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The Actuary The magazine of the Institute & Faculty of Actuaries

Credit where credit is due

The new State Pension Credit (hereafter referred to as the pension credit) is the latest building block of state pension provision, which currently consists of:
– The basic state pension (BSP).
– The state earnings-related pension scheme (SERPS), which is being replaced for future accruals of benefit by the state second pension (S2P) from 2002/03.
– Special payments to pensioners, such as winter fuel payments.
– Contracting-out arrangements.
– Various means-tested benefits, including the minimum income guarantee (MIG).
Pension credit is expected to start in October 2003 and will consist of two parts. It will subsume the MIG, which will be renamed the guaranteed credit and, in addition, provide a new benefit the savings credit. A person may be eligible for either or both parts of the pension credit.
The introduction of the savings credit means that, for the first time, pensioners may gain from the benefit system as a result of their savings, rather than being penalised because of them.

Drawbacks of the current system
Currently a pensioner who has saved to provide a small pension but still has a total income less than the MIG will have no higher income in retirement than a similar pensioner who has not saved. They will both receive the MIG. The effect of the current means-testing rules is that most poor pensioners with a modest pension would have been better off if they had used the money saved while working to provide a higher standard of living during their working life rather than saving any of it.
The savings credit will mean that a poorer pensioner with a small second-tier pension will now usually receive some extra income over and above the MIG and thus end up with a higher income than a similar pensioner who has not saved. The rationale for this is to encourage lower earners to save.
Currently MIG is the minimum income that the government has set for pensioners, and for those whose income is below this level, their income is topped up on a means-tested basis. In 2002/03 the MIG for a single pensioner will be £98.15pw, which is £22.65pw more than the BSP of £75.50pw for a single person with a full contribution record. For couples, the corresponding figures for 2002/03 are a MIG of £149.80pw and a BSP of £120.70pw, where the wife qualifies for the BSP on her husband’s contributions a difference of £29.10pw.

Increasing gap
The gap between the BSP and the MIG has increased significantly in recent years, as the MIG has been uprated by significant amounts in excess of average earnings increases. The BSP is generally uprated in line with prices, although it has also benefited from above-normal increases for 2001/02 and 2002/03. Pensioners who had low earnings during their working life often have little or no private pension, SERPS, or other savings, and find that their income in retirement is less than the MIG.
To receive the guaranteed credit it is necessary to have reached the female state pension age, which is currently 60, rising to 65 by 2020. To qualify for the savings credit, a person, or their partner (who need not be married to them) must be aged 65 or over. For a couple, their entitlement will be assessed based on their joint financial position.
Government illustrative figures in 2003/04 are £77pw BSP and £100pw MIG for a single person and £123pw BSP and £154pw MIG for a couple. The actual figures are likely to be slightly more than this. If pensioners have less income than MIG levels, the guaranteed credit will increase their income up to this level.
For example
Suppose that a single pensioner aged 65 or over, receiving the BSP of £77pw, has other income. The savings credit will be 60% of their other income up to a maximum savings credit entitlement of £13.80pw. Thus, if the other income (which includes SERPS) were £23pw the pensioner would get no guaranteed credit but the maximum savings credit, and his total income would be £113.80pw, a 14% increase in income compared to the current position. Pension credit is not taxable.
Single pensioners with total income above £100pw will receive less than the maximum savings credit, as the maximum savings credit of £13.80pw is reduced by 40% of the amount by which total income exceeds £100pw.
Figure 1 illustrates the position in 2003/04 for single pensioners with a full BSP of £77pw and various levels of other income.
A single pensioner with total income of £135pw or more from BSP and other income will receive no pension credit. Similar principles apply to pensioner couples. The maximum savings credit for a couple is £18.60pw, and entitlement to pension credit will be extinguished when their total income exceeds £200pw.
If a pensioner is not entitled to the full amount of the BSP, they will not receive any savings credit in respect of that part of their other income equal to the difference between their actual BSP and £77pw.

Five-year entitlement
Another significant change from the current means-testing regime is that, with pension credit, awards will be made for five-year periods, subject to routine adjustments for inflation. There will be a requirement to report a small number of life events and there will also be provision for reassessment where other income levels fall. The move away from a weekly entitlement, as currently applies to MIG, is likely to make pension credit more attractive to those with an entitlement.
The treatment of capital will be more favourable under pension credit than under MIG. Under MIG, if a pensioner has savings above £12,000 they are completely excluded from the MIG. If they have savings between £6,000 and £12,000 the amount of MIG is reduced. Under pension credit, a person’s capital will be assumed to earn a 10%pa return, half the 20% previously assumed, on the amount of capital over £6,000. Amounts of capital under £6,000 (which will apply to about 85% of pensioners getting the pension credit) will be ignored, as will the actual income received on capital. Thus, a person with capital of £10,000 will be assumed to have income of £400pa or £8pw when assessing their pension credit.
The new rules will mean that a single pensioner who receives the full BSP of £77pw but no other pension income can have capital of approximately £18,000 and still qualify for some guaranteed credit, compared to £12,000 under the current rules. Such a pensioner would need capital of approximately £36,000 to lift them above entitlement to any savings credit as well.

Other benefits
Any pensioner who receives the guarantee part of the pension credit will be entitled to full Housing Benefit and Council Tax benefit (HCTB), if they meet the other relevant conditions. This will ensure that pensioners who benefit from the savings credit do not see their gains clawed back by a reduction in their HCTB. However, for those pensioners who only receive the savings part of the PC, the current cut-off limit of £16,000 on savings will apply, and pensioners with more than this will not receive HCTB.
The government expects that over 5m pensioners some 50% of all pensioners will be eligible for pension credit when it is introduced, thus extending means testing to many more pensioners and improving the income of many poorer pensioners immediately.
Government estimates of the cost of the pension credit are £1bn in 2003/04 (half a year) and £2bn in 2004/05. These costs will be met from general taxation, not the National Insurance Fund. The £1bn in 2003/04 is made up of approximately £220m extra HCTB, £450m for the savings credit, and the balance is higher guaranteed credit payments as a result of such things as the more favourable treatment of capital.

The cost
The government has now published estimates of the cost of the pension credit in the longer term. One might expect the costs of the pension credit to grow significantly in future, but this will depend significantly on the way that the MIG threshold (illustrated at £100pw in 2003/04) and the savings credit threshold (illustrated at £77pw in 2003/04) are increased each year. The cost will be greatest if the MIG threshold increases with earnings and the savings threshold increases with prices each year. (Note that the savings credit threshold is not linked to the level of the BSP in legislation.) On this basis the government estimates the cost of the pension credit as £26bn in 2050 in constant price terms. Costs will be significantly lower if the MIG threshold is not increased in line with earnings.
The pension credit represents another step in the process of concentrating improvements in state pension provision on poorer pensioners, following the recent large increases in the MIG and the introduction of S2P, which is much more favourable to low earners than SERPS. o