The single state pension , coming to a pensioner near you , from April 2016 is supposed to be simple. It will operate under the same rules for everyone. But that doesn’t mean that everyone will get the same pension (as this tale tells), and sadly it doesn’t mean that everyone will be winners
One group that look like losing out are the “lucky” people who were in final salary schemes that were and still are contracted out of the State Second Pension (formerly called SERPS).
When Barbara Castle introduced SERPS in 1978, employers who take the trouble to fund and manage defined benefit schemes could pay reduced rate national insurance for those in the scheme, if the scheme chose to contract out and Guarantee a Minimum Pension for the workers.
After 1988, some of the cost of index-linking was passed back to the employer, although the Government was still there to pay the top-up if and when inflation exceeded 3pc.
But, and this is the important bit, the schemes only had to be funded to guarantee a flat rate pension, they did not need to offer top-up increases on the Guaranteed pension because the State would pay these (and pick up the bill).
What’s the problem?
Under the arrangements that take effect from April 2016, these people won’t get the inflation-linking benefit any more. The Government won’t pick up the bill, and if you want your increases back, you’ll have to do it yourself, either from a drawdown arrangement or buying extra state pension (if you are allowed).
In our low-to-zero inflation age, this perk might not seem valuable. But when it comes to pensions, payable over a period of decades, it really is precious.
If a 65-year-old wants to buy an annual income for life of £10,000, without inflation proofing, it will cost about £200,000. If he wants to buy an income for life starting at £10,000 and then rising in line with inflation of 3pc, it will cost £300,000. That’s the value of index-linking.
At the moment, for those who are retired, the Government’s inflation-related contribution to their contracted-out pension is effectively made along with their basic state pension. For these people, nothing will change under the new arrangements.
But when the Government started the move to a single-tier state pension, no provision was made for making inflation-related payments to those reaching state pension age after April 2016.
Are you a loser?
Very probably yes, but possibly no – depending on the extent to which your company has been paying pension increases on your Guaranteed Minimum Pension. I know of one large scheme that thinks it has been paying these increases by mistake!
I work for a firm of actuaries, we spend a lot of our time exploring just what a scheme is or isn’t paying by way of Guaranteed Minimum Pensions. This exciting game is known as GMP reconciliation and it is played on computers by geeks.
The truth is that there has been so much to-ing and fro-ing between the DHSS/DSS/DWP and the occupational pension schemes, that many schemes are unclear whether they’re paying GMP increases and if so, how much.
The conversations are conducted in earnest nowadays as the end of contracting-out means that matters have to be drawn to a close. Long words such as “crystallisation and cessation” are bandied around, to use a more vulgar phrase “the shit is about to hit the fan”.
With the end of contracting out, the cashflow advantage to companies paying reduced rate national insurance comes to an end. This will make carrying on promising to pay the old benefit promises will become even more expensive to companies and to members.
Either contributions will go up, or the scheme will have to move to a different pension benefit structure- typically a defined contribution structure – at least for future pension rights.
The bottom line is that the end of contracting out is bad news for occupational pension schemes and bad news for most people who have been contracted out via a Guaranteed Minimum Pension.
How big a loser?
How much will they (we) lose? That will depend on the size of their contracted-out pension, the rate of inflation and how long they live. But with inflation factored in at 2pc‑3pc, actuaries estimate the figure at up to £20,000 for men and slightly more for women, because they live longer.
Is this a cover up?
Well put it this way, if there’s a shred of comfort for Steve Webb, it’s that he’s not going to have to deal with this mess! The DWP have been, at best, economical with the truth, but since Ruth Gilbert broke this story on this blog , following great investigative work by Richard Dyson in the Daily Telegraph, I’ve been having a few conversations which suggest that the DWP have been at best “economical with the truth”.
In a former guise, this would have been food and drink for Ros Altmann, who’d have had a campaign running on this by now. I am absolutely sure that Altmann knows exactly what is going on and probably has the numbers.
It will be an early test for her, how she manages the communication of this little glitch in what has so far been a very successful project. Was this cut pre-meditated or accidental, is it a stealth tax or a bungle? That’s for Ros to assess and communicate.
What is for sure is that the Treasury will look askance at any special pleas for compensation to those losing out from the glitch. What is interesting to me is to understand to what extent state members of state funded schemes (including the civil service schemes) will be protected.
What about the public sector?
To some extent it may be better that “we’re all in it together” , as those in corporate DB schemes may find the cuts unwelcome but not unfair. If there is a sniff of ring-fencing the public sector increases, that may be another thing.
But the bigger issue is that if the cuts impact public sector DB pensions to the extent they do private sector schemes, then we can expect an outcry from unions like UNITE and UNISON on behalf of the millions of workers who have here-to-now had just about everything indexed to the hilt!