in the detail.  The implementation and administration of the single tier pension will not be straightforward for the Government.  In particular, there will be complicated transitional arrangements which will apply for many years because the new system will take into account rights accrued before April 2017.

The Government’s proposals will have a major effect on private sector defined benefit contracted-out pension schemes.  If no further steps are taken, national insurance contributions for both employers and members could increase without any proportionate change to scheme benefits (to keep costs the same).  In order to address this, it is proposed that employers would have a power to change future service benefits or increase member contributions.  Employers and trustees will need to consider whether, and if so, how this power is to be used in advance of the end of contracting-out in April 2017.

The White Paper mentions possible changes to the law on the conversion of GMPs.  We hope that these changes make GMP conversion workable so that schemes have a practical solution for how to address this notoriously complicated area.