D-day arriving for UK pensions

Analysis
By Julian Knight
BBC News personal finance reporter

Rises in the state pension are to be linked to earnings

After years of talk, D-day is here for the UK pensions system.

What will happen to UK pensions over the next half-century and beyond will be mapped out when the government publishes its White Paper on pensions this week.

It will contain an overhaul of the state pension system and will lead inevitably to people working longer.

The White Paper follows the authoritative and exhaustive work of the government's Pensions Commission, headed by Lord Turner.

The Commission looked at the UK pensions system root and branch and came up with a programme, a route map, for pensions stretching far into the 21st century.

"I think people see that the report took us at least in the right direction and has identified the right issues that need to be tackled," Ros Altmann, governor of the London School of Economics and ex-government pensions adviser, told BBC News.

What we know

The vast bulk of what is in the White Paper is already known.

At a stroke many more women will have a full basic state pension Malcolm McLean, Pensions Advisory Service (OPAS)

A fortnight ago, a deal was brokered between Tony Blair and Gordon Brown to allow the link between pensions and earnings to be restored in 2012 or after.

This will lead to a higher state pension.

As for the Commission's proposal that the state pension age should rise to 68 by 2050, this also looks a racing certainty to make it into the White Paper.

John Hutton, the Work and Pensions Secretary, said in February that a rise in the state pensions age was "inevitable".

HAVE YOUR SAY I sympathise with all who have to work until at least 68 JSB, Derby Send us your comments

However, the increase in the state pension age is expected to be phased in, rising first to 66 in the 2020s.

So the big, headline-grabbing, measures - working longer and higher pensions - seem decided.

State pension reform

If the Pensions Commission blueprint is followed, the White Paper could see fundamental reform of how the state pension works.

GUIDE TO UK PENSIONS Facts and figures outlining the depth of the UK pensions crisis At-a-glance

At present, people have to earn the right to a state pension through paying National Insurance Contributions (NICs).

Men have to make 44 years of NICs and women 39 years to be able to claim a full basic state pension.

But many women take time out of the workforce to look after children and elderly relatives.

As a result, fewer than half of all women earn the right to a full basic state pension.

Add to this the fact that women generally earn less than men and have inferior private pension saving, and it becomes clear why David Blunkett - during his short stint as Work and Pensions Secretary - referred to women's pensions as a "scandal".

With this in mind, the Pensions Commission proposed that entitlement to the state pension could in future be based on residency rather than NICs.

But ditching the contributory principle - which has been at the heart of the pensions system since its inception - has proved a bridge too far for the government.

Instead the government is going to try and find a way for the present system to work better for women.

Mr Hutton in a speech to the Fabian society on 18 May indicated that the number of years it takes for people to qualify for a full basic state pension would be cut to just 30.

"This will definitely help women's pensions. At a stroke many more women will have a full basic state pension," Malcolm McLean, chief executive of the Pensions Advisory Service (OPAS) told BBC News.

In addition, reform of Home Responsibility Protection (HRP) is on the cards.

HRP pays NICs for people who stay at home to look after children and elderly relatives.

"HRP is too complex and inflexible. For example, some people are barred from claiming HRP for the tax year a child is born. Replacing it with a simple flexible credit makes sense," Mr McLean said.

Hard lobbying

The risk is that we will see a levelling down of employer pension provision Alison O'Connell, Pensions Policy Institute

One of the Commission's proposals, widely expected to make it into the White Paper, is the setting up of a National Pension Saving Scheme (NPSS).

Under the NPSS proposal, people who do not belong to a workplace pension scheme would be automatically enrolled.

Employees would contribute 4% of their salary, employers 3% and the government 1%.

The fact that employers would be compelled to contribute to their workers' NPSS has dismayed business.

Business groups have lobbied hard for an employer opt out from the NPSS, but the Whitehall smoke signals suggest that their call has fallen on deaf ears.

But according to Alison O'Connell, director of the Pensions Policy Institute, the NPSS may have an unfortunate knock-on effect.

"The risk is that we will see a levelling-down of employer pension provision," she said.

"In short, this means that employers will shut their more lucrative pension schemes and choose merely pay into the NPSS."

And according to Ms Altmann, "levelling" out could have a dramatic effect on the level of workplace pension saving.

"Most workplace pension schemes involve employers contributing between 5% and 15% of salary," she said.

"If the NPSS sets a 3% minimum then firms are going to cut to those levels. Experience suggests that a minimum contribution level soon becomes a maximum."

Further consultation

Who gets to run the NPSS is up for grabs.

Insurers want a big role, but some critics suggest that the industry is tarred with the brush of pensions mis-selling. In other words, they can not be trusted.

But with the NPSS not supposed to start until 2010, a spokesman for the Association for British Insurers (ABI) told BBC News that the mechanics of how the NPSS will work may be put out to consultation, a view shared by Ms O'Connell.

"As far as the state pension is concerned, we will see definitive reforms but when it comes to the NPSS the White Paper will have the feel of a Green Paper," Ms O'Connell said.

Ultimately, though, the government is likely to go for a hybrid approach; with contributions collected by the government, but the investment managed by insurers and possibly some fund management firms.

Not generous

In a few years time we will need another review of pensions, as things have got worse again and workplace pensions evaporated Ros Altmann, London School of Economics

The White Paper, however much of a landmark, is unlikely to call time on the UK pensions crisis.

For example, there is still the running sore of declining workplace pensions.

"The position of workplace pensions has eroded faster than the Pensions Commission envisaged. Final salary pension schemes have been closing right, left and centre," Ms Altmann told BBC News.

Pension problems will persist

"Ultimately, the legacy of the Commission may well be just a later state pension age and the NPSS. In a few years time we will need another review of pensions, as things have got worse again and workplace pensions evaporated," she added.

But at least the future of the state pension system will be settled. However, it won't be a overly generous future.

Under the Pensions Commission proposals, the proportion of national wealth due to be spent on pensions is only set to rise by a fraction.

In effect, the White Paper sets out a low-cost way to pay for the state pension system, which should prevent recipients from suffering absolute poverty.

However, if people want a comfortable old age they are still going to have to save very hard.