House of Commons - Social Security

Select Committee on Social Security Seventh Report

PENSION PROVISION

53. Our Report on the Contributory Principle contained a detailed account of the history and workings of the National Insurance system, much of it as it relates to state pension provision.[88] We do not repeat that detail here. However, in considering the appropriate policy response to tackling pensioner poverty we have reviewed the pension system as it relates to today's pensioners and how that will change for future pensioners, taking account of the new state second pension which is to replace the State Earnings Related Pension Scheme (SERPS), and the introduction of stakeholder pensions. In this section we give a brief factual account of the different types of pension provision in order to help clarify the arguments we go on to make later in the Report.

The first tier: the basic state pension

54. The basic state pension is the first tier of pension provision. It is paid at a flat rate (i.e. unrelated to past earnings) according to the extent to which contributions have been paid or credited. A full basic state pension is currently worth £67.50 a week. A married woman without a full contribution record can claim a basic state pension on her husband's contributions. In that case the maximum she will receive while he is alive is £40.40 (the 'married woman's' rate). Since 1980, the basic state pension has been uprated each year in line with prices while earnings have risen faster than prices. The National Pensioners Convention told us that "Between 1975 and 1982, the basic state pension was consistently around 22-23% of the average earnings of adult full-time workers, and the statutory requirement to increase it annually at least in line with average earnings would have ensured that it remained at that level or higher. Instead, the breaking of the earnings link in 1980 has had the effect of reducing the relative value of the basic pension to about 16% of average earnings."[89]

55. Although in popular mythology the basic state pension was uprated in line with earnings for many years, the Minister of State pointed out that the link between the level of the basic state pension and earnings lasted a relatively short period - between 1975 and 1979.[90] Prior to 1973, there was no legal duty to ensure that benefits kept pace with inflation. In 1973, the then Government introduced a general requirement to review the value of benefits annually, due to come into effect by 1975.[91] However, by 1975, this general duty to review benefits had been amended, to give a duty to uprate long-term benefits such as pensions by relation to earnings or prices, whichever was most advantageous.[92] Earnings were used as the basis for upratings up to and including November 1979, with the exception of November 1976 when prices rose faster than earnings.[93] The 1980 Social Security Act, which limited the uprating of pensions to prices only, took effect from November 1980.

56. To receive a full basic state pension, men must usually have 44 qualifying years of NI contributions out of a working life of 49 years (aged 16-64). Women usually need 39 years out of 44 (16-59) although this will rise gradually to be the same as for men by 2020. All employees with earnings above the lower earnings limit, and the self-employed earn rights to the basic state pension. The extension of contribution credits for periods of unemployment, sickness, maternity and caring, the introduction of home responsibilities protection and the abolition of a married woman's option to rely on her husband's NI contribution record means that it is becoming easier to qualify for a full basic state pension without working every year. This is particularly true for women. Currently only a quarter (26.5%) of women over 60 receive a basic pension independent of a husband's records. Of these, only half get 100% of the full rate.[94] The Government Actuary assumes that by 2025 married women retiring in that year will be entitled to state pensions worth on average 84% of the full basic rate, compared with 57% now.[95] However, it will be many years after that before all women pensioners will be in this situation and by then, if the state pension is linked only to prices, a full basic state pension will be worth less in relation to average earnings.

Second tier pensions

57. Since 1978, all employees earning above the lower earnings limit have had to pay towards a second-tier pension, either through SERPS or through a private pension. SERPS was originally designed to give a maximum addition to the basic state pension of 25% of a person's earnings between the lower and upper earnings limit. But the 1986 Social Security Act reduced significantly the value of SERPS for people retiring after 1999. SERPS being paid to new pensioners has therefore reached a maximum. For people reaching pension age in 2010, their SERPS pension will be at most 20% of their relevant earnings. Widows currently inherit 100% of their husbands' SERPS pensions, but for widows of people who die after October 2002, this is reduced to 50%.

58. If employees contract out of SERPS into a private second tier pension, they pay a reduced National Insurance Contribution or get a rebate of their NI contributions paid into their private pensions. SERPS and the contracting out arrangements provide a degree of compulsory second tier pension for employees. There is no equivalent compulsion for self-employed people to contribute towards a second-tier pension.

59. From 2002, SERPS is to be replaced with a new state second pension. From that date, no new SERPS rights will be accumulated, and rights to the state second pension will begin to accrue. By 2050, the state second pension will have completely replaced SERPS. People retiring between 2002 and 2050 who have contributed to both types of pension will have a pension based on a mixture of the two schemes. Like SERPS, the state second pension will apply to employees and they will be able to contract out of it into a private pension.

60. SERPS provides employees with a supplement to their basic state pension which is purely proportional to past earnings between the lower and upper earnings limit. Someone whose weekly earnings were £100 above the lower earnings limit would receive a pension of half that of someone with earnings of £200 more than the lower earnings limit. In the first phase of the state second pension it will depend on past earnings but it will provide a pension which is a higher proportion of the earnings of those on low earnings compared with those on higher earnings. In the second phase, the state second pension will become a flat-rate top-up to the basic state pension. Entitlement will depend on having earned at or above the lower earnings limit but will be unrelated to earnings in any other way.

61. In calculating a person's entitlement to SERPS, the past earnings on which it is based are revalued to the year of retirement according to increases in average earnings. However, during retirement, SERPS entitlements are increased each year only in line with prices, like the basic state pension. A similar arrangement will apply to the state second pension so that the value of a full second state pension for newly retired people will rise in line with earnings. However, once retired, pensioners will see their state second pension increase each year in line with prices only.[96]

The third tier: voluntary private provision

62. Many people make additional voluntary private provision beyond the compulsory element of second tier pensions, through occupational pensions and personal pensions. From 2001, stakeholder pensions will offer a new means of contracting out of state second tier pension provision. The Department's memorandum states that "the new Stakeholder Pension gives a safe, flexible, low-cost way to save for a pension to around 5 million workers for whom a private pension is not a cost-effective option."[97] Once in payment, private pensions tend to be increased each year by at most the rise in prices.

The safety net: the Minimum Income Guarantee

63. Pensioners with income and savings below specified levels are also entitled to a top-up from the Minimum Income Guarantee (MIG) (formerly Income Support for Pensions). Those with savings below £8,000 (£12,000 from April 2001[98]) are entitled to an amount which brings their income up to specified levels.[99] These levels depend on age and whether the pensioner is part of a couple or is single. The levels for single people aged 60-74, 75-79 and 80+ are £78.45, £80.45 and £86.05 respectively. For couples the corresponding levels are £121.95, £125.35 and £131. So the MIG is above the single person's basic state pension level and above a couple's combined basic state pensions where the woman is receiving the married woman's rate of pension. The present Government has given a commitment to link the MIG to increases in average earnings for the remainder of this Parliament.[100] However, there are concerns that the MIG is too low: as we have already noted, the Minister admitted that it was not enough and that he would not be able to live on that amount.[101]