Pensions White Paper

Introduction

The Pensions White Paper was published yesterday1. This confirms that a flat rate state pension of £144 per week (at today’s prices) will be introduced from 2017, at the earliest. All individuals with a NICs record of 35 years will be eligible for the flat rate state pension.

But as with many major changes, whilst there are winners, there will also be losers.

In this Alert:

• Key points
• Background
  
• Who will benefit?
  
• Who will lose out?
  
• Abolition of Contracting-out
  
• Can changes to occupational pension schemes be made?
  
• State Pension Age
  
• Next steps

Key points

• From 2017, the BSP will be a flat rate pension of £144 per week, at today’s prices.
• There will be a process of transition to the flat rate state pension. As part of this transition, some people will receive a top-up to the flat rate pension.
• As a consequence of the abolition of DB contracting-out, members of contracted-out DB schemes will have to pay higher NICs and sponsors will lose the contracting-out rebate.
• There will be a review of the SPA every five years – starting from the next Parliament (i.e. after 2015).

Background

The current system comprises the BSP, the additional state pension (commonly known as S2P but formerly SERPS), which is linked to earnings, and the pension credit (a means tested benefit). In the April 2011 Green Paper, the DWP put forward two broad options for delivering reform:

• accelerating existing reforms so that S2P becomes a flat rate structure more quickly; or
• moving to a single-tier flat rate pension.

The White Paper confirms that the Government has chosen the simpler solution of moving to a flat rate pension system. As part of the changes, DB contracting-out will be abolished.

There will be a transition process when the flat rate state pension is implemented. This is complicated, but the Government states that it will ensure that individuals who would be entitled to a higher payment than the new flat rate state pension at the date of the change will not lose out.

Who will benefit?

The biggest winners from today’s announcement on the move to a flat rate state pension may be women – often poorly paid and with significant breaks in NICs due to childcare responsibilities, many women would otherwise face having to claim pensions credit to make up their income to basic state pension levels. The low paid and the self-employed will also similarly benefit.

Who will lose out?

There are several key groups who will lose out as a result of the changes. These include:

• Some existing pensioners – the new flat rate pension will not apply to them, so many existing pensioners will continue to be eligible only for the current BSP at £107.45 per week uprated (in accordance with the “triple lock”).
• Higher earners – people who may have been able to accrue additional state pension by paying more NICs will not now receive full value for those contributions, as they will effectively have their state pension entitlement capped at the new flat rate.
• Occupational pension scheme members contracted–out on a DB basis and sponsors of contracted-out DB schemes – both groups will have to pay higher NICs after DB contracting-out is abolished to make way for the new BSP.

Abolition of Contracting-out

When DC contracting-out was abolished, generally the protected rights simply converted into normal DC benefits. But on the abolition of DB contracting out, the plan is to retain the past service contracted-out rights within the scheme. Schemes will therefore be required to retain records and apply the restrictions attached to DB contracted-out benefits.

In addition, the contracting-out rebate will no longer be available. This rebate is paid to contracted-out schemes to reflect the fact that they provide benefits in place of the state second pension. At present, if an individual is contracted out, the employer and the employee pay NICs reduced in total by 4.8%.2

Occupational pension scheme members who are contracted-out on a DB basis pay reduced NICs on earnings between the lower earnings limit (£5,564 for 2012/13) up to the upper accrual point (which is £40,040 for 2012/13). This is at the rate of 10.6% instead of the standard rate of 12% (at 2012-13 tax year rates). Sponsors will also lose their rebate of 3.4%.

Given that scheme sponsors are already feeling squeezed by the introduction of automatic enrolment, the loss of this rebate will hit hard.

Can changes to occupational pension schemes be made?

The White Paper recognises that some scheme sponsors may wish to make changes to occupational pension schemes in anticipation of the loss of the contracting-out rebate. The White Paper suggests it will be possible for employers to manage this transition by either reducing future pension accrual or increasing employee contributions.

Some schemes will not be able easily to amend scheme rules because of specific amendment power restrictions. To ensure the “ongoing viability” of DB pension schemes, the Government “proposes to give employers powers to change scheme rules for this purpose without trustee consent”. The modification powers would be available only for a limited period and to cover changes required to “offset the cost of additional employer National Insurance contributions”.

At present, there are no further details on how this would work.

State Pension Age

As well as the changes to BSP, the White Paper covers increases to the SPA. The Government proposes to implement a five yearly review of SPA, starting from the next Parliament.

Next steps

The changes will be implemented by a new Pensions Act. The Pensions Bill 2013 will be published shortly and we will be following progress.

1 This follows the April 2011 Green Paper “A state pension for the 21st century”
2 This was reduced from 5.3% from April 2012 after the Quintennial Review