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The Actuary The magazine of the Institute & Faculty of Actuaries

DWP sets out plans for ‘simpler, fairer state pension’

Plans that will see the biggest shake-up of the UK state pension system for generations have been unveiled by the pensions minister, Steve Webb.

The green paper ‘A state pension for the 21st Century’ from the Department for Work and Pensions (DWP) sets out options on how to simplify the system for future pensioners. It includes a single-tier state pension currently estimated at around £140 a week, set above the current guarantee element of Pension Credit. This would replace the existing combination of entitlements that make up the present state pension. It has been calculated that inflation-linked increases will take the means-tested guarantee up to around £155 by the time the changes are implemented in 2015 or 2016.

The DWP says that the aim of the redesign, still based around the contributory principle, is to lift millions out of means-testing over time and put an end to inequalities in the current system that penalise women, low earners and the self-employed.

Secretary of state for work and pensions, Iain Duncan Smith said: "Over the years, small changes to the state pension system have turned what started as a relatively simple contributory system into a complex mess, leaving people utterly confused as to what the state pension means for them.

"We have to send out a clear message across both the welfare and pension system: you will be better off in work than on benefits and you will be better off in retirement if you save."

Steve Webb added: "The current state pension system is dogged by complexity and confusion. It makes it very difficult to save for retirement and leaves millions of people relying on complicated means-tested support.

"I’m proud to bring forward proposals that will end the unfairness inherent in the system and secure a fair, decent and simple state pension fit for the 21st century. These reforms will transform pension saving in this country for millions of people."

The Actuarial Profession responded to the green paper by saying it welcomes moves to simplify the system.

Huw Evans, of the Profession’s pensions committee said: "The Actuarial Profession has argued that a state pension system that is fair, simple, easy to understand and transparent will make it easier for people to make informed decisions about their financial future.

"In 2009, the Actuarial Profession published a book entitled ’100 years of state pension: learning from the past’. We will use the lessons from this research to learn from the mistakes and successes of the past as we play a full and engaged role in the debates and decision making to come."

Otto Thoresen, director general of the Association of British Insurers, also welcomed the plans: "The proposals to create a flat-rate pension are an important move towards a simpler and more understandable pension system. It will help people plan better for their retirement, stop people falling into the means-testing trap and ensure that it always pays to save."

Katja Hall, chief policy director of the Confederation of British Industry said: "One major hurdle the government must overcome is the increase in cost to employers of providing final salary pensions to employees, as a result of abolishing the contracting out rebate in defined benefit schemes. The government is right to be consulting on the state pension age. With increasing life expectancy, we will need to work for longer to pay for our retirements."

Marc Hommel, pensions partner at PwC commented:
"It’s refreshing to have some positive pensions news - any simplification of the current complexity is to be welcomed. The proposed flat-rate state pension provides employers and their workers with greater predictability and clarity on future retirement income, and will help both to more easily plan additional retirement provision. The proposals to end means-testing also make much more workable the requirements to automatically enrol employees into quality pension arrangements. It’s encouraging that the Government is working to ensure state and workplace pensions are fundamentally connected."

"We hope that the Government will make it easy for employers to change their own pension arrangements to link future retirement ages to longevity in the same way as is being proposed for state pensions."

"At long last, employers can now get on with formulating their policies for retirement provisions, taking into account the raft of new legislation and other proposals that have removed the default retirement age, simplified state pensions and ended means-testing, and introduced flexibility in form and timing of taking retirement savings. There is more opportunity now for employers to flex their imagination and design retirement saving arrangements that offer both employers and their workers a better and more appropriate deal."

Bob Scott, senior partner at LCP, said: "The move to a flat rate state pension, and therefore the abolition of the state second pension, will lead to the end of contracting out for DB schemes. A higher flat-rate pension will be seen as good news in the long term but, unless employers make further changes to their DB schemes, they will face extra costs and scheme members will see their pay-packets hit with extra tax / NI charges.

"In total, these amount to 5.3% of relevant salaries, or around £105 a month for someone on average earnings. And, faced with the prospect of yet another round of changes to the DB scheme, some employers might simply decide to close their schemes - which is unlikely to be good news for their members either. Whatever companies decide to do, they will need to consider very carefully how they communicate with their members who are likely to view this as yet another reduction in the value of their occupational pension package."

In a statement Punter Southall commented:

The DWP green paper puts forward two options for reform of the state pension system:
>> The first option is to accelerate current reforms
>> The second, more radical, option is to replace the current state pensions with one flat-rate pension, which would lead to the end of contracting out for defined benefit schemes

Whilst the headlines have been eye-catching, the Government has left the green paper very open and it is unclear at this stage which approach it will favour. The first approach could be just tinkering around the edges, whereas the second would see one of the biggest shake-ups in state pension provision and trustees (and sponsors) should be aware that this proposal would lead to the end of contracting out for defined benefit schemes. No-one can deny the current state pension system is too complicated and reform is long overdue. It remains to be seen what the final proposals will be, bearing in mind the need for them to be affordable.