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


Institute/Faculty of Actuaries Response to: The Pension Credit: a Consultation Paper (CM 4900)


  The actuarial profession welcomes the opportunity to respond to the Government's consultation document on the Pension Credit. The profession supports the aims of widening the opportunity to achieve a decent income in retirement and of providing security for those who cannot save (DSS 2000a).

  We begin by setting out our interpretation of the Pension Credit document. We assume that:

  1.  From 2003 the Minimum Income Guarantee (MIG) will be £100 per week

  2.  For every pound of private income above the level of the basic state pension (BSP), pensioners will receive the Pension Credit.


  Fellows of the Institute of Actuaries and the Faculty of Actuaries provide advice to companies about occupational pension schemes and other employee benefits, as well as to Trustees of occupational pension schemes. Fellows are less likely to provide advice to individual savers who fall into lower income brackets, but this area is also a concern since occupational pension schemes often have a wide membership.

  Since the 1980s, the extent to which the state has been involved in providing retirement income "as of right" (that is, in return for National Insurance contributions) has been eroded, whilst means tested benefits available to those over state pension age have increased in value. The recent promise to increase the MIG to £100 per week means that a single person who received median earnings whilst in work would have to have paid nearly 40 years' National Insurance contributions in order to have a state retirement pension (that is, from BSP and State Earnings Related Pension or State Second Pension) equal to the MIG.

  The average time spent unemployed is approximately 17 per cent of a working lifetime (this estimate is based on data in Labour Market Trends, 1998, Vol 106 No 9 and Labour Market Trends, 1999, Vol 107, No 1), or 8½ years in a working lifetime of 49 years. Some periods away from paid employment carry full credit towards the BSP, but even so pensioners receive, on average, only 80 per cent of the BSP.

  We would like to respond to the consultation in the following areas:

    I.  The Pension Credit.

    II.  Abolishing the capital limits.

    III.  Integrating the tax and benefit systems.

I.  The Pension Credit


  We noted above that someone on median earnings would have to have a nearly complete record of National Insurance contributions in order for their state retirement pensions to exceed the MIG. Single people with shorter contribution histories, or who have been paid less than median earnings, could get no benefit from the first tranche of any private income they had managed to save.

  People on low incomes wanting to save for retirement thus have to make a difficult choice. By making such provision, whether by joining an employer's occupational pension plan or by making private saving, employees could become worse off:

  1.  Because income employees might otherwise have received during their working lifetimes has been deferred until retirement, when it just reduces entitlement to means tested benefits.

  2.  Because loss of the MIG can mean loss of other means tested benefits that are, potentially, quite valuable.

  Couples are in a slightly different position since, although entitlement to state retirement pensions is based increasingly on individual National Insurance contributions, eligibility for means tested benefits is based on household income. Together with the increasing incidence of family breakdown, this makes estimates of the financial position of couples in retirement quite unreliable. For this reason, and because the majority of pensioners in receipt of means tested benefits are single, we concentrate on the position for single pensioners. However, the points we make are relevant to couples as well.

  Whilst the MIG has been the "headline" figure on which means tested income has been publicised, those on low incomes could also be eligible for other means tested benefits. The most financially significant of these are Housing Benefit (HB) and Council Tax Benefit (CTB), which the DSS estimates could amount to approximately £3.4 billion in 2001-02 (compared to £3.9 billion for income support) (DSS, 2000b).

  HB and CTB have tapers of 65p in the pound and 20p in the pound respectively, so that private income is not lost pound for pound for those only entitled to these benefits. However, together the tapers result in the high marginal tax rate of 85 per cent. Currently the tapers start to apply once income is above the MIG (otherwise individuals could experience marginal tax rates of over 100 per cent). Depending on the amount of rent and council tax a pensioner has to pay, those with incomes of up to £15,000 per annum could be in receipt of means tested benefits. That is, marginal tax rates of 85 per cent will apply to most tenants on low incomes.

  Because of the taper, it might appear that this group of people does indeed benefit from their savings. Clearly they are better off in retirement than had they not saved. But in order to get to this position they have been worse off during their working lifetimes. If they saved in a pension scheme then they will have done so without incurring much tax, but in payment their savings are taxed at 85 per cent. If the savings accumulated in a building society they will have been taxed at the individual's marginal rate, say 23 per cent, and in retirement they will be taxed at a further 85 per cent. In either case, the individual's lifetime wealth would be higher if no savings had been made.

  In the past the value of income support was lower and, relatively, the value of the BSP was higher. This meant that most employees with occupational pensions could expect to receive incomes in retirement greater than means tested benefits. With the increase in the MIG and the decrease in state pensions this position is likely to deteriorate significantly and, under current policies, it will continue to do so. For example, if real earnings growth is 1.5 per cent per annum, the MIG will increase from the estimated £100 per week in 2003 to approximately £150 per week in constant price terms 27 years later, nearly double the level of the BSP.

  For people to be able to plan effectively for retirement, the foundation on which savings are built needs to be made more stable. Ideally, this means that the BSP should be the headline benefit. It might need to be underpinned by a MIG, but this should be a safety net for those unable to find employment for a large part of their working lifetime.

  Clearly, since the BSP is paid to all eligible employees regardless of their income there would be cost implications in increasing its value to take the place of the MIG as the target minimum income. We consider this later in our response. However, if the Government genuinely wishes to "reward the thrift" of those on low incomes, it cannot do so by imposing high marginal rates of tax on their savings.


  The consultation paper describes the Pension Credit as a "reward" for pensioners on low and middle incomes. In fact, the Pension Credit is a benefit taper of 40p in the pound, similar to that applied to HB and CTB. It will result in a smaller penalty being applied to some savings than is the case presently.

  Chart 1 of this response shows the marginal tax rates that are applied to the savings of an individual in receipt of a BSP of £62 per week (80 per cent of the full BSP in 2003), under three scenarios:

    (i)  Under the current means testing regime;

    (ii)  Under the regime that will be applied if our interpretation of the consultation document goes ahead; and

    (iii)  The regime that would apply if the values of the BSP and the MIG were exchanged.

  The calculations ignore the effect of HB and CTB, which will complicate the picture.

  We can see the following:

    —  Under the current system, pensioners with incomes lower than the MIG experience marginal tax rates of 100 per cent. Those with incomes above the MIG experience the appropriate marginal tax rate for their level of income (for example 0 per cent for those whose income is less than the single person's tax allowance plus the age allowance).

    —  Introducing a Pension Credit only on income in excess of the full BSP means that pensioners with incomes lower than the BSP will still experience marginal tax rates of 100 per cent.

    —  Those pensioners with incomes greater than the BSP will experience marginal tax rates of 40 per cent. Since pensioners with incomes just above the income tax threshold could still be entitled to the Pension Credit, they could experience a marginal tax rate higher than 40 per cent. However, this group can expect to be better off under the proposed Pension Credit regime than they currently are, or than they would be if the current regime continued.

    —  The effect of reducing the benefit taper applied to the MIG from 100 per cent to 40 per cent is to extend the income range over which means testing applies. As the taper falls, the marginal tax rates of those already subject to means testing falls, but those brought within the net will experience higher marginal tax rates. Ironically, reducing the taper (and so reducing the savings penalty) will increase the number of people who experience poor net rates of return on their saving.

    —  By increasing the BSP to £100 per week whilst keeping the MIG at £77, pensioners will experience the appropriate marginal tax rates for their level of income.

  Individuals within a couple who each accrue the average entitlement to BSP and remain together are less likely to experience marginal tax rates of 100 per cent, provided their entitlement to Pension Credit starts at the level of the married person's BSP.

  If their entitlement to Pension Credit starts at the single person's BSP, they would receive Pension Credit in respect of some of their income from the BSP, which seems contrary to the intention of the consultation document.

  The position of a person who is over 60, and thus entitled to MIG, but under state pension age and thus not eligible for state pension is not clear. The position would appear to be even more complicated for couples, given the possible permutations of ages above and below 60 and state pension age. The Government should also consider whether their proposals will be sustainable, once the State Pension Age for women begins to increase in 2010.

  The effect is more complicated when HB and CTB are taken into account, and will depend on how the MIG and Pension Credit tapers are integrated with HB and CTB tapers. There must be some change to the basis for integration, otherwise individuals could be subject to marginal tax rates greater than 100 per cent. In any case, it is likely that marginal tax rates will remain higher, and more people will be subject to these high marginal tax rates.

  We support the principle of encouraging more people to save for their retirement. However, there is evidence that many people find it difficult to save and that there are significant costs to saving in approved pension vehicles. To overcome these obstacles, the Government must provide a savings environment where the low paid genuinely benefit from their savings, rather than not being penalised quite so extensively as they are at present. Reducing the effect of the taper from 100p to 40p in the pound will clearly make some people better off. However, any taper will act as a disincentive to saving.

  Currently the low paid face far more disincentives to save than the high paid and they save (proportionately) far less. If they are to be expected to save more it must be made rational for them to do so. This could happen if, as suggested, means testing resumed its role as provider of last resort, and the BSP became a minimum income.

II.  Abolishing the capital limits

  We welcome the decision to remove the current onerous means test and replace it with a less intrusive test. However, total removal of a means test on capital could encourage the development of financial products designed to convert income into capital. In particular, it could place a further obstacle in the way of pension savings, where the majority of the savings must be converted to income at retirement.

  It seems absurd that someone with a large amount of capital but no income flowing from it should be entitled to claim means tested benefits. The Government might like to consider a high level cap or other anti avoidance provisions.

III.  Integrating the tax and benefit systems

  Many people are aware of the tax allowances for people aged over 65, which help to raise many of those on low incomes out of the income tax system. However, the fact that the allowance tapers from £1,385 (£1,645 if aged 75 or over) to £0 for those on incomes over £16,800 (1999-2000 tax year) is less well known. The effect of the taper is to impose a marginal tax rate of 33 per cent on those with incomes of between £16,800 per annum and £19,570 per annum (£20,090 if aged 75 or over).

  The Government is concerned that by increasing the BSP, those with higher incomes will benefit to the same extent as those with lower incomes. Indeed, as the DSS have pointed out, because of the effect of means testing, in absolute (but not proportional) terms, the better off will benefit more.

  To a limited extent, removal of the age allowance "claws back" a proportion of the BSP. This principle could be extended. For example, the 33 per cent marginal tax rate could be extended up to the higher rate tax bracket. After all, those in work have to pay National Insurance contributions on their incomes above the Lower Earnings Limit so effectively pay tax at 33 per cent on all their income above the single person's allowance.

  Extending the tax coverage of the better off elderly can be justified in many ways:

  1.  Concentrating the cost of retirement over the time whilst people are in paid work, means that some people could experience poor working lifetimes and relatively better off retirements. If the cost were spread over all those with the ability to pay, whether in work or in retirement, people's net lifetime incomes could become more stable.

  2.  If the state pension age remains at 65, the elderly will spend an increasing proportion of their adult life in retirement. The extra marginal tax rate could be designed to ensure that the cost of ageing is shared equitably between those in work and those in retirement.

  3.  Those who are better off are likely to have received a tax free lump sum from their pension schemes at retirement. There is little economic rationale for this benefit and it is regressive in the sense that it is more valuable to those on higher marginal tax rates.


  The Pension Credit document notes that the gap between rich and poor pensioners has grown dramatically over the past 20 years. This is partly due to the success of occupational pension schemes. By introducing stakeholder pensions the Government hopes to extend the benefit of retirement saving to the low paid. However, those on above average earnings have a clear playing field on which to plan their savings, since the likelihood that they will be eligible for means tested benefits is small. The lower paid need to have similar clarity in order to plan effectively for retirement.

  The current benefit and tax system neither provides clarity, nor acts equitably across different income groups. Extending the reach of means testing, whilst applying tapers at different rates for different benefits will result in an even more incoherent system. Whilst the Pension Credit will improve the position of those with small amounts of income in addition to the BSP, if it is introduced without significant adjustment, it will become impossible to provide savings advice to those on low to medium incomes (or to their agents). No one who thinks they might fall within the means testing system can be expected to plan rationally in these circumstances.

  The tradition in the UK has been for the state to encourage individuals to save for themselves, whilst recognising that the private sector cannot meet everybody's needs. This is why Beveridge kept means tested benefits to underpin the BSP and private savings. Attempting to underpin private savings through means testing ensures that the private sector will fail the most vulnerable groups. Effectively, means testing institutionalises mis-selling, since certain groups will receive a negative return on their savings, regardless of the private provider's efforts.

  If people on low incomes are to be expected to save for retirement, then the Government has a responsibility to ensure that, in most circumstances, they are able to get a positive return on those savings. It can do this by providing a BSP that is both comfortably in excess of means tested minimum incomes, for those with nearly full working histories, and a reasonable proportion of earnings.

  There will always be circumstances in which people are unable to accrue a full entitlement to BSP, in which case there must be a means tested safety net. But the need for this should only arise in a small minority of cases. In these circumstances we could return to our work with confidence that we are not actually doing our clients and their employees a grave disservice by encouraging the provision of occupational pension schemes.

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