Pension changes cheered but high earners take a hit

BUSINESS leaders hailed the government’s plans for a “simple, understandable, state pension” yesterday, but admitted that both employers and staff would have to take a financial hit as part of the proposed reforms.

“The introduction of a flat-rate state pension, with an end to means-tested retirement income benefits, is essential if pension saving is to make sense for modest earners,” said Malcolm Small, pensions adviser at the Institute of Directors yesterday.

“[This] will help give prospective pensioners a clear idea of what the state will provide – and just as importantly, what it won’t.”

But Tom McPhail, head of pensions research at Hargreaves Lansdown, warned the new rules could mean high earners missing out on some of the pensions perks they have access to today.

“If you’re earning above-average income and are 30 you won’t have built up a pension of more than £144 a week,” said McPhail. “You’re now not going to have a chance to build that – you’re going to pay the same National Insurance to get less.”

At the moment there is a basic state pension of £107 a week, which combines with various pension credits and earnings-related elements to produce a final payout. As a result two million retirees currently receive a state pension of over £150 a week, while others receive far less.

The new plan combines the basic state pension and the earnings-related element. Everyone who pays National Insurance (NI) for more than 10 years – or is registered as carer or on qualifying benefits – will now receive some state pension payments when they retire. The exact amount will increase proportionate to how long they paid NI, with every year of contributions up to 35 years increasing the individual’s pension until it hits a universal rate of £144 a week.

People who have already built up an entitlement of more than this will be allowed to retain the higher sum. But changes will not come into effect until 2017 at the earliest, meaning some people about to stop work will receive a pension well below £144 a week.

All contracting out of pensions will cease when the new system is introduced, meaning a rise in NI payments for those who still enjoy defined-benefit pension schemes. Critics say the increase in contributions – which could see an employee on £40,040 a year pay an extra £481 in NI – may be the death knell for the remaining final salary schemes in the private sector.

The 25-year-old City worker
“Young people who expect to earn more than the average person during their career have missed out on the potential to receive more than the basic state pension,” explains Peter McDonald, a PwC partner. “But they face greater certainity as long as the government’s promise not to means test the pension stays in place.” All workers will require 35 years of contributions before collecting their state pension, rather than 30 today.

High earners in their 30s and 40s
“Somebody nearer 40 who is earning around £40,000 a year will benefit,” says McDonald. “But this is the group that has been most affected by closures to defined-benefit schemes.” People who have already become eligible for a weekly state pension of more than £144 will keep their advantage. But around 700,000 contracted-out high-earners in private sector defined-benefit schemes will pay more in National Insurance. 

The 65-year-old about to retire
The reforms announced yesterday will not be implemented until 2017, after the next general election. As a result those are due to retire in the next few years – and people who are already pensioners – will have their payments calculated under the old system throughout their retirement, even if the sum is below the new flat rate of £144. “The cliff-edge nature of the policy is one thing for government to consider,” admits McDonald.