Select Committee on Work and Pensions Appendices to the Minutes of Evidence


APPENDIX 8

Memorandum submitted by the ESRC SAGE Research Group, London School of Economics (PC 11)

SUMMARY

  In the context of a broader package of pension reform, the proposals for the Pension Credit have a number of positive features. When implemented, the Pension Credit will lessen the very punitive treatment of savings that many pensioners currently experience. Additionally, a lighter touch administration, the linking of Pension Credit to claims on Housing Benefit and Council Tax Benefit and further attempts to increase take-up through the new Pension Service should result in higher incomes for significant numbers of pensioners. A number of unresolved issues may, however, jeopardise the future performance of the Pension Credit and compromise its role in fulfilling the Government's aspirations of encouraging and rewarding individual savings as well as supporting those unable to provide for themselves. We highlight three such issues.

  First, the Pension Credit will not do enough to support the poorest pensioners. The guarantee part of the Pension Credit will offer an income only just above the poverty line, such income being around £60 below a "modest but adequate" amount for a single pensioner. Additional support is targeted at those with savings—by definition not the poorest pensioners. We are particularly concerned that those without a full entitlement to the Basic State Pension (among whom women are disproportionately represented) will not be equally rewarded for their thrift.

  Second, the Pension Credit is adding complexity to an already bewildering system of provision. This is likely to compound the anxiety and confusion already in existence around the issue of pensions and, hence, decrease the likelihood of younger generations saving enough for their old age. While there is a role for public information here, it is not clear how far this will overcome the very real problems of uncertainty in individual lifecourses as well as the changing political environment that make advice and planning very difficult.

  Third, the Pension Credit raises issues about the sustainability of the current pension settlement. It is imperative that legislation is based on full information about the longer term costs of the credit so that a judgement about affordability and best value may be made. There is a significant risk that future Governments will "pick off" small parts (such as the Pension Credit itself or the State Second Pension) of the highly fragmented pension system in order to find short term budgetary savings.

1.  POORER PENSIONERS

  Estimates suggest that between a quarter and two-fifths of pensioner households were in poverty in 1999-2000. Reforms must continue to address the needs of these substantial numbers of poorer pensioners. Considerable progress has been made through increases in the Basic State Pension and the Minimum Income Guarantee. However, questions remain about the ability of the proposals to provide pensioners with an adequate and decent standard of living.

1.1  The adequacy of the pension credit

  The guarantee part of the pension credit is set at £100 per week for a single person in 2003. This will bring the income of those pensioners who claim the credit to just above the "official" poverty line (half mean household income after housing costs). However, research by the Family Budget Unit suggests that a "low cost but acceptable" level of income for a single pensioner would be £107 in 2003 prices, and a "modest but adequate" income would be £164 per week. Questions also need to be raised about the degree to which the poorest pensioners are sharing in increases in national prosperity. We estimate that in 2003 the Pension Credit guarantee will represent about 16 per cent of average male earnings, while the maximum amount of savings credit will be worth around 2.5-3 per cent of average male earnings.

1.2  Rewarding savings vs. targeting the most needy

  The reward for savings will not be felt equally by those who do not have full entitlement to the Basic State Pension. By setting the savings credit threshold at the rate of the full Basic State Pension, the credit will not enhance the incomes of those with only a partial Basic State Pension and a modest amount of additional savings or pension. Currently, 51 per cent of women do not receive a Basic State Pension in their own right, and recent research suggests that as many as 22 per cent of women aged 55-59 and 12 per cent of those aged 50-54 will not reach full pension entitlement even though these cohorts of women will benefit from full Home Responsibilities Protection. Thus, the 'pensioner poverty trap', while reduced, will not be eliminated by these proposals.

1.3  Take-up

  Government reforms since 1998 have had the net effect of increased means-testing of the older population, with the Pension Credit extending means-testing to an even greater proportion of pensioners (estimates suggest that by 2025 two-thirds of single pensioners and half of couples will be entitled to the Pension Credit). This emphasis on means-testing makes the take-up of benefits a crucial factor in the success of the Pension Credit. The new Pension Service and five yearly assessment periods are to be welcomed as attempts to address this issue. However, the scale of the challenge faced by this new administrative structure should not be under-estimated—in 1999-2000 between 22 and 36 per cent of pensioners entitled to the Minimum Income Guarantee were not making a claim, with single female pensioners making up the majority of those non-claimants. These figures bear testimony both to the continuing complexity of the system and the very real stigma attached to making a claim. In addition, the savings credit may offer relatively low sums and this may further lessen take-up. Hence, the Pension Service needs to be closely monitored and evaluated with regard to its success in increasing take-up. (It should be noted that administrative complexity would be much reduced and the problem of take-up all but eliminated if the vehicle chosen to deliver to the pensioner population had not been a means?tested one.)

1.4  Gender differentials

  A result of older women's higher rates of poverty is that they are more likely to claim the guarantee part of the Pension Credit. However, their lower additional pensions and savings combined with lower entitlement to the Basic State Pension means that women will be less likely to receive the savings credit. In addition, as the Pension Credit will operate on a family means-test there will be no individual reward to savings and occupational pensions and the issue of who receives payment of the Pension Credit is raised. If, as with the Minimum Income Guarantee, the majority of claimants are male heads of household, then the credit will do little to improve women's independent incomes in later life.

1.5  Earnings and the incentives to be in employment

  The proposals state that the questions of how earnings will be treated in both the calculation of the savings credit and whether they will be disregarded in the calculation of the guarantee are yet to be decided. We would argue that the Pension Credit should be neutral towards the type of income rewarded and that earnings should be treated identically to additional pension and savings income and hence attract credit. Even if this option were not pursued, a strong argument should be made for establishing an earnings disregard in the calculation of entitlement to the Pension Credit. Otherwise, the risk is that Pension Credit claimants will face a 100 per cent marginal tax rate on earnings creating disincentives to extend the working life beyond 65. This clearly does not tally with the Government's aspirations of active ageing or flexibility in retirement age.

2.  COMPLEXITY

  The Pension Credit adds a further layer of complexity to an already bewildering system. Alongside the two elements of first tier provision (Basic State Pension and the Pension Credit) an individual is now able to choose from four second tier pensions (occupational, personal, Stakeholder, State Second Pension) and, if they want to make additional savings, two additional pensions vehicles (personal and Stakeholder pensions) not to mention the huge variety of other forms of saving. Not surprisingly, there is considerable confusion among the general population, and even specialised financial advisers, about the implications of recent reforms. This complexity at the level of the pension system is compounded by the complexity in individuals' lives. Making the "correct" pension decision involves not only perfect information about future pension reforms but also about lifetime earnings. We believe that these complexities have serious implications for the incentives to save, and the choice of pension vehicle, for current generations of workers.

2.1  Incentives to save

  The concern to reward current pensioners for their savings and the desire to create incentives for future generations of pensioners to save have both been used as rationales for the Pension Credit. We would argue that while rewards to saving are in place for current pensioners (with the provisos given above), the Pension Credit may not have the desired effect on the incentives of younger people to save. If the credit is to be an effective incentive:

    (a)  individuals have to understand how it works,

    (b)  the incentive has to be sufficient for behaviour to change, and

    (c)  individuals have to change their behaviour.

  We envisage problems at all stages. First, the complexity of the system is such that it may be difficult to disseminate information about the Pension Credit and even more challenging to ensure that it is generally and correctly understood. Second, it is questionable whether the incentive to save introduced by the Pension Credit will be large enough to induce behavioural change and dissuade people from current consumption. The marginal tax rate implied by the savings credit is 40 per cent (ie pensioners will be able to retain 60 pence of every additional £1 of savings). It is debatable whether this reward will be sufficient to overcome the fact that future consumption may be subject to a discount (ie £1 of future consumption is worth less than £1 of current consumption). Finally, individuals can only adapt their savings behaviour correctly where they have information about their income in later life. In reality, no-one has such information. Government can go some way to filling this information gap. Indeed it was the ambition of the 1998 Green Paper "to provide everyone with a personalised forecast of their complete pension position, state and non-state, which they can use in planning the savings and investments they wish to make". However, these forecasts have yet to materialise. Perhaps more fundamental, a correct decision would require information about all future changes in pensions policy. The climate of rapidly changing pension policy adds to consumer uncertainty and we would anticipate that significant numbers of individuals will respond by not saving or saving insufficient amounts for later life.

2.2  Implications for stakeholder pensions

  We foresee potentially negative effects of the Pension Credit on the take-up of Stakeholder Pensions. We welcome the proposals to include the State Second Pension as part of that income that is rewarded. However, it should be acknowledged that this reduces the incentive to contract out of the State Second Pension into a Stakeholder Pension. Estimates suggest that when the system is fully matured, an individual earning £12,500 per year (and therefore in the target group for Stakeholder pensions) will retire on an income little different from an individual who earned £7,500 per year and remained within the State Second Pension. A similar issue arises in the choice between Stakeholder Pensions and ISAs. Traditionally, the tax environment has been more favourable to pensions specifically to encourage ring-fenced savings that produce an income stream for later life. The pension credit, however, will treat income from savings and from additional pensions identically. In the current tax environment, those requiring flexibility (both in when and how savings are used) may be more inclined to save in ISAs than in a Stakeholder Pension.

3.  SUSTAINABILITY OF THE CURRENT PENSION SETTLEMENT

  In the area of pensions in particular, reforms need to be assessed not just in terms of the level of current provision but also with regards to their contribution to the stability of the pension system overall. Individuals require a degree of certainty in the long term in order to plan for their retirement. However, pensions have been subject to repeated reform over the last 50 years, creating uncertainty and insecurity for the older population and those of working age. One of the central aims of the 1998 Green Paper was to deliver "the security we all want, now and for the future". However, it is questionable whether the sum of reforms will achieve this goal or whether the pension system will be reinvented yet again in the near future.

3.1  Affordability

  A key factor in the sustainability of the current settlement is its affordability. The proposals provide the cost of reform for the year 2004-05 as £2 billion. However, the affordability of the Pension Credit is a longer term concern fuelled both by demographic change (especially as the baby boom generation moves into retirement from 2020) and by the falling relative value of the Basic State Pension over time which will increase the numbers entitled to the Pension Credit. An open and informed debate requires that projected costs over a much longer time horizon be made available in the public domain.

3.2  Political stability

  The suggestion that the Pension Credit be linked to earnings growth through this parliament is welcome as it gives greater certainty to this part of the pension system. Stability will only be assured, however, if in the longer term decisions around indexation of all parts of the pension system (including the Basic State Pension) were protected as far as possible from overly frequent political manipulation. While it is not desirable to make decisions about indexation inviolable, an instrument that ensured the automatic indexation of pension incomes would be preferable. The fragmentation that exists in the current pension system introduces further political risk in that future Governments in search of budgetary savings will be able to pick off small parts of the pension system, such as Pension Credit. Overall, the long time horizon needed for a stable system suggests that pensions is an area where there is considerable need for cross-party agreement and discussion.

4.  CONCLUSION

  To conclude, it is not clear whether the Pension Credit is the most appropriate vehicle with which to meet the Government's aspiration of rewarding and encouraging saving as well as supporting those without additional provision. It is difficult to dismiss the issue of complexity and its consequences for current take-up as well as future incentives to save. The piecemeal nature of reforms has made it very difficult for a true assessment to be made of the reform package as a whole. There is, therefore, a strong imperative on Government to provide detailed and long term costings of the proposed reform so that issues of affordability and best value can be debated openly.

Dr Katherine Rake

Co-Director

11 January 2002


 
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