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Security in retirement:towards a new pensions systemMay 2006



Security in retirement:towards a new pensions system

Presented to Parliament by

the Secretary of State for Work and Pensions

by Command of Her Majesty

May 2006

Cm 6841 £27.00





ContentsPrime Minister’s Foreword .................................................................................. v

Foreword ................................................................................................................... vii

Executive summary ................................................................................................. 1

The National Pensions Debate ........................................................................... 27

Chapter 1: Encouraging and enabling private pension saving .............. 29

Chapter 2: Strengthening existing provision ................................................ 83

Chapter 3: Providing a foundation for private saving .............................. 101

Chapter 4: Extending working life in an ageing society .......................... 137

Chapter 5: Consultation arrangements ........................................................... 159

Annex A: Measuring undersaving for retirement ........................................ 165

Annex B: Improving fairness in the state pension system –technical detail ..................................................................................... 169

Annex C: Adequacy in pensions outcomes ................................................... 174

Annex D: The extent and impact of demographic andsocietal change .................................................................................... 176

Annex E: Outcomes under the reformed system – further detail ......... 190

Annex F: Research and evidence ....................................................................... 200

Annex G: Glossary .................................................................................................. 203

Regulatory Impact Assessments and technical appendicesare published alongside this document.





Prime Minister’s Foreword I am proud of what the Government has achieved for pensioners. We saidour first priority would be tackling pensioner poverty. There is more to do,but since 1997 two million pensioners have been lifted out of poverty.Thanks to measures like the Pension Credit, Winter Fuel Payments, freeTV licences and above-inflation increases in the basic State Pension,pensioners are now less likely to be poor than the population as a whole.

But while pensioner poverty was the most pressing problem, we also have

to address, like countries across the world, the long-term challenges andopportunities of an ageing society. In particular, we need to put in place

an affordable and sustainable pension system which meets the needs of generations to comeand encourages people to save for their retirement. It was to chart the way to meet thesechallenges that we set up the independent Pensions Commission four years ago.

The reforms we are proposing are based on its report. They take forward our modernisationof the welfare state and simplify the pension system and its contributory principle, create andreward a new culture of saving, are fairer to women and carers and continue to target mostresources on those most in need.

It is a bold blueprint. It involves difficult decisions for everyone – Government, business, thepensions industry and individuals. But thanks to the work of the Pensions Commission, weknow already that there is wide support for the principles behind these reforms.

Over the coming months, we will work to build on this support to forge a nationalconsensus. We know this will not be easy but tackling long-term challenges rarely are. Ourobjective is to put in place a sustainable, affordable and trusted pensions system which willmeet the needs of those in retirement and our country in the future.

The Rt Hon Tony Blair MP

Prime Minister’s Foreword v





Foreword Today we face the challenge of profound social and demographic changethat demands a new kind of policy response. The immediate crisis ofpensioner poverty is being successfully addressed, but the next challengeis just around the corner. In the next 50 years, the number of people overpension age will increase by more than half and there will be only twopeople working for every one person in retirement – compared with fourtoday.

Millions of people today are not saving enough for their futures. And ourpension system suffers from structural problems. Because of the historical

legacy of complexity few people understand how it fits together. It is unfair to many whoare caring for others, and particularly to women. It reflects a view of family relationships thatdates back to the early years of the State Pension itself.

As the Pensions Commission has made clear, we face some stark choices about the pathahead. We don’t want the retirees of the future to be worse off than those today. Butneither should our response be simply to spend more public money on the State Pensionalone. A new balance must be struck between State, employers and individuals to share the

responsibility to save and provide for the future.

To meet these new challenges any reforms must meet five key tests. They must promotepersonal responsibility, be fair – particularly to women and carers, and provide greatersimplicity so that roles are clear. They must be affordable, and offer a sustainable solutionthat commands a national consensus. Our proposals for reform are designed to meet thesefundamental requirements.

The proposals in this paper set out a new structure for the UK pensions system for the longterm. I’d like to thank the Pensions Commission for their hard work in creating the basisfor consensus. We can now lay the foundation on which this generation and the next can

work and save for a long and healthy retirement. And they can do so in confidence that thereforms we are proposing will last between the generations.

The Rt Hon John Hutton MP

Foreword vii





Executive summary

1





Executive summary 3

Executive summary

Progress since 1997

Tackling pensioner poverty – our first priority

1. Government has a responsibility to protect its citizens against poverty and insecurity inretirement. The actions we have taken since 1997 – establishing Pension Credit, WinterFuel Payments and real terms increases in the value of the basic State Pension – have

helped pensioners escape from poverty.

2. This Government introduced the Minimum Income Guarantee for pensioners, now partof the Pension Credit, which has raised the minimum income pensioners are entitledto from £68.80 a week in 1997 to over £114 today. More than 2 million pensionershave been lifted out of absolute poverty, and 1 million out of relative poverty. Andwe have seen sustained increases in pensioner incomes, with the poorest benefitingmost. Pensioners are now less likely to be poor than younger people. In addition,the savings reward in Pension Credit has tackled the penalty of the 100 per centmarginal deduction rate that many savers faced, for the first time rewarding 1.9 millionpensioner households who saved for retirement.

3. The years of economic instability and high unemployment in the 1980s and early1990s were damaging to pensions and pensioners. High inflation eroded the value ofsavings. Unemployment, which hit 3 million twice, denied millions the opportunity tobuild additional pension entitlements. Uneven and unsustainable growth made it harderto plan for the future with confidence. Thanks to the Government’s commitment tomaintain economic stability, invest in Jobcentre Plus and the New Deal, and make workpay, Britain now has the highest employment rate of any of the G8 countries. Some2.3 million more people are now in work compared to 1997.

4. These policies have brought significant benefits for pensioners. The high rate ofemployment has given more people the opportunity to save for their retirement, andhas helped contribute to stable growth in the economy. The Government is committedto maintaining this macroeconomic stability.



Improving the pensions system

5. We now spend £10.5 billion a year (nearly 1 per cent of GDP) more on pensionersthan we would have done if we had simply continued the policies we inherited in1997. Combined with growth in private pension saving, this has meant pensionerincomes have risen across the board, with the poorest benefiting most. We haveachieved these gains while maintaining the affordability of the system as a whole.

1

4 Executive summary

1 Throughout this paper and the accompanying Regulatory Impact Assessment, the costs of reform of private pensions arepresented on a 2005/06 price base (the latest year for which actual prices are available). Estimates of expenditure on state

pensions are presented on a 2006/07 price base, consistent with our latest estimates of long-term public expenditureprojections. Both reflect best practice for their respective purposes. The difference in base year has a slight impact on costsin £, but the estimates are consistent when looked at in terms of percentage of GDP.



6. In addition to tackling pensioner poverty, the Government has taken significant steps toimprove other aspects of the pensions system since 1997.

7. We introduced the State Second Pension in 2002, crediting in low earners and somecarers who missed out on its predecessor, the State Earnings-Related Pension Scheme(SERPS). Consequently, some 4 million people now have the chance to build up adecent additional pension for the first time. We introduced stakeholder pensions andrequired that all employers with five or more employees should provide access eitherto a stakeholder pension or to an occupational scheme, as an important step towardsencouraging more private saving and bringing down the cost of saving.

Executive summary 5



8. The Pensions Act 2004 has improved security and confidence for occupational pension

scheme members. The Pension Protection Fund (PPF) means that over 10 millionmembers of salary-related pension schemes know that they will receive compensationif their employer becomes insolvent and the pension scheme is under-funded. TheFinancial Assistance Scheme (FAS) will help groups close to retirement who lost outbefore the PPF was established. Following the Prime Minister’s announcement toexpedite the review of the FAS planned for CSR07, the Government has decided toextend the FAS so that it will assist eligible people who were within fifteen years oftheir scheme pension age on or before 14 May 2004. This should ensure that up to afurther 30,000 people who lost significant amounts when their pension schemes werewound up, will benefit from the new arrangements. Under this extension, schemebenefits will be tapered so that the Government will pay the full 80 per cent to those

within seven years of scheme pension age, 65 per cent to those within eight to elevenyears of scheme pension age and 50 per cent to the remainder.

9. The Pensions Regulator will help to protect members’ benefits and promote goodadministration of work-based pension schemes. It has wide powers to investigateschemes and take action where necessary and takes a proactive, risk-focusedapproach to regulation. The Regulator also provides practical support for the regulatedcommunity. And the Finance Act 2004 swept away the complexity of many separatetaxation regimes, replacing them with a single, flexible regime based on the simpleconcept of a lifetime allowance of £1.5 million for tax-privileged pension saving.

10. We have also supported private saving by helping people to make better informedchoices about their retirement, introducing a range of pension forecasts to giveindividuals an understanding of the income they are likely to receive in retirement. Sincetheir introduction, the Government has issued just over 20 million of these forecastsand we are developing web-based retirement planning services.

11. We have taken steps to outlaw age discrimination and promote older working. Wehave set a long-term aspiration to reach an employment rate equivalent to 80 per centof the working-age population, including a million more older workers.

12. As the Pensions Commission made clear, private pension incomes are at an all-timehigh. Living standards have risen for all, but, over the past 25 years at least, more forpensioners than for working-age adults.

The case for further reform

13. So we have already made great strides to tackle the immediate problem of lowpensioner incomes and put in place necessary reforms to help people plan for thefuture. But we have long recognised that further steps would be needed to ensurethat people could get the retirement income they expect in the future. In December2002 we established the independent Pensions Commission, to review the regime forUK private pensions and long-term saving. We asked it to consider the longer-term

Executive summary



challenges faced by the pensions system and whether the existing voluntary pensions

regime represented an adequate response. The Pensions Commission concluded thatthere is no immediate ‘pensions crisis’, but it outlined those key longer-term challenges,and the need for early action.

Demographic and social change

14. Today, people can expect to live longer than ever before. In 1950, a man aged 65 couldexpect on average to live to the age of 76. Today, he can expect to live to 85, and by2050 to 89. Women will live for even longer – on average, perhaps, into their earlynineties. This is a huge change, ranking among the greatest social achievements of thelast century.

15. At the same time, lifestyles and expectations for working life and retirement havechanged dramatically since the UK state pension system was first created. In 1948,divorce and remarriage were relatively rare, and it was not unusual for a man orwoman to spend their whole working life with one employer.

16. Today, men and women work throughout their lives, and we recognise the value ofthe service that carers, both of children and of people with disabilities, contribute tosociety. It is much more common for people to be involved in more than one long-termrelationship in the course of a longer life. And it is more likely that people will work

for a number of different employers, and mix periods of working, caring, and studyingduring the course of their lives.

17. Increasing longevity is something that we should celebrate, but it also raises significantchallenges. These challenges aren’t unique to the UK or specific to governments.Ageing societies are a challenge facing most of the industrialised world, and in manycountries state spending is projected to rise to meet that challenge. Figure 3 illustratesthe rising dependency ratio for other countries. Some of these countries have alsoshown the dangers of establishing unsustainable policies, requiring them to reducecommitments.

Executive summary



18. In addition, we are about to experience a dramatic acceleration in the dependency ratio– the balance between the numbers of people of working age and those over StatePension age. Rising longevity means this is on a long-term upward trend. However,with the large cohort of baby-boomers born just after the Second World War swellingthe workforce, this ratio has been artificially depressed in recent decades. As thatgeneration goes through to retirement, we will rapidly catch up with the long-term trend.

19. Figure 4 shows the pensioner population as a percentage of the working-agepopulation. In 1950, this ratio stood at just 19 per cent. Today, it has risen to around

27 per cent. By 2050, once the ratio has caught up with the underlying trend, it mightbe 47 per cent. This demographic shift is transforming the context for pensions policy.

Executive summary



Undersaving for retirement

20. Retirement undersavers can be defined as those who are likely to receive an incomethat does not provide for their reasonable expectations of quality of life duringretirement. These expectations will vary to reflect different circumstances andaspirations – and consequently a single, fully comprehensive measure of undersavingfor retirement is not easily identifiable. However, some analysts have used the ideaof replacement rates, that is income in retirement as a percentage of an individual’sfinal salary. In providing an income for their retirement, individuals will have differentintentions regarding their retirement age and different types of assets at their disposal.In addition to pensions, they may have other financial and non-financial assets,

including property. Total net wealth is now higher than it has ever been before, havingrisen by around 60 per cent in real terms since 1997. However, the numbers of peoplesaving in pensions vehicles are declining.

Executive summary



21. Since the 1970s, employers have been retreating from occupational pensions as rapid

increases in life expectancy and then the end of the high equity market in the late1990s pushed costs higher than had been anticipated when occupational pensionschemes were designed. This trend has continued, with 2 million fewer members ofopen private sector occupational pension schemes in 2004 than in 2000.2

22. Occupational schemes have changed in nature as well as decreasing in scale, with ashift from defined benefit (DB) to defined contribution (DC).

10 Executive summary

2 GAD survey.



23. The Pensions Commission suggested benchmark replacement rates which vary by

in-work income. Their analysis found that between 9.6 million and 12 million peoplewere saving at a rate which would not deliver them retirement incomes in line withthose benchmark rates.

24. Retirement undersaving has arisen for a variety of reasons: because individuals havenot trusted private pensions, because suitable savings vehicles have not been available

to them, and because, in the face of a historically complex pensions system, financialshort-sightedness and inertia have left inaction as the default option.

Executive summary 11

3 IFS analysis of ELSA (to be published 2006).



25. Stakeholder pensions reflect our belief that the workplace provides the best

environment for delivering private pensions. But although over 2.7 million stakeholderpensions have been sold, they have highlighted the areas where further action needsto be taken, especially for those people not traditionally served by the savings market.Barriers to saving mean that, unprompted, people often do not take the decision tostart saving – and as people move jobs, persistency in pension saving is low. This meansthat administration, advice and sales costs for providers are high, and makes it difficultfor them to serve some sectors of the market profitably.

26. We need to do more to overcome these barriers to saving and drive costs down stillfurther. Information and significant financial incentives are often insufficient. A long-standing feature of the UK pensions system has been its complexity, which can confuse

both employers and individuals trying to make the best financial decisions for the longterm. The high cost of saving for those without good employer-based provision anda lack of access to suitable products remains problematic. In other words, and as thePensions Commission has concluded, the current structures need to be reformed toaddress the challenges of an ageing population.

27. As well as saving more in response to increased life expectancy, many individualswill choose to work longer in order to build up a retirement income that meetstheir expectations. More years in work can enable greater accruals of state pensionentitlements as well as providing the opportunity to save more. Since 1997, the

employment rate of those aged between 50 and State Pension age has increased from65 per cent to over 70 per cent, and there are now more than a million individuals overState Pension age who are in work.4

Inequalities in the state pension system

28. The pensions system we have today is rooted in the society of the 1940s. Societyhas moved on and, unless we act now, women and carers retiring in the next twodecades will continue to suffer the effects of the system of contributions which appliedduring their working lives. Figure 7 shows that among those recently reaching StatePension age, around 85 per cent of men have entitlement to a full basic State Pension,

compared with only about 30 per cent of women. The introduction of Pension Credithas improved the position of women, who represent two-thirds of those to havebenefited from its introduction. We published a detailed analysis of the pensionsposition of women – past, present and future – with an analysis of the effect of existingNational Insurance rules in the Department for Work and Pensions Research ReportWomen and pensions: The evidence, in November 2005.


4 LFS 2005 spring quarter.



Complexity

29. The first State Pension – a means-tested scheme for those aged 70 or over – wasintroduced in 1908. Since then, a series of legal and other changes have modified,reformed and adjusted that simple provision, towards a pensions system todaydescribed by the Pensions Commission as the most complex in the world.

30. Our changes to the state pension system since 1997 have been essential to tackle theimmediate problems that we found, and, as we have set out, they have been verysuccessful. Incentives to save in the current system remain strong. Recent research hasshown that incentives for many on low incomes have improved as a direct result of theintroduction of Pension Credit.5

5 Weale M, van de Ven, J, Sefton J, and 2005, The effects of means-testing pensions on savings and retirement, NationalInstitute of Economic and Social Research (NIESR).




31. Problems with incentives could, however, develop if a pensions system evolved in which

a significant majority of pensioners were entitled to Pension Credit in the long term.That has never been the intention of this Government.

History of pensions legislation

10 The Liberal Government came forward with a plan for a non-contributory pension.Implemented from January 10, this ‘Lloyd George Pension’, worth 5 shillings, waspayable equally to men and women from age 70.

111 The National Insurance Act required workers and employers to pay compulsoryflat-rate contributions for health and unemployment cover. The insurance scheme was

extended in 1926 to provide contributory pensions for old-age, widows and orphans.

14 The basic State Pension was introduced as a universal State Pension in return forflat-rate contributions paid by all workers and their employers (except by married women,who could opt out).

11 Graduated Retirement Benefit (GRB) introduced three new concepts to stateprovision: earnings-related contributions, an earnings-related pension, and contracting outof GRB for those with occupational pensions.

14 A legal base for regular uprating (by the best of prices or earnings) was introduced.The ‘best of’ legislation ended in 1 and was replaced by a prices link.

1 The State Earnings-Related Pension Scheme (SERPS) was introduced to replaceGRB, which had been wound up in 1975.Home Responsibilities Protection (HRP) wasintroduced for carers.

15 The Pensions Act established an equal State Pension age of 65 – to be phased inbetween 2010 and 2020 – strengthened the regulation of occupational pensions, andaltered the terms for contracting out of SERPS.

2002 SERPS was replaced by the State Second Pension providing low earners witharound twice the pension they would have earned under SERPS.

2004 Pensions Act (see paragraph 8)

Alongside the contributory system, a comprehensive means-tested pension has developed.Means-tested Supplementary Pensions were introduced in 141. National Assistance,introduced in 14, was replaced with Supplementary Benefit in 1, then withIncome Support in 1 (developing into the Minimum Income Guarantee in 1),and with Pension Credit in October 2003.




Looking to the future

32. To address these challenges, we established the Pensions Commission in December2002. We asked it to review the operation of the UK pensions system and makerecommendations for reform. In November 2005 the Commission published itsrecommendations.

33. The Government has set five tests for the reform package, building on our successesand principles for reform to date. Any reformed pension system must:

• promote personal responsibility: tackling the problem of undersaving forretirement;

• be fair: protecting the poorest, and being fair to women and carers, to savers, andbetween generations;

• be simple: clarifying the respective roles of the State, the employer and theindividual;

• be affordable: maintaining macroeconomic stability and striking the right balancefor provision between the State, the employer and the individual; and

• be sustainable: setting the basis of an enduring national consensus, while being

flexible to future trends.

34. Having assessed the recommendations of the Pensions Commission, we will:

• Introduce low-cost personal accounts to give those without access to occupationalpension schemes the opportunity to save. People will be automatically enrolled intoeither their employer’s scheme or a new personal account, with the freedom to optout. Employers will make minimum matching contributions.

• Improve the foundation for all while continuing to tackle pensioner poverty. We will

reform the state pension system by uprating both the guarantee element of PensionCredit and the basic State Pension in line with earnings growth, rather than prices.We will make the State Pension fairer and more widely available and we will raisethe State Pension age in line with increasing longevity.

35. The reforms set out here will make an immediate difference to those working andsaving for retirement, striking a new balance of responsibility between employer, Stateand individual. At the same time, we will continue to protect the poorest pensionersfrom poverty, and we will ensure that all pensioners share in rising national prosperity.We will bring forward legislation on these reforms during the second session of thisParliament.




A new pensions settlement: our proposals for reform

Our first priority is to make it easier for more people to save more for theirretirement. To achieve this, in 2012 we will introduce the following:

36. A new scheme of personal accounts, which will provide a straightforward opportunityto contribute to a high-quality, low-cost savings vehicle. The scheme will have thefollowing key features:

• Employees will contribute 4 per cent of a band of earnings of between around£5,000 a year and £33,000 a year.

• Employers will make minimum matching contributions of 3 per cent on the sameband of earnings.

• A further 1 per cent will be contributed in the form of normal tax relief.6

• There will be support for all employers during the introduction of compulsoryemployer contributions:

– their contributions will be phased in over a three-year period, at the rate of 1 percent each year;

– the contribution rate will be set out in primary legislation to create stability;

– the priority is to design the scheme and the transition phase so that burdens onemployers are minimised; and

– we will consult on transitional support for the smallest businesses and whether alonger phasing period is needed.

• Automatic enrolment for employees into either the new personal accounts schemeor their own employer’s occupational scheme providing it meets a minimumstandard:

– Employees will be able to opt out of this provision, in which case the employerwould not contribute;

– Non-employees, including the self-employed and non-workers, will be able to optinto the scheme.

The new system of personal accounts with automatic enrolment will provide a simpleand straightforward way for people to take personal responsibility for the income they

want in retirement.

1 Executive summary

6 1 per cent represents basic rate tax relief on individuals’ contributions – in addition, individuals may be entitled to higher-ratetax relief and neither employers nor employees pay tax or National Insurance contributions on employer contributions.



Initial analysis suggests that the best delivery model for the personal accounts scheme

is that proposed by the Pensions Commission, but the Government will conduct furtheranalysis of this, and industry alternatives, in order to strike the right balance betweenvalue for money for the taxpayer and value for money for the saver. We will bringforward proposals later this year.

Secondly, in order to make the system of personal accounts effective, we willprovide a solid foundation on which people can save. To achieve this, we willreform state pensions so that they are simpler and more generous, and will ensurethat pensioners share in rising national prosperity.

37. During the next Parliament, we will re-link the uprating of the basic State Pension to

average earnings. Our objective, subject to affordability and the fiscal position, is to dothis in 2012, but in any event by the end of the Parliament at the latest. We will makea statement on the precise date at the beginning of the next Parliament.

We will also:

• reform the State Second Pension so that it becomes a simple, flat-rate weeklytop-up to the basic State Pension. Accruals will gradually start to become flat rateat the same time as we start to uprate the basic State Pension by earnings. Weestimate that the State Second Pension will become completely flat rate around

2030 or shortly afterwards; and

• ensure that, before implementing the earnings link of the basic State Pension,means-tested provision continues to be focused on those with small savings, bytaking steps from 2008 to target the Pension Credit on this group.

Thirdly, from 2010, we will make the State Pension fairer and more widely available.

38. We will radically reform the contributory principle, by recognising contributions tosociety while retaining the link between rights and responsibilities. This will be achievedby the following measures:

• streamlining the contribution conditions to the basic State Pension by reducing thenumber of years needed to qualify to 30;

• replacing Home Responsibilities Protection with a new weekly credit for thosecaring for children;

• introducing a new contributory credit for those caring for severely disabled peoplefor 20 hours or more per week;

Executive summary 1



• abolishing the initial contribution conditions to the basic State Pension, so that

caring for children or the severely disabled will build entitlement to the basic StatePension, without having to make a minimum level of contributions; and

• making a number of other simplifications to the rules for entitlement to the basicand State Second Pensions, and abolishing a number of complicated and out-datedprovisions such as adult dependency increases and autocredits.

The current system is unfair to those with caring responsibilities, who tend to bewomen, and means that their social contributions are not fully recognised by the statepension system. This modernised contributory system will better reflect the differentways in which people contribute to society, and will ensure that carers have improvedopportunities to build State Pension entitlements.

Fourth, we will support and encourage extended working lives.

39. We will:

• gradually raise the State Pension age in line with gains in average life expectancy.The State Pension age for women is already due to rise from 60 to 65 between2010 and 2020, to equalise with men’s State Pension age. There will be asubsequent rise for both men and women which will follow the same approach,

beginning with a rise from 65 to 66 over a two-year period from 2024, then againby one year over a two-year period from 2034 and from 2044; and

• take measures to support longer working, as set out in the publication A new deal for welfare: Empowering people to work , and consider greater flexibility around,and communication of, State Pension deferral.

We note the Pensions Commission’s suggestion that the age at which people becomeentitled to the Guarantee Credit in Pension Credit could remain at 65, in order toprotect those with the lowest life expectancies. We think this is an issue that mustbe considered nearer the relevant time in the light of the available evidence about

inequalities in life expectancy and trends in working among older people.

We also propose to periodically commission reviews, drawing on a range ofindependent expert advice in the light of emerging evidence on demographic change.

40. The increased State Pension age will share the growth in life expectancy between timespent in work and time spent in retirement, and it will secure the financial stability andsustainability of the state pension system for the long term.

1 Executive summary



Finally, we will streamline the regulatory environment.

41. We will do this by:

abolishing contracting out for defined contribution schemes at the same time asre-linking the uprating of the basic State Pension to average earnings;

• reducing burdens on schemes by bringing forward legislation to allow schemes toconvert Guaranteed Minimum Pension rights into scheme benefits;

• introducing a rolling deregulatory review of pensions regulation, in light of thePensions Act 2004;

• piloting a Pensions Law Rewrite Project; and

• re-examining the existing regulatory landscape.

Any such simplifications will be aimed at easing the regulatory burden on employerswho provide good occupational pensions. They, and other measures in the proposedreform package, will be taken forward with regard to the Government’s wider agendato promote better regulation and reduce the administrative burdens on business.

•

Executive summary 1



Key outcomes of the reforms• Everyone will be able to enrol into a new, low-cost personal account;

• Automatic enrolment ensures that employees will be saving for a pension unless theyactively decide not to do so;

• Up to 10 million people could be saving in a personal account;

• By retirement, their pension funds could be worth up to around 25 per cent morebecause of lower charges;

• In 2010, 70 per cent of women reaching State Pension age will be entitled to a fullbasic State Pension, compared to 30 per cent now;

• By 2025, over 90 per cent of women and men reaching State Pension age will beentitled to the full basic State Pension – compared to about 80 per cent withoutreform;

• By 2050, the basic State Pension could be worth twice as much as if it had been linkedto prices;

• Anyone who has been in employment or caring throughout their working life couldreceive £135 a week at retirement in state pensions – which is £20 a week above theguaranteed income level;7

• Fewer pensioners – down to around a third by 2050 – could be entitled to PensionCredit.


7 These figures are relative to average earnings. If expressed in 2005/06 prices, following these reforms, an average earner

retiring in the 2050s will receive £340 per week in state pensions.






Meeting the five tests for reform

We believe the reform package set out in this Paper meets the five tests for reform:

Personal responsibility

42. Automatic enrolment will ensure that employees have automatic access to aretirement savings vehicle. We will also ensure that the self-employed and non-workershave access to the scheme of personal accounts. Everyone will have the opportunity tosave easily, as an essential step towards tackling undersaving for retirement.

43. We need to be clear that individuals must be responsible for their own plansfor retirement. The reforms will ensure the provision of high-quality savings vehicles,and a solid state foundation to private savings. But the choice of how much to save,the level of risk to take with investments, and how long to work must be available tothe individual. That provides the right balance of choice and support for individualresponsibility.

44. Through these reforms people should see greater return from their private savings thanthey would under today’s system.

Fairness

45. Protecting the poorest. We are committed to uprating the Guarantee Credit forpensioners in line with earnings growth. This means that the value of the £114guaranteed minimum income for single pensioners today will continue to keep pacewith the growth in national wealth.

46. We are creating a system which establishes a new contributory principle for statepensions. We are committed to the principle of giving ‘something for something’,rewarding those who have worked and cared for decades before retiring. Our measuresto reform the contributory rules for the basic State Pension and State Second Pensionwill achieve that.

47. Cutting the number of qualifying years required for entitlement to the basic StatePension will immediately give fairer outcomes, particularly for women. All those whohave worked or cared for 30 years will get full entitlement to the basic State Pension.Under the current system, around half of women reaching State Pension age in 2010would have received a full basic State Pension. Under our reforms, that proportion willrise to around 70 per cent. And, by 2025, over 90 per cent of people reaching StatePension age will get a full basic State Pension.

48. We will widen access to high-quality private savings schemes. We expect that

around 6 to 10 million people might be enrolled in the new scheme of personalaccounts once it is fully rolled out.




49. We have set the rate of contribution for the new scheme of personal accounts so as

to strike a fair balance between the contribution needed from employers and fromemployees. We are also setting a fair and lasting balance between the generations.Current workers must both pay for provision for today’s pensioners (through NationalInsurance) and save more for their own future. We have had to strike a balancebetween what it is right and reasonable for them to provide in order to improve thesituation for those retiring in the next decades, the rate at which we can afford touprate the basic State Pension, and the expectation on today’s and tomorrow’s workersto save more for themselves.

Simplicity

50. The Pensions Commission observed that “the UK has the most complex pensionssystem in the world”. The combination of our reforms to state and private pensions willdramatically simplify the system, and make the decision to save a very straightforwardone for individuals.

51. Our reforms of state provision will simplify the system considerably. The earnings-linked foundation of the basic State Pension will ensure that the decision to save can bemore straightforward. Our reforms to coverage will ensure that many more people canbe confident of entitlement to the full basic State Pension.

52. Automatic enrolment gives access to private savings vehicles to people ofworking age. For eligible employees, unless they choose to opt out, joining that schemewill be automatic. Taken together, these reforms will mean that it is much simpler forindividuals to save.

53. We will also simplify the rules and structure for private provision through:

• changes to contracting out which will help to simplify the savings decision; and

• a review of current legislation and the regulatory landscape.

Affordability

54. Figure 9 shows the latest cost figures based on a 2012 start-date for the earningsuprating of the basic State Pension. As paragraph 37 sets out, our objective, subjectto affordability and the fiscal position, is to uprate the basic State Pension by earningsfrom 2012 but in any event at the latest by the end of the Parliament. We will make astatement on the precise date at the beginning of the next Parliament.






Sustainability

55. Fundamental to the problems we face with pension provision today is a lack of trustand understanding between individuals, employers and the state as to their respectiveroles and responsibilities in pension provision. We need to reset that balance. But wealso need to reform the system so as to give trust and confidence to all parties that thisis a sustainable deal for the long term. We need consensus that this is a sensibleway to strike the balance. And we need to set up the system in such a way that it canrespond flexibly to future societal changes.

56. The National Pensions Debate was established in February 2005, with the secondphase beginning in December that year. Overall, the Government has heard the views

of nearly 10,000 people in face-to-face discussions and via DWP’s website.

57. This was just part of an extensive programme of Government consultation withstakeholders. We are confident that the solution we have reached strikes the rightbalance between the views of all those parties affected. The National Pensions Debateclearly shows that out of the four alternatives identified by the Pensions Commission,people want a solution that strikes a balance between saving more, redirecting statespending on pensioners, and a rise in the average retirement age. Our proposedreforms strike exactly that balance.

Northern Ireland58. The provision of social security and pensions in Northern Ireland is governed by

the long-established and widely accepted policy of parity with Great Britain. TheGovernment believes that this should remain the basis of future provision in NorthernIreland and will have regard to it in implementing any proposals set out in this paper.

Conclusion

59. These reforms set the direction for the long-term future of pensions and retirementsavings. They will create a system that is coherent, comprehensive and which willstand the test of time. The reforms meet our five key tests and strike the right balancebetween the responsibilities of the state, the individual and the employer.

60. We welcome comments on these proposals.






The National Pensions DebateThe National Pensions Debate was launched in February 2005 with the publication ofPrinciples for reform: The national pensions debate. Over the course of 2005, Ministersfrom the Department for Work and Pensions (DWP) met with members of the public andregional stakeholders across the UK, aiming to:

• raise awareness of the tough decisions that society faces in ensuring a fair andadequate retirement income for all in the future; and

•allow the UK public to have their say on emerging options for reform of the UKpensions system.

BackgroundBetween June and November 2005, Ministers held eight National Pensions Debates indifferent regions across the country, to raise awareness of the tough pensions choiceswe face and to allow the public to engage in the debate and share their thoughts andexperiences regarding pensions. At the same time, Ministers engaged with regionalstakeholders on these issues.

With the publication of the independent Pensions Commission’s proposals for reform

in November 2005, the focus of the National Pensions Debate switched to deliberativeconsultation, using the broad framework of the Pensions Commission’s second report as abasis for discussion with both stakeholders and the general public.

StakeholdersIn order to build consensus for a long-term pensions settlement, on 18 January 2006DWP Ministers held the first of two seminars with Age Concern, the Association ofBritish Insurers, the Confederation of British Industry, Help the Aged, the InvestmentManagement Association, the National Association of Pension Funds and the TradesUnion Congress. These and other organisations were also engaged in the debate throughmeetings with Ministers.

At an event on 28 February 2006, representatives of the pensions industry presented forin-depth debate alternative models to the Pensions Commission’s proposed NationalPension Savings Scheme. The event was attended by DWP Ministers, MPs, Lords, PensionsCommissioners, Regulators and representatives of employers, consumers, the financialsector, and government departments.

National Pensions DayAs part of the ongoing National Pensions Debate, regional events were held inSouthampton on 18 February 2006 and in Manchester on 25 February 2006. These events

were also used to inform the development of a National Pensions Day. Materials at theevents were refined following feedback from participants and observers.

The National Pensions Debate 2



2 The National Pensions Debate

A Citizens Advisory Panel was set up to consider the materials and provide a realisticviewpoint on their content. The panel was made up of members of the public andmatched the demographic profile of the sample that was used for the deliberative events.

The National Pensions Day, which took place on Saturday 18 March 2006, was adeliberative consultation exercise organised by DWP in conjunction with the research-based consultants, Opinion Leader Research. Over 1,000 participants attended six eventsheld simultaneously across the UK. These events took place in London, Birmingham,Newcastle, Glasgow, Belfast and South Wales. Those attending were asked to considerand vote on the broad framework of the Pensions Commission’s proposals.

Views were also collected through an online debate and via feedback from stakeholder-run events.



29

Chapter 1:Encouraging andenabling privatepension saving

29





Chapter 1: Encouraging and enabling privatepension saving

Summary

Millions o people are not currently saving enough to meet their expectations or incomeonce they retire. There are persistent and powerul barriers to people taking the long-termsavings decisions that would be needed to address this problem. These include inertia,nancial myopia, the cost o pension saving and the complexity o the decisions involved.

The Government will respond to that challenge with a radical reorm o private pensionsaving in the UK.

First and oremost, we need to tackle at source these barriers to saving, to create anenvironment in which individuals take personal responsibility or ensuring that theiraspirations or retirement income are met.

In order to achieve this, we will:

• introduce a new pension saving scheme o low-cost,portablepersonalaccounts,making private saving truly accessible or all;

• introduce automaticenrolment into a private pension or all employees, to maximisecoverage and combat savings inertia;

• set a nationalminimumemployercontributiono3percent, between earnings oaround £5,000 and £33,000 a year; and

• set a minimumoveralllevelocontributiono8percent or the personal accountso employees and encourage additional contributions rom employees.

These reorms are a key part o our strategy to meet the ve tests or pension reorm. Inparticular they will help to promote personalresponsibility, by helping to overcome thebarriers to saving; simpliy the system or individuals, by clariying the savings decisionsthey need to take; and make the system air, by ensuring access to high-quality, low-costprovision or all.

Chapter1 • Encouraging and enabling private pension saving 31



32 Chapter1 • Encouraging and enabling private pension saving

The challenges acing the pensions system

Currentpensionersarerelativelywellprovidedor

1.1 As the Pensions Commission made clear, private pension incomes are at an all-timehigh and, or the irst time ever in a period o economic growth, pensioners are lesslikely to be at risk o poverty than younger people.1

1.2 A key driver o improvements in pensioners’ incomes has been private pensioncoverage and generosity. Recent retirees have beneited rom relatively generousdeined beneit (DB) occupational pensions and also rom historically good rates o

return in deined contribution (DC) pensions.

1.3 Other actors have also boosted the income and assets o current pensioners. TheState Earnings-Related Pension Scheme (SERPS) was introduced in 1978, and peopleretiring today are beneiting rom its most generous provision. In addition, the value ohousing wealth has doubled as a percentage o GDP since 1980, and home ownershipamong recently retired people has increased rom under 50 per cent to approaching80 per cent since 1981.2

Recenttrendsinprivatepensionprovision

1.4 But the Pensions Commission also made clear that private pension saving is in decline,and that this decline has been an underlying trend or a number o years. This isdespite household net wealth having risen by around 60 per cent in real terms since1997. Even at the peak o private saving, many people were not making suicientprovision or their retirement. But while there were 12.2 million active members ooccupational schemes in 1967, the number has been decreasing so that, in 2004,there were around 9.8 million members remaining, o which over hal were in thepublic sector.3

1 Pensioner Income Series, DWP.2 Economic and fiscal strategy report and Financial statement and budget report, March 2006.3 GAD, Occupational Pension Schemes 2004.




1.5 Contributions to occupational pensions have allen rom above 3 per cent o GDP inthe early 1980s to less than 2 per cent in 2002. And the proportion o private sectoremployees participating in occupational schemes has allen rom around 37 per cent in1991 to around 26 per cent in 2004.4

1.6 There has also been a recent acceleration o some trends. In particular, recent yearshave seen the closure o many DB occupational schemes, although some o thesehave been replaced with DC schemes. This has led to a rapid all in the number oactive members o DB schemes.

4 Pensions Commission, 2004, Pensions: challenges and choices: The First Report of the Pensions Commission.




1.7 DB schemes are those that oer a pension based on a certain ormula (usually yearsworked and inal salary). They are not necessarily better than DC schemes, where thepension depends on the perormance o underlying investments such as shares. Formany people the greater lexibility o DC provision better matches the greater mobilityin the labour market and the increase in the number o jobs people may expect to doduring their lives.

1.8 However, a shit rom DB to DC provision is oten associated with a cut in averagepension contribution rates, particularly those made by the employer. This means thatpeople are likely to end up with signiicantly lower pensions when they come toretire. On average, total contributions into DB schemes are currently around 19 percent o earnings, compared to 9 per cent or DC schemes.5 Figure 1.iii shows averagecontributions into DB occupational pensions (split between open and closed schemes)and DC occupational pensions. But a simple comparison o contributions to DB andDC schemes is not appropriate, as contribution levels to DB schemes can vary over

5 GAD, Occupational pension schemes 2004. The recently published Employers’ pension provision survey 2005 has similar

indings or occupational schemes (with ten or more members) – in 2005, employers contributed 10 per cent to open DBschemes on average (median) and only 5 per cent to open DC schemes; employees contributed on average 6.9 per centto open DB schemes and 5 per cent to open DC schemes.




time and DC schemes are more likely to be contracted in (so the pension is received in

addition to State Second Pension rather than instead o State Second Pension).

Undersavingorretirement

1.9 Many people are not saving enough to generate the level o income they will want inretirement. A number o studies have used a range o data to estimate the numbero people who are not saving enough to reach a level o income they might consideradequate.

1.10 Measures o retirement income adequacy are based on replacement rates, whichmeasure people’s retirement income as a percentage o their income in work. Typically

people are content with a modest all in income at retirement because they tend tosee a all in the cost o living (or example, travel to work and housing costs). However,

.




ew people are likely to be content with a retirement income that is dramatically less

than that which they had while working. While there is scope or debate around theappropriate target replacement rates, the Pensions Commission proposed a ‘slidingscale’ o 80 per cent or the lowest earners, to two-thirds or average earners and50 per cent or the highest earners.6

1.11 Estimates o the current level o undersaving or retirement are diicult to constructbecause they rely on poor data and there are measurement diiculties, such aswhether to measure income at a household or individual level and whether to includeestimates o non-pension inancial assets and inheritance. However, key recent studiesind the ollowing.

• New inormation has recently become available rom the English Longitudinal Studyo Ageing.7 For the irst time this allows us to use comprehensive data on people’saccrued pension rights and non-pension inancial assets (though it is available onlyor people aged 50 and over). Using this data, it is possible to estimate that, basedon the Pensions Commission’s replacement rate benchmarks, there are 7 millionpeople undersaving or retirement. However, there are questions about whetherindividuals would access some o these non-pension inancial assets to create aretirement income and whether the trends or older workers will persist oryounger generations.

6 These replacement rates are based on gross income. Replacement rates based on net income would be higher.7 IFS, 2005, Prepared for retirement? The adequacy and distribution of retirement resources in England , with DWP internal

adjustments. More detail on the igures is provided in Annex A.






1.17 Over 2.7 million stakeholder pensions have been sold since their introduction in April

2001,11 the majority to their target group o moderate earners. O those stakeholderpension plans that received a contribution in the 2003/04 tax year, over three-quarterswere or people earning under £30,000 a year and around two-thirds were or peopleearning less than £20,000 a year. Total contributions to stakeholder pension schemesin the 2004/05 tax year were around £2.4 billion.

1.18 The low charges in stakeholder pensions have also helped to exert downward pressureon personal pension charges in general. The impact o this has been dramatic: chargeson personal pensions ell by around a third between 1999 and 2001 to around thestakeholder pension charge cap level.12

Inormationandeducation

1.19 Since 2002, the Inormed Choice programme has looked at ways to raise awarenessand understanding o retirement provision, and to promote individual responsibility orretirement planning.

1.20 To ensure that everyone has timely inormation about their own circumstances, wehave introduced a range o pension orecasts as part o this programme. The orecastsgive individuals an understanding o the income they are likely to receive in retirementbased on their National Insurance contributions or credits. They are supplemented by

lealets that set out options or improving their position – such as working longer anddeerring receipt o their pensions or making additional contributions.

1.21 DWP now issues the ollowing types o orecasts:

• Combined Pension Forecasts (CPFs): Issued in partnership with employers andpension providers, CPFs show State Pension inormation alongside a orecast oan individual’s current private pension. By the end o March 2006, over 2,700employers or pension providers had signed up to issue CPFs and over 6.3 millionCPFs had been produced.

• Individual Pension Forecasts (IPFs): IPFs are tailored to an individual’s circumstances,taking into account actors such as marital status, current employment status,or any periods spent abroad. IPFs can also address the impact o options such asworking longer, going abroad or getting married or divorced. Over 7 million IPFshad been issued by the end o March 2006.

• Real-Time Pension Forecasts: In October 2004 we launched a service wherebyindividuals can contact DWP electronically to obtain an online IPF. DWP had receivedmore than 107,000 requests by the end o March 2006.

11 Source: ABI.12 Source: Financial Services Authority (FSA).




• Automatic State Pension Forecasts (APFs): First issued in 2003, APFs are unsolicited

orecasts sent by DWP to all working-age people who have not received any othertype o orecast in the previous 12 months. By the end o March 2006, over 12million APFs had been issued.

TaxsimpliicationandtheFinanceAct2004

1.22 The Government provides generous tax relie to encourage people to save or anincome in retirement. From 6 April 2006 (A-Day), the many existing sets o rulesgoverning the taxation o pensions were replaced with a single, uniied regime.

1.23 The new regime introduced simpliied rules around the tax treatment o pensions,

oering less complex and more lexible retirement arrangements or individualsand employers.

1.24 There is now no limit on the amount o pension saving an individual can build up in apension scheme or the number o pension schemes they can save in – although thereare limits on the amount o tax relie individuals can get.

1.25 The two key eatures o the new regime are a single lietime allowance and an annualallowance or the amount o tax-privileged savings. The single lietime allowance iscurrently set at £1.5 million (rising to £1.8 million by 2010/11 and to be reviewed

subsequently). A tax charge is made where an individual has an excess above the£1.5 million allowance. Individuals can also get tax relie on contributions up to100 per cent o annual earnings up to the annual allowance, currently £215,000(rising to £255,000 by 2010/11 and to be reviewed thereater).

1.26 Additionally, i scheme rules allow, individuals can take up to 25 per cent o theirpension und as a tax-ree lump sum.

Memberprotection

1.27 We recognise that people will only save i they have conidence that when they have

done so the pension will be there when they need it. The Government has worked toensure that the environment is sae enough to give people the conidence they need.

The Pension Protection Fund

1.28 The Pensions Act 2004 established the Pension Protection Fund (PPF) to protectmembers o inal salary pension schemes by paying compensation should the employerbecome insolvent and the pension scheme underunded. It also pays compensation topension schemes that are unable to meet their obligations due to raud. The PPF wentlive on 6 April 2005 and is unded through compulsory levies imposed on schemesthat are eligible to apply or PPF assistance.




1.29 To reduce cross-subsidy and promote airness, the PPF charges a risk-based levy, so

that schemes that pose a higher risk pay more or the PPF compensation cover, andcosts are kept down or good employers with well-unded schemes. The FinancialAssistance Scheme will help some o those who lost out beore the PPF wasestablished.

The Pensions Regulator

1.30 The Pensions Act 2004 also established a new regulatory body or work-basedpensions, The Pensions Regulator (TPR). The new regulator has a deined set ostatutory objectives:

• to protect the beneits o members o work-based pension schemes;

• to promote good administration o work-based pension schemes; and

• to reduce the risk o situations arising that may lead to claims or compensationrom the PPF.

1.31 TPR was developed to take a proactive, risk-ocused approach to regulation. Resourcesare concentrated on schemes where the greatest risk to the security o members’beneits is identiied, so well-run schemes have a lighter regulatory burden than

beore. It also provides practical support or the pensions community.

Remaining problems

1.32 These reorms have clearly changed the pensions landscape and introduced choiceand lexibility or pension schemes, but the issue o undersaving or retirement amongtoday’s workers still remains.

Unclearincentivestosave

1.33 Pension Credit has successully boosted the income o millions o pensioners and hasalso ensured that they are better o or having saved. In addition, it has improvedincentives to save or some people. For example, research commissioned by DWP13 estimated that the introduction o Pension Credit led those on low to middle incomes(comprising 12 per cent o the population) to have better incentives to save and towork longer.

13 National Institute or Economic and Social Research, 2005, The effects of means-testing pensions on savings and retirement .




1.34 However, the way in which elements o the State Pension and Pension Credit system

are uprated means that the coverage o Pension Credit is spreading. I currentindexation arrangements continued, the proportion o pensioner households entitledto Pension Credit would increase rom around 45 per cent today to around 70 percent by 2050. This is discussed urther in Chapter 3.

1.35 The potential uture spread o Pension Credit could reduce incentives to save or somepeople. However, it has never been the Government’s intention to move over thelong term towards a system where a signiicant majority o pensioners are entitled toPension Credit.

1.36 People are less likely to engage with long-term inancial planning i the decisions they

need to make and the system within which they make them are overly complex. ThePensions Commission concluded that the UK pension system is the most complexin the world. A recent survey ound that two-thirds o people agreed – they indall pensions conusing.14 This complexity is likely to urther aect undersaving orretirement.

1.37 There is relatively low awareness o the inancial incentives to save in a pension. In thesame survey, only a quarter o people (26 per cent) spontaneously mentioned tax relieas an advantage o pensions, and even when prompted, only 43 per cent were awareo the tax beneits o saving in a pension.

Understandingundersavingorretirement

1.38 Behavioural economists have conducted research on how people make inancialdecisions, including why people may not join a pension even when it is in theirinterests to do so. Traditional economics suggests that people make decisions basedon a rational assessment o the costs and beneits to themselves. However, inreality many people ind pensions diicult and complicated, and have a tendency todisengage rom savings decisions. Even though most people realise they need to saveor retirement, or a number o reasons many never get round to doing it. We knowthat the diiculty o making inancial decisions oten leads to individuals not acting at

all. Box 1a explains some o the reasons why people may not join a pension.

15

14 Marketing Sciences Ltd, Retirement planning monitor 2005.15 Notably Choi, Laibson, Madrian, Thaler and Benartzi.




Box1a:ReasonsorundersavingorretirementConventional economics suggests that people will try to smooth their spending over theirlietime. Thus, when people are young, they may choose to borrow money to und theireducation or to buy a house, spending more than their income; as they get older and theirincome increases, they can pay o their debts and start to save, so spending less than theyearn. However, actual spending tends to track income more closely than these theorieswould suggest.

Behavioural economics is the combination o psychology and economics, and helps toexplain people’s decision making. It has identied a number o reasons why people do notsave or retirement, even when it is their interest to do so.

People may realise they should save or retirement but lack the willpower to change theirbehaviour appropriately. Inertia oten leads people to ollow the path o least resistancein decision making, making the easiest rather than necessarily the best decision, andprocrastination can lead to them not making any decision at all.

In addition, people oten live or today and struggle to see what their uture needs mightbe. When presented with the option o having money now or more money in the uture,people requently choose to take the money now, even though they would be bettero i they waited. This is reinorced by the act that people oten don’t understand that

infation can erode the value o any money they have ‘under the mattress’. This behaviouris infuenced by aversion to losses, since people are oten only willing to accept a loss totheir income when the potential gains are very high and they eel losses more intenselythan they eel gains.

1.39 The FSA’s baseline survey o inancial capability in the UK16 shows that many peopleare ailing to plan ahead adequately or their retirement or or an unexpected expenseor drop in income. For example, 37 per cent o people who said the State Pensionwould not provide them with the standard o living they hope or in retirement had noadditional pension saving. And 39 per cent o people say they tend to live or today

and let tomorrow take care o itsel. However, even today when pensioner incomesare historically high, 21 per cent o people who have already retired do not ind theirincome suicient to give them the standard o living they hoped to have.

16 Atkinson A, McKay S, Kempson K and Collard S, 2006, Levels of financial capability in the UK: Results of a baseline survey , FSA Consumer Research 47.




Highcostsodeliveringtothoseonlowandmoderateincomes

1.40 The act that pensions need to be sold in a regulated market to protect consumers hasled to a relatively expensive sales and marketing process or personal pensions.17 ThePensions Commission’s research suggests that it costs around £800 to sell a personalpension to somebody working or a medium-sized employer. In addition, consumersoten do not persist in making pension contributions or long, even once they havebegun making them. The Pensions Commission ound that, on average, consumerspersist in saving or only around ive years.

1.41 This combination o high up-ront costs and non-persistency means that providershave a relatively short period in which to recoup relatively large sales costs. This has

two eects on consumers.

1.42 Firstly, it leads to relatively high charges. Although the cost o saving in a personalpension has allen considerably with the introduction o stakeholder pensions, itremains high compared with most occupational pensions. Few personal pensions soldto individuals have charges signiicantly below the stakeholder charge cap (1.5 percent per year o unds under management, alling to 1 per cent ater ten years).

1.43 By contrast, many occupational pensions and some group personal pensions are ableto achieve administration charges equivalent to around 0.3–0.5 per cent or less. Theimpact that this can have on the size o someone’s pension und is considerable.

Someone saving 8 per cent o median earnings or 40 years at the higher level ocharge might expect to have a pension und on retirement worth around 20 per centless than an equivalent person saving at the lower level.

1.44 Secondly, it means that it is more economic or providers to sell to some consumersthan others. Higher earners, who will have more unds in the scheme generatinghigher revenue, or those who work or larger employers, where providers can achievesales and marketing economies o scale, are more attractive. The inancial servicesindustry does not generally seek to sell personal pensions to low to moderate earners,particularly i they work or smaller employers, because it is not economic to do so.

1.45 Further reorm is needed to tackle the problem o undersaving or retirement, reversethe decline o private pension provision and overcome these barriers.

17 Pickering A, 2006, A simpler way to better pensions: An independent report .




Personal accounts: a low-cost savings scheme

1.46 To address the problem o undersaving or retirement, and in line with the PensionsCommission’s recommendation, the Government proposes in 2012 to introduce anew, low-cost scheme o personal accounts or those people currently without accessto adequate pension savings. Eligible employees will be automatically enrolled into thenew scheme and, along with their employers and the State, will make contributions intothe scheme on a DC basis. Individuals will have appropriate levels o choice over howto invest their unds. The accounts will be portable between employers and betweenperiods o employment, sel-employment and economic inactivity.

1.47 The new scheme will:

• signiicantly increase the number o people currently saving or retirement; and

• have low charges so that individuals keep more o their savings.

1.48 The key eatures o the scheme will be:

• an organisational structure that ensures lowcharges and good-qualityservice or individuals;

• automaticenrolment or all eligible employees but with the reedom to opt out;

• a minimumoveralllevelocontribution rom employers, employees andthe government, to promote a minimum level o pension saving, with peopleencouraged to contribute more;

• a nationalminimumemployercontribution , increasing incentives to save;

• opt-inaccess available to, among others, the sel-employed and those notcurrently in paid work; and

• portableandlexibleaccounts , to it in with modern lie and the greaterlikelihood o people moving between jobs.

1.49 Together these measures will provide individuals with a low-cost means o buildingprivate retirement income in addition to their state pension entitlement, with apresumption to save or many. The ollowing sections discuss the key elements o ourreorms in more detail and indicate areas where we intend to consult urther.




Box1b:Howmanypeoplewillbeinthepersonalaccountsscheme?Around 10 million employees will be eligible or automatic enrolment into a personalaccount. There are uncertainties about the number o people who might choose to opt outbut we estimate that between 5 and 8 million employees will remain in personal accounts.Women, those working part-time, low and moderate earners are those less likely to havecurrent pension provision and thereore will be well represented in our target group.

Others may choose to opt in to the scheme. The scheme will be available to both thesel-employed and those not in paid work. It is dicult to estimate how many individualsin these groups will want to join the scheme but, in the long term, over 1 milliono these individuals may opt in to personal accounts.

In total, we estimate that when up and running, the personal accounts scheme might havebetween 6 and 10 million members.

In addition, we estimate that over hal a million people will be newly automatically enrolledinto their employer’s existing scheme.

Thedesignopersonalaccounts

1.50 The key objectives in designing a system to deliver personal accounts are that:

• the administrative burden on employers should be minimised;

• accounts should be ully portable or people moving between employers, periodso employment, sel-employment and economic inactivity;

• individuals should have the appropriate level o choice to take personalresponsibility or saving or their retirement;

• government involvement in delivery should be minimised;

• people should receive high and consistent standards o service; and

• costs and charges should be as low as possible.

1.51 The Pensions Commission recommended the introduction o a new, high-coverage,low-cost National Pension Savings Scheme (NPSS). They suggested that the NPSSshould be established as a non-departmental public body with the administration,servicing and und management unctions outsourced to private contractors.




Box1c:ThePensionsCommission’sproposal• Automatic enrolment (with the option to opt out) or all employees into either a

high-quality employer scheme or into a new National Pension Savings Scheme (orpersonal account).

• Minimum total deault contributions o 8 per cent on a band o earnings (between thePrimary Threshold and the Upper Earnings Limit or National Insurance contributions),with encouragement to save more.

• A low-cost national savings scheme, with a suggested annual management charge o0.3 per cent in the long run.

• Individuals choose how to invest their unds and a small number o bulk-bought optionsare available.

1.52 Ater the publication o the Pensions Commission’s second report, the Governmentinvited the pensions industry to consider this proposal and, i appropriate, to suggestalternative ways in which the same broad outcomes o wider coverage and low-costpension saving could be achieved. The Government is grateul or the eort andengagement shown by the pensions industry to meet the challenges set out by the

Pensions Commission.

1.53 All o the alternative proposals we received agreed with the Pensions Commission thatautomatic enrolment should be the key entry mechanism into the scheme and that amodest minimum employer contribution should be introduced at the levels proposed.




Box1d:AchallengetothepensionsindustryFollowing the publication o the Pensions Commission’s report, the Government challengedthe pensions industry to come up with ways to deliver personal accounts.

The NationalAssociationoPensionFunds(NAPF) proposed a model o Supertrusts,which built on existing multi-employer occupational schemes. There would be between 10and 20 Supertrusts, which would each be overseen by a board o governors who wouldoutsource operations. Under the scheme, employers would choose which Supertrust theiremployees joined. Employees would not be able to choose their investment strategy – theboard o governors would do that or all members.

The AssociationoBritishInsurers(ABI) put orward Partnership Pensions as a wayo delivering personal accounts. This system built on the existing stakeholder pensionplatorm, where collections were paid directly rom employers to pension providersthrough the BACS system o collection. In addition, they proposed a Retirement IncomeCommission to oversee the system and ensure that it worked or individuals. Again, theyproposed that the initial choice o providers lay with employers but that individuals couldmake a dierent choice i they wished.

The InvestmentManagersAssociation(IMA) put orward an option based largely onthe Pensions Commission’s proposals, but ocusing on how some o the processes, such as

governance and und management, could work in practice.

The Government has careully considered these options and concluded that neitherSupertrusts nor Partnership Pensions contain all o the eatures needed or personalaccounts. We believe that a successul system must be designed around personalresponsibility and appropriate levels o choice. In addition, the burden on employers mustbe minimised.

However, we have used eatures o all o these proposals to rene and improve the modelswe are outlining in this paper. Moreover, in the next phase o reorm, we want to continueto work with the pensions industry to nd the best solution to deliver personal accounts.

We are also interested in looking at whether Supertrusts could work alongside personalaccounts to oer more choice in pension provision.




Deliveringpersonalaccounts

1.54 We have analysed careully the proposals put orward by the Pensions Commissionand key stakeholders or delivering a personal accounts scheme. In the light o thatanalysis and the objectives set out above we have identiied the eatures and unctionsthat will need to exist in any new system.

Collectionandreconciliation

1.55 Ater individuals have joined the system, they will need to start contributing to theirpersonal account. We propose that there should be a simple, low-cost payment-

collection system. This will be delivered in a way that does not place an undue burdenon employers. We will be working with employers to ensure that they have conidencein the collection mechanism and that the process o collection is as straightorward aspossible.

1.56 In addition to central collection o contributions, we believe that urther personalaccount scheme unctions will need to be centralised in order to:

• allocate a deault pension provider or pension und or those individuals who donot make an active choice;

• ensure that individuals can continue to contribute to a single personal account astheir circumstances change;




• provide inormation rom a single point to assist the regulator as it monitors

scheme compliance; and

• ensure individuals receive a consistent level o service.

Transerringbetweenemployers

1.57 One o the key unctions o personal accounts is that contributions will continue whenindividuals move between participating employers. Research18 suggests that the abilityto move the account between employers was thought to be a particularly importanteature: people elt that this would increase a sense o ownership o the pension,would encourage those people who change jobs requently to participate and wouldovercome the current problem many people ace o keeping track o pensions romdierent jobs. Research with employers similarly revealed that they view this as animportant eature. They thought a pension that individuals could take with them asthey moved employers would be both popular with employees and encourage themto stay opted-in to a scheme.19

Compliance

1.58 Employees will gain important new rights under the proposals – automatic enrolmentinto either a personal account or qualiying workplace scheme and access to an

employer contribution. It will be important to saeguard those rights by puttingin place an eective compliance regime which remains light-touch, risk-basedand proportionate.

1.59 It is important that employers get the help and support they need to move to the newscheme. We would seek to make it as easy as possible or employers to comply withthe new requirements. We will develop a ull employer communications and educationpackage to support the introduction and implementation o personal accounts.

1.60 However, a range o enorcement powers will also be needed to enable regulatoryauthorities to respond to the minority o employers who persistently ail to comply

with their obligations.

1.61 We are giving careul consideration to the precise nature o the regulatory approach,the necessary enorcement powers and how they might be applied.

18 Research by Ipsos MORI or DWP (Hall S, Pettigrew N and Harvey P, orthcoming in 2006, Public attitudes to personal accounts: Report of a qualitative study ).

19 Research by BMRB or DWP (Marshall H and Thomas A, orthcoming in 2006, Employer attitudes to personal accounts:Report of a qualitative study ).




Administeringpersonalaccounts:twodistinctapproaches

1.62 As outlined above, the core elements o a new personal accounts system will beautomatic enrolment, a simple mechanism or collecting contributions and somecentralised unctions. However, there is one remaining issue – the administration othe accounts, on which we would like to consult urther. The decision we take on thisissue will depend, among other things, on the appropriate role or consumer choice inthis area o retail inancial services.

1.63 Whichever delivery mechanism is avoured, individuals will have a number o choicesto make in personal accounts.

• Do I opt out o the scheme?

• What sort o investments should I make?

• Should I make additional contributions?

1.64 In answering all these questions, people can adjust their decisions to save and invest tomeet their own personal needs, their preerences and their aspirations or retirement.

1.65 As part o our consultation and discussions with commentators, a number o peoplehave suggested that there is value in oering individuals a urther choice:

• Who do I want to administer my pension?

1.66 Thereore, we are outlining two possible approaches to administeringpersonal accounts.

Option 1: The Pensions Commission’s approach – competition for contracts

1.67 The Pensions Commission suggested that all personal accounts should be provided bya single organisation. The day-to-day running o the scheme would be outsourced to

a number o pension administrators. Everyone would deal with the NPSS and wouldreceive consistent service standards and outcomes. Individuals would be able to makedecisions about whether to opt out o the scheme, whether to contribute above theminimum and their preerred approach to investment.






Option 2: An alternative approach – competition through branded

providers1.68 Another option to deliver personal accounts would be to build on existing pension

provision. Automatic enrolment, collection and compliance would be as outlined inthis paper. However, rather than using a single organisation, a number o pensionproviders would oer personal accounts. This option has a number o dierencesto the one proposed by the Association o British Insurers (outlined in Box 1d). Forexample, it would have a centralised unction to collect and reconcile contributions,allocate deault providers and collate inormation. People would be able to choose theprovider that was right or them (or they would be allocated one).

1.69 A model in which individuals have a choice o provider is likely to be more expensiveto administer. We would also need to consider whether introducing additionalchoice or the consumer would add risks that may require regulatory interventionwith consequent costs. This could have an impact on the inal individual und size.However, the advantage o this approach is that it would rely to a greater extenton the existing inrastructure and could thereore have advantages when coming toimplementation.






1.70 We are interested in views on whether this is a choice that people would beneit

rom making.

• Would oering a choice o branded provider add value or the consumer?

• Would a choice o branded provider give individuals greater conidence in thesystem and greater ownership o their accounts?

• What is the connection between type o choice and cost?

• On what basis would individuals make a choice o pension provider?

• What are the pros and cons o vertically integrated providers, oering bothadministation and und management?

• With multiple providers how could charges be set in a way that encouragescompetition to thrive?

• Would it be possible to restrict the number o providers in the scheme to providescale economies and drive down costs?

• In each approach what inormation would individuals need?




Box1e:TheimportanceoindividualchoiceinpersonalaccountsIn the Pension Commission’s approach, the NPSS would be responsible or day-to-dayadministration o all accounts, though consumers would still be able to make a choicebetween investments. In the alternative approach consumers would ace two choices. Therst would be between branded pension providers to administer their personal accounts,and the second would be a choice between investments oered by that provider. (In bothapproaches, in the absence o a consumer choice the individual would be allocated intothe deault option(s).)

These dierences are set out in the gures below. Figure 1.viii shows the choicesconronting the consumer in the Pensions Commission’s approach, Figure 1.ix the choicesconronting the consumer in the alternative approach.




Box1e:Theimportanceoindividualchoiceinpersonalaccounts(continued)

I consumers are well inormed, choice can help drive competition, innovation and quality.However, evidence indicates that many people do not make well-inormed choices or shoparound when purchasing nancial products. Survey evidence20 indicates that people eeloverwhelmed and conused by the amount o inormation available and the complexityo the choices they ace; 20 per cent o people reported that they had made a decisionwithout seeking any advice or inormation to help them make their decision.

People tend to choose nancial products on the basis o amiliarity: or example BMRB 21 ound that 58 per cent o products were bought rom a company where the respondentwas already a customer.

Consumers tend to preer less choice when purchasing pension products; too much choiceleads to inaction and conusion. For example, recent ocus groups on personal accountssuggested that having a choice o providers would add a layer o complexity and wouldnot generally be welcomed by people.22 UK qualitative research23 also suggests that lessnancially inormed respondents wanted a simplied product.

1.71 Initial analysis suggests that the best delivery model is that proposed by the PensionsCommission. However, the Government will conduct urther analysis o this andthe alternatives in order to strike the best balance between value or money orthe taxpayer and value or money or the saver. We wish to consult urther on theadministration o personal accounts. In assessing approaches, our key objectiveswill be minimising the cost to members o the scheme and maximising eectivecompetition between irms involved in the provision o the scheme. In conducting thisconsultation, we will analyse options against the ollowing criteria:

• the level o charges, both in the short and long term;

• value or money or the taxpayer;

• the appropriate type o consumer choice;

• simplicity or employers and individuals;

• the promotion o personal responsibility;

20 Atkinson A, McKay S, Kempson E and Collard S, 2006, Levels of financial capability in the UK: Results of a baseline survey ,FSA Consumer Research 47, Financial Services Authority (FSA); www.sa.gov.uk/pubs/consumer-research/crpr47.pd

21 FSA, 2000, Better informed consumers: Assessing the implications for consumer education of research by BMRB.22 Research by Ipsos MORI or DWP (Hall S, Pettigrew N and Harvey P, orthcoming in 2006, Public attitudes to personal

accounts: Report of a qualitative study ).23 For example ABI, The pensions annuity market: Consumer perceptions.




• the administrative burden on employers;

• implementation timetable;

• the level o overall risk;

• the governance o the scheme;

• consumer protection; and

• maximising eective competition between irms.

1.72 We will bring orward proposals on the approach to administration in personalaccounts later this year.

Governanceothescheme

1.73 Regardless o which approach to delivery is taken orward, a personal accountsscheme requires a robust governance and regulatory regime. Such a regime will needto be transparent, sustainable and create consumer conidence. Personal accountswould be managed independently rom government, including decisions on the rangeo und choices and the structure o the deault und.

1.74 In seeking the right structure to achieve these goals, we will be drawing on expertiserom the inancial sector, existing regulatory organisations and internationalexperience. Irrespective o who administers personal accounts, our ocus will beon ensuring that the governance body will provide an overriding duty o care toscheme members. It will provide them with assurances that their accounts are beingadministered eiciently and will inorm individuals about their investment choices.

Investmentandundmanagement

1.75 Personal accounts will build unds on a deined contribution basis. As with all deinedcontribution products, the value o the individual’s und can luctuate over time due

to changing investment perormance. For example, the value o stocks and shares candecrease as well as increase. The risk that investments do not do as well as expectedlies with the saver, though this risk can be mitigated by an investment strategythat progressively moves unds into less volatile investments as the individual nearsretirement (oten reerred to as ‘liestyling’). There is no absolute guarantee that thevalue o the und would be more than the value o the contributions invested, andthat there would be investment growth. The value o these investments thereorecannot be underwritten by government.

1.76 Funds will be passed on to proessional and independent und managers or investment,

as in current industry practice. We will ensure that a range o investment options,including socially responsible investment, will be provided under personal accounts.




Accessingpensionsavings

1.77 Personal accounts will be subject to the same annuitisation rules as other pensionschemes. We expect that most individuals will buy an annuity when they come to taketheir pension. This relects the current system, which enables individuals to decidewhen to annuitise and to shop around or the best product and a price to suit theirpersonal circumstances.

Box1:Annuities

The Government considers that annuities are the most appropriate way to secure anincome in retirement and this applies equally to personal accounts.

The Government provides tax incentives to encourage people to save or retirement.A 25 per cent tax-ree lump sum can be taken rom the pension pot but the rest must beconverted into a secure retirement income or lie by age 75, usually by buying an annuity.This protects people rom the risk o running out o money in retirement as people tend tounderestimate how long they will live.24 Research shows that pensioners want ‘security’,‘a guaranteed income level’ and ‘little or no risk’25, and so it is not surprising that studiesshow annuities oer good value or money, since this is what they provide.26

The Pensions Commission endorsed the undamental principle o an income in retirement

being secured by an annuity. It suggested consideration o changes to encourage a marketor draw-down products,27 compulsory annuitisation being limited in amount and ages orst and last possible annuitisation rising in line with lie expectancy.

The Government discussed the economics o mass market draw down with stakeholdersand ound it was likely to remain viable only or those with large pension pots or sucientother assets to bear investment risk. However, other new products might be suitable orthe mid market and the Government has provided the ramework under the current taxand regulatory regime or the market to develop these. The Government is encouraged bythe emergence o such ‘mid-market’ products.

The Government has ruled out allowing an upper limit on the amount individuals haveto annuitise. Such a change would only aect a small number o better-o individualsand would add considerable complexity.

24 Women aged 60–69 underestimate their lie expectancy by more than our years, and men by more than two years.

Source: O’Brien, Fenn and Diacon, 2005.25 ABI, 2004, The pensions annuity market: Consumer perceptions.26 Discussed in Cannon and Tonks, Annuities pricing survey , DWP Research Paper.

27 Draw down exists as an alternative to annuitisation until 75, whereby people can leave their pension und invested anddraw an income by cashing in portions o their und. Draw down is currently only economic or larger unds.




Box1:Annuities (continued)The age o rst annuitisation is already increasing rom 50 to 55 rom 2010. Latestavailable evidence suggests that 75 is the appropriate upper age limit. The Governmentis prepared to monitor and review any new evidence as to whether the rst and last agelimits should be changed in the uture.

The Pensions Commission said that the ocus o policy should be to encourage laterannuitisation. While the age o annuitisation is a decision or individuals, the Governmentagrees that delaying annuitisation may be benecial or some, particularly as thecurrent fexibility is only used by a minority28 and evidence suggests the benets o later

annuitisation are poorly understood.29

The Government will work with stakeholders toimprove inormation and will be setting out more technical details on annuities and theunderlying evidence base later in the year.

Lowcharges

1.78 The Pensions Commission suggested that there could be an annual managementcharge o 0.3 per cent in the long run. The Government believes that it is critical thatcharges or personal accounts are maintained at as low a level as possible. Under a

1.5 per cent management charge, an individual saving or 40 years will lose around20 per cent o their pension compared with a charge o 0.5 per cent.

1.79 In the long term, we are conident that we can deliver a system that radically reducescharges, and which will be sel-inancing. In the short term, charges will needto relect the choice o delivery mechanism, unds under management, contractspeciication and inancing arrangements. We will also consider other undingstructures or personal accounts.

28

Only 5 per cent choose to annuitise between ages 70 and 74. Source: The future of the pension annuity market , 2003.29 ABI sources already cited.




Box1g:Whyarelowchargesimportant?A higher annual management charge (AMC)30 means that, or a given rate o pensioncontribution and und growth, less money is accumulated in an individual’s pension undeach year. Consequently, less growth is accrued and compounded each year, ultimatelyresulting in a smaller pension und and, all else being equal, a smaller pension incomeupon retirement. Furthermore, this eect is more signicant the longer the duration osaving. This is because deductions are made rom a pension und that is accumulated overthe years, which aects the return earned rom und growth each year, thereby aectingthe size o the nal und.

Figure 1.x illustrates this or a median earner (£23,000) who saves in a pension or 40years.31 Under a 0.5 per cent charge, their pension und at retirement is worth £73,000,meaning that £8,000 o their und has been lost in charges; whereas under a 1.5 percent charge, their pension und is worth £59,000 and £22,000 is lost in charges.32 Thisindividual’s pension und is thereore approximately 20 per cent smaller purely as a result othe dierence in charges. This pattern o variation across charges is similar or all earningslevels, although the absolute size o pension unds varies proportionately according todierent income levels.

30 An annual management charge is a charge made each year by managers o a pension und to each pension accountholder, to cover the expenses associated with running the individual’s und. Although it is conventionally expressed as

a percentage o unds under management, it is usually deducted rom individual accounts monthly. Other chargingstructures can be used, or example charges on contributions or on early termination o contracts. Not all o thesestructures are permissible on all products, or example stakeholder pensions cannot impose an exit charge.

31 In this analysis we assume that there is no relationship between annual management charges and the returns achieved by

managers or investors. ‘Active’ und managers usually charge much higher ees compared with ‘passive’ und managers,

but evidence to date suggests that both types o und managers achieve a similar rate o return. Research on this area isongoing.

32 The amount lost in charges was calculated as the dierence between the und size under the relevant charge comparedto what the size o the und would be under a zero charge.




Box1g:Whyarelowchargesimportant?(continued)

Is 0.3 per cent achievable?

1.80 Much o the debate since the publication o the Pensions Commission report has ocusedon whether a system o personal accounts could be delivered at such low costs.

1.81 The current system o private saving has a number o costs that can be reduced oreradicated in the system we are proposing. The use o automatic enrolment should

drive down the costs o marketing and acquisition. The establishment o a centralbody would increase portability, reducing the number o times high start-up costs oraccounts would be incurred. And the establishment o a central body would ensurethat persistency o saving is increased, urther reducing the costs o saving throughewer, but larger, pension unds.

1.82 The exact cost o the scheme will be dependent on the inal design, the inancing othe scheme and the service it oers to consumers. We believe that 0.3 per cent maybe achievable in the long term, depending on decisions we take on scheme design.We invite views on this and will put orward proposals later this year.




Automatic enrolment or employees

Thecaseorautomaticenrolment

1.83 Automatic enrolment introduces a presumption to save but does not mean thatemployees will be compelled to save – they will be able to opt out o the scheme ithey wish. But unlike the present situation in most pension schemes, where an activedecision must be taken to join, with automatic enrolment people need to take anactive decision to opt out. People who want to save but do not get around to makingthe decision to start will no longer lose out.

1.84 The principle that automatic enrolment should orm a key part o the new nationalpensions saving scheme has generated widespread support and consensus romstakeholders and interest groups.33 Since the publication o the Pensions Commission’ssecond report, there have been expressions o support or the proposal romrepresentatives o employees, consumers and employers. Preliminary indings rom oursurvey o employers34 indicate that the majority o employers agree that automaticallyenrolling employees into a pension scheme is a good idea.

33 Research by Ipsos MORI or DWP (Hall S, Pettigrew N and Harvey P, orthcoming in 2006, Public attitudes to personal accounts: Report of a qualitative study ).

34 Research by BMRB or DWP (Bolling K, Grant C and Fitzpatrick A, orthcoming in 2006, Employer attitudes to personal accounts: Report of a quantitative survey ).




Box1h:Automaticenrolment:theevidenceEvidence suggests that automatic enrolment is one o the most eective ways ocombating people’s tendency not to act when aced with dicult nancial decisions.It will play a key role in achieving high participation rates or personal accounts.

The Employers’ Pension Provision Survey 2005 ndings show a link between automaticenrolment and increased levels o pension scheme membership. Within private rms with20 or more employees, the proportion o employees that were in a pension averaged60 per cent (median 77 per cent) where the rm used automaticenrolment. Thiscompared with 41 per cent or traditionalopt-in.

In case studies o our private sector schemes, automatic enrolment was associated withincreased participation rates.35 For example, in one rm the participation rate went rom25 per cent or existing employees, to 80 per cent or new joiners who were automaticallyenrolled.

Automatic enrolment has the greatest impact among groups where participation ratesare low. American research into 401(k) schemes showed that automatic enrolment hadthe largest eect among people with low incomes, minority ethnic groups and women.36 Given the low pension provision among these groups, we would expect their participationrates to increase most rom the introduction o automatic enrolment.

Research with employers showed that a majority o them (60 per cent) were in avouro automatic enrolment. This support was across rms o all sizes. Among those withless than ve employees, 60 per cent o employers were in avour, and 72 per cent oemployers with more than 50 employees were in avour.37

There is equally strong support among individuals. At the National Pensions Day,92 per cent o people were in avour o automatic enrolment.38

“It saves you the hassle of trying to sort out pensions really.”

“People who are out there thinking, ‘Oh, I’ll get round to it’ – it’s there, it’s done for them.”

Participants in research or DWP on attitudes to personal accounts.39

35 Horack and Wood, 2005, An evaluation of scheme joining techniques in workplace pension schemes with an employer contribution, DWP Research Report 292. Note: other actors including a required employee contribution, supportingcommunications and employer commitment may have inluenced the outcomes achieved.

36 Madrian and Shea, 2002, in Munnell and Sunden, 2004, Coming up short: The challenge of 401(k) plans,The Brookings Institute.

37 Bolling K, Grant C and Fitzpatrick A, orthcoming in 2006, research by BMRB or DWP, Employer attitudes to personal

accounts: Report of a quantitative survey. 38 Opinion Leader Research, 2006, National Pensions Debate Final Report prepared or DWP.39 Hall S, Pettigrew N and Harvey P, orthcoming in 2006, research by Ipsos MORI or DWP, Public attitudes to personal

accounts: Report of a qualitative study.




Whoshouldbeautomaticallyenrolled?

1.85 All eligible employees will be automatically enrolled into a pension scheme, either thenew national scheme o personal accounts or an employer scheme oering equivalentor greater beneits.

1.86 We have looked closely at the age and income level at which automatic enrolmentshould begin, rom the point o view o both employees and employers. We haveconcluded that employees should be automatically enrolled when their earnings areabove a lower threshold o around £5,000 a year. This is also when contributionswould begin to be paid (contribution band levels are explained in paragraph 1.103).

1.87 This is a suitable point to automatically enrol employees because we want to bring asmany employees into the scheme as possible, at a level o contributions they are likelyto be able to aord. Because contributions will be calculated on a band o earningsstarting at around £5,000 a year, costs will be low or people earning just above thislevel. Low earners will be brought into pension saving, will get into the savings habit,will see their savings increase as their earnings grow and, o course, they will have theright to opt out.

1.88 The Pensions Commission recommended that employees should be automaticallyenrolled rom the age o 21. We have looked closely at this issue. Our judgement isthat, to maximise the simplicity o the scheme and minimise administrative burdens

on employers, there is a case or aligning the age at which people are automaticallyenrolled at 22 – the age at which the adult rate or the National Minimum Wageis payable.

1.89 We intend that:

• employees aged 22 or over will be automatically enrolled into a personal accountwhen commencing employment, or into alternative workplace provision, i it isavailable to them;

• employees will be automatically enrolled on changing employer, and then everythree years, should they initially choose to opt out and continue to work or thesame employer; and

• employees will be automatically enrolled when their earnings reach the lowerthreshold.

1.90 We estimate that starting automatic enrolment at this age and level o earnings willmean that around 10 million employees will be eligible or enrolment into the scheme,including many part-time workers (as shown in Figure 1.xi).




Opt-inaccesstopersonalaccounts

1.91 Automatic enrolment will not apply to people who are:

• sel-employed;

• not in paid work;

• over State Pension age; or

• under 22 years o age.




1.92 As we want to encourage all individuals to save or their retirement, these groups will

be able to join personal accounts on an opt-in basis, with individuals taking an activedecision to participate.

1.93 The sel-employed and those not in paid work, by deinition, have no access to anemployer contribution and so may need to think careully about pension savingdecisions. We think it is important that they should have access to low-cost personalaccounts i they wish to save.

People who are self-employed

1.94 The sel-employed make up a key segment o our target group. Box 1i looks in more

detail at the sel-employed and pension-saving behaviour.

Box1i:Pensionsavingandthesel-employed

There are currently approximately 3 million working-age sel-employed people in the UK.40 There has been a steady long-term decline in the proportion o sel-employed people whoare contributing to private pensions. This is illustrated in the General Household Survey ,which shows that 66 per cent o ull-time sel-employed males belonged to a personalpension in 1991/92 but this had declined to 49 per cent by 2003/04.

As a group and across the income distribution, sel-employed people aged 50 to StatePension age have, on average, lower state and private pension wealth but higher non-pension wealth than the employed.41 In terms o total wealth (given by the sum o StatePension, private pension and non-pension wealth), the sel-employed as a group havemuch higher total wealth than the employed.

1.95 We recognise that participation rates or personal accounts could be aected i thesel-employed are not able to join the scheme easily. Ater detailed consideration, wehave concluded that there is no practical way o providing an automatic enrolmentprocess or this group. This is because it would not be possible to deduct personal

account contributions rom income, or to presume a minimum contribution rate.Thereore, we propose to oer membership on an opt-in basis. To encourageparticipation levels, access to the scheme will be straightorward and simple, helpingto minimise the eort required to join and contribute. And the tax beneits o pensionsavings will be clearly signalled.

40 All igures are derived rom the Family Resources Survey (FRS) 2005 unless otherwise stated.41 Non-pension wealth, broadly speaking, consists o owner-occupied housing and non-housing wealth. Non-housing wealth

consists o inancial wealth (like savings and shares) and physical wealth like a business or investment property.




People who are not in paid work

1.96 Those people who are not active in the labour market, including those with caringresponsibilities, may want to start or continue to save in personal accounts duringthese breaks rom the labour market. We propose that people who are not in paidwork should be able to contribute to personal accounts.

1.97 Tax relie on pensions is payable to people outside o the labour market. Receiving£28 rom the Government or every £100 they contribute, up to a maximum o£3,600 o total contributions a year, could provide an incentive or the individualsin this group to join the personal accounts scheme.

People over State Pension age and young employees

1.98 It is appropriate that those who want to continue to work and save ater StatePension age can make a conscious decision to do so. People over State Pensionage who are in employment will not be automatically enrolled but will be entitledto opt in to personal accounts and receive an employer contribution. People still inemployment with a personal account when they reach State Pension age will remainwithin it unless they choose to opt out. People over 74 will not be able to remain inthe scheme, since in line with other deined contribution schemes, unds held in thescheme must secure an income by the age o 75. Young people aged between 16 and21 will be able to save in a personal account on an opt-in basis and have access to an

employer contribution.

Contribution levels

1.99 Everyone will have their own view o the level o income they want to have inretirement. Thereore personal accounts need to be as lexible as possible. ThePensions Commission suggested a minimum total contribution o 8 per cent ona band o earnings. Our analysis and research suggests that this is the right level.

1.100 The Pensions Commission research42 suggested that most median earners expectreplacement rates in the range 45–67 per cent and, crucially, very ew want less than45 per cent. Contributions o 8 per cent, combined with a State Pension as outlinedin Chapter 3, should be enough on average to deliver replacement rates o around 45per cent or lietime median earners who start saving at around age 30, and more orthose starting to save at a younger age.

42 Pensions Commission, 2005 , A new pension settlement for the twenty-first century: The second report of the Pensions Commission, Appendix D.




1.101 We propose to set minimum contribution levels at 8 per cent to help individuals align

with the lower end o the replacement rate range identiied in the research. Werecognise that people have dierent expectations o retirement income, and may haveother savings and assets that can add to their retirement income. The aim oour policy is to provide people with a simple, low-cost way o pension saving whichresults in a reasonable level o retirement income and provides the lexibility oradditional savings.

1.102 We have set the rate o contributions or the new scheme o personal accounts insuch a way that it could achieve a replacement rate o around 45 per cent o earningsor a median earner with a reasonably ull working lie. Actual replacement rates canvary substantially depending on earnings, employment status, the age at which saving

starts, National Insurance record, investment choices and returns, and annuity choices.These replacement rates should thereore be seen as a guide or setting contributionrates rather than implying certainty about replacement rate outcomes.

Thebandoearningsonwhichcontributionsarepaid

1.103 The Pensions Commission proposed that the earnings band should start at the PrimaryThreshold or National Insurance purposes (currently £5,035) and inish at the UpperEarnings Limit (currently £33,540).

1.104 By calculating contributions on a band o earnings rom around £5,000 to around£33,000 rather than all earnings:

• the cost o contributions will be lower or the lowest earners and their employers,and costs will be limited or those employing higher earners;

• it will avoid the ‘cli edge’ that would arise at the point o automatic enrolmenti contributions were based on all earnings; and

• contributions will begin at around the same point as tax and National Insurancecontributions, the earnings level at which individuals begin to take responsibility

or retirement saving by contributing to their State Pension.

1.105 We have looked at this issue careully and agree with the Pensions Commissionthat the minimum contribution levels proposed are the right ones and that theband proposed is broadly right. In research, the majority o employers thought thatthe proposed levels o employer and employee contributions were about right andthere was support or the idea that these should be based on banded earnings.43

43 Bolling K, Grant C and Fitzpatrick A, orthcoming in 2006, research by BMRB or DWP, Employer attitudes to personal accounts: Report of a quantitative survey . And Marshal H and Thomas A , orthcoming in 2006, research by BMRB or DWP,

Employer attitudes to personal accounts: Report of a qualitative study.




In other research individuals agreed that the contribution levels were about right.44

The Commission recommended that the value o contributions in relation to earningsover time should be maintained, and we are exploring ways to achieve this.

Thebalanceoresponsibilitiesbetweenindividuals,employersandtheState

1.106 The Pensions Commission suggested that the 8 per cent contribution should comprise:

• employers contributing 3 per cent;

• employees contributing 4 per cent; and

• the State contributing 1 per cent as normal tax relie, as under the current rules. 45

1.107 Our research showed that people think the recommendations set out by the PensionsCommission oer a air balance o responsibilities between individuals, their employersand the State.46

Thecaseoranationalminimumemployercontribution

1.108 The Pensions Commission made a strong case or the need or an employer

contribution to pensions. We propose that employees will have access to contributionsrom their employer on a band o earnings i they are saving in a qualiying workplacescheme or a personal account. This will give a new group o employees a realincentive to save and will mean that millions o people, or the irst time, will haveaccess to a minimum employer contribution to supplement their own savings.

1.109 This is not a decision that has been taken lightly but we have been convinced that anemployer contribution has two main advantages:

• It increases participation rates – driving down costs and helping more individualsto build up pension savings.

• It makes savings more attractive – increasing the incentives to save and makingsaving decisions more straightorward.

44 Hall S, Pettigrew N and Harvey P, orthcoming in 2006, research by Ipsos MORI or DWP, Public attitudes to personal accounts: Report of a qualitative study.

45 1 per cent represents basic rate tax relie on individuals' contributions – in addition, individuals may be entitled to higher-ratetax relie and neither employers nor employees pay tax or National Insurance contributions on employer contributions.

46 Hall S, Pettigrew N and Harvey P, orthcoming in 2006, research by Ipsos MORI or DWP, Public attitudes to personal accounts: Report of a qualitative study.




Increasing participation rates

1.110 The Pensions Commission noted in its inal report that the employer contribution is anessential element o the personal accounts package, and that without it, participationrates would be signiicantly lower.

1.111 There is a growing body o evidence which clearly demonstrates that there is anassociation between an employer contribution and increased participation rates, andthat an employer contribution helps people to save. The key to a successul personalaccounts system will be high levels o participation. It is only by making it an attractivesystem to a large part o our target group that we can drive down costs signiicantly.

Box1j:Evidenceoraminimumemployercontribution:increaseinschememembership

• The Employers’ Pension Provision Survey 2005 suggests a positive relationship betweenan employer’s pension contributions and levels o scheme membership. In rms with atleast one scheme member, where there was no employer contribution, 28 per cent oemployees were members; with a contribution o less than 3 per cent, 47 per cent oemployees were members; with a contribution o more than 3 per cent but less than6 per cent, 53 per cent o employees joined; and with an employer contribution o6 per cent or more, membership levels rose to 60 per cent.47

• The Employer Task Force reported that 72 per cent o employees with access to anemployer’s pension scheme with an employer contribution are saving in a pension. Only21 per cent o those who do not have access to an employer contribution aresaving privately.48

• Preliminary ndings rom our research with employers indicate that the majorityo employers were in avour o a minimum level o employer contribution. Largeremployers tend to be more likely to be in avour than smaller ones (just over seven inten o those with 250 or more employees are in avour compared with just over hal othose with less than 50 employees).49

Making saving more attractive

1.112 Employer contributions oer a simple and transparent incentive to start saving in apension. Employees only receive the contribution i they are in the scheme, providing aclear beneit rom pension saving. Evidence clearly shows that the idea o an employercontribution is attractive to employees.

47 This inding was supported by regression analysis which controls or the eects o other actors. These indings are indicativeonly, because o missing data on contribution and membership levels and because comparisons were based on very ew

employers in the survey (12) who made zero contributions.48 Employer Task Force on Pensions, 2004, Report to SoS for DWP .49 Bolling K, Grant C and Fitzpatrick A, orthcoming in 2006, research by BMRB or DWP, Employer attitudes to personal

accounts: Report of a quantitative survey.




Box1k:Evidenceoraminimumemployercontribution:employeeandemployerviews

• At National Pensions Day, 85 per cent o people thought that employers should makea contribution.

• Quantitative research to gauge people’s rst reactions to the Pensions Commissionreport ound a majority (70 per cent) o those surveyed believed that all employersshould be made to contribute to a pension or their employees. Among employees inthe survey who were not members o an employer’s pension scheme, 62 per cent saidthey would begin to contribute to a company pension i their employer did.50

• DWP ocus group research in November 2005 explored public reactions to pensionreorm options. In line with other research, the main reason given or joining anemployer’s scheme was an employer contribution.51

• Qualitative research exploring initial reactions to personal accounts ound that theconcept o additional contributions (rom employers and the Government) was seenby most as a strong incentive to participate.52

• Research with employers ound that a majority o employers were in support o aminimum employer contribution. The reasons given or this support included that they

elt they had a share o the responsibility or the issue and that they wanted to helptheir employees. Furthermore, 66 per cent o micro employers (those with ewer thanve employees) elt that a level o 3 per cent was about right or too little. This supportrose to 74 per cent among employers with 50 or more employees.53

Impactonotherschemes

1.113 Personal accounts are intended to complement, and not replace, existing pensionprovision rom employers. I an employer already oers a suitable alternative

scheme, they will be able to seek exemption rom the personal accounts schemeand automatically enrol their employees into their existing scheme instead.

50 Marketing Sciences Ltd internet and telephone research with over 1,000 people, Views on the Turner Report , 2005. The

sample or this survey was not nationally representative as it included disproportionate numbers o people whose employerscontribute to their pension.

51 IFF research, orthcoming, Pensions and savings: 12 ocus groups with people aged 18–65.52 Research by Ipsos MORI or DWP (Hall S, Pettigrew N and Harvey P, orthcoming in 2006, Public attitudes to personal

accounts: Report of a qualitative study ).53 Research by BMRB or DWP (Bolling K, Grant C and Fitzpatrick A, orthcoming in 2006, Employer attitudes to personal

accounts: Report of a quantitative survey ).




1.114 We will consult with employers and the pensions industry to develop detailed

proposals on the scheme eatures that would enable an employer to seek exemption.It is important to ensure that such schemes are at least as avourable to employees aspersonal accounts. For example, we would want to ensure that:

• or deined contribution schemes, the contribution levels into the scheme are atleast equal to the minimum contribution levels or personal accounts;

• or deined beneit schemes, the total beneits accrued by members are at leastequal to those that are estimated to accrue rom minimum contributions intopersonal accounts; and

• automatic enrolment procedures are in place to allow employees in employer schemesthe same opportunity to overcome inertia and save that personal accounts will oer.

1.115 We will also need to take account o other actors such as the level o charges andwaiting periods. We are planning to consult on detailed proposals or how this wouldwork later in the year.

1.116 Personal accounts will provide a oundation or private pension saving which willcomplement existing occupational and private schemes. Some stakeholders haveexpressed the concern that irms may ‘level down’ their existing provision to the

minimum requirements o the personal account scheme – in particular by reducingtheir employer contribution level to 3 per cent.

1.117 Employers oering pensions with contributions above 3 per cent already have a highproportion o their employees in these schemes. The average contribution or irmscontributing above 3 per cent is currently 8.8 per cent. I employers were to leveldown to cover the cost o paying a 3 per cent contribution or those employees newlyenrolled into a pension, average contributions to existing scheme members wouldhave to all rom 8.8 per cent to 8.2 per cent.

1.118 Evidence indicates that the extent o levelling down is likely to be limited. Our

research indicates that employers who contribute more than 3 per cent view theirpension scheme as an important recruitment and retention tool which they wantto keep.54 Preliminary indings rom a quantitative survey indicate that, o thoseemployers contributing 3 per cent or more and who report that the introduction opersonal accounts would mean an increase in total pension contributions, only justover 1 per cent said they would level down, and the vast majority o these reportedthey would level down to a level above 3 per cent. Only 2 per cent o all employers,where the introdution o personal accounts would mean an increase in total pensioncontributions, reported that they might close their scheme.55

54 Research by BMRB or DWP (Marshal H and Thomas A, orthcoming in 2006, Employer attitudes to personal accounts:Report of a qualitative study ).





Theimpactoanationalminimumcontributiononemployers

1.119 In 2004, £36 billion was contributed to unded pension schemes56 by employers.Based on a rate o participation o around two-thirds in personal accounts, weestimate that additional employer contributions would be worth around £2.6 billion.The exact amount will depend on actors such as employee opt-out rates andearnings levels.

1.120 Firms will ace an average increase in their labour costs o 0.6 per cent. This increase islower than the 3 per cent minimum employer contribution because:

• the 3 per cent contribution is on a band o earnings only and an employee will

never get more than 2.5 per cent o their ull earnings;

• many employees are already receiving 3 per cent or more, so there is no additionalcost or this group;

• not all employees newly eligible or the contribution will take it up; and

• neither employers nor employees pay tax or National Insurance contributions onthe employer contribution.

1.121 Figure 1.xii shows the likely amount that an employer will have to pay or a

ull-time employee. For example, or an employee earning around £23,000 a year, theeect o the requirement to contribute would be equivalent to adding 26p tothe hourly wage.57

Figure1.xiiLikelyemployercontributions

Employercontribution in

a year (£)

As apercentage o

all earnings (%)

Increase inhourly wage

(£) Annual earnings (£)

10,504 164 1.6 0.08

23,000 539 2.3 0.2630,000 749 2.5 0.3635,000 855 2.4 0.41

Source: DWP

Notes: Annual earnings of £10,504 is equivalent to being paid at the National Minimum Wage of £5.05 per hour for 40hours per week, 52 weeks a year including paid holidays. Annual earnings of £23,000 is the median annual earnings of all people in full-time employment (ASHE 2004).Results for the increase in the hourly wage are based on someone working 40 hours per week, 52 weeks a year including paid holidays.Contributions are estimated using the 2006/07 Primary Threshold of £5,035 and the 2006/07 Upper Earnings Limit of £33,540.

56 ONS, Pension trends 2005.57 I the employee worked 40 hours 52 weeks a year, including paid holidays.




1.122 There are around 1.2 million employers in the private sector.58 A minimum employer

contribution o 3 per cent on a band o earnings coupled with automatic enrolmento employees would aect three types o employers – those that currently:

• oer no provision or who provide access to a pension but do not contribute(around 980,000 employers);

• oer some pension contributions but less than 3 per cent (around 8,000employers); and

• oer a contribution o 3 per cent or more (around 170,000 employers), who wouldace higher participation rates due to automatic enrolment.

1.123 Figure 1.xiii illustrates dierent types o employer provision broken down by irmsize (number o employees). It shows that the majority o irms have ewer than 50employees, and that these irms are less likely to oer any pension provision.

Figure1.xiiiEmployerscurrentlyoeringacontributiontoapensionschemebyfrmsize

Number o employers currently oering . . .

Number o

employees inthe rm

No provision

and/or nocontributions

Some

contributionsbut less than 3%

Contributions

o 3%or more Total

1–4 650,000 7,000 110,000 770,000

5–49 310,000 0 53,000 370,000

50–249 19,000 870 5,500 26,000

250+ 4,100 34 1,800 6,000

Total 980,000 7,900 170,000 1,200,000

Source: Employers Pension Provision Survey 2005 and Small and Medium-sized Enterprise Statistics 2004

Notes: Figures may not add to total due to rounding.Figures rounded to 2 significant figures.

58 Source: Small Business Service.




1.124 Figure 1.xiv illustrates the eects o personal accounts by irm size. It shows that

proportionately more employees will be eligible or automatic enrolment in irms withewer than 50 employees. The minimum contribution as a percentage o labour costsis also higher or these irms.

Figure1.xivTheeectsopersonalaccountsbyfrmsize

Firm size (number o employees) 1–4 5–49 50–249 250+

Number o private sectoremployees (million) 2.2 4.6 2.6 9.1

Number o employees eligible

or automatic enrolment (million) 1.4 3.3 1.7 4.4

Personal accountparticipation rates (%) 70 70 65 60

Number o personalaccount members (million) 0.9 2.2 1.0 2.6

Capped average earningsper participant (£) 15,500 18,300 19,300 18,300

Average cost per employee (£) 140 190 170 110

Costs o minimumemployer contribution (£ million) 300 900 400 1,000

Minimum employer contributionas percentage o labour costs (%) 0.9 0.9 0.7 0.5

Sources: DWP modelling using Employers’ Pension Provision Survey 2005, Family Resources Survey 2004/05, Annual Survey of Hours and Earnings 2004 and Small- and Medium-sized Enterprise Statistics 2004Notes: Figures may not sum due to rounding.Participation rates and costs are based on our central estimate of opt-out at around one third. We estimate that therange of opt-out rates will be between 20% and 50%.Number of employees who are eligible includes some who we expect may be automatically enrolled into their employer’s scheme rather than a personal account. We estimate that around 10 million employees will beautomatically enrolled into a personal account. The costs of the minimum employer contribution include the cost of those newly participating in their employers’ schemes.Employers are only mandated to make contributions on earnings between the Primary Threshold and Upper EarningsLimit, and therefore earnings have been capped at £33,540 and actual contributions will be made on earningsabove £5,035.

1.125 We will design personal accounts to minimise the burden on employers. Employerswill need to undertake a range o tasks which will vary depending on existing payrollsystems and the type, and level, o pension provision already oered. There will besome set-up costs and some ongoing tasks. Precise costs will be subject to urther

detailed design work. At this stage early estimates suggest total set-up costs to allemployers could be around £230 million, and total ongoing annual costs around£90 million – about £10 per new scheme member.




Long-termimpact

1.126 Employers may manage this additional cost in a number o ways. They can adjustprices, oer lower wage increases or absorb the cost through lower proits.59 Ourresearch with employers suggests that the majority will use these mechanisms.60

1.127 Economic theory suggests that the main mechanism or employers will be to pass onthe costs through lower wage increases. In the case o personal accounts, a lexiblewage response will be acilitated by the act that participation is voluntary and thatindividuals will have ull ownership over their pension und.

Employees on the National Minimum Wage1.128 For employers with sta on the National Minimum Wage, the scope or adjustment

through lower wage rises will be limited. However, o those who would be automaticallyenrolled, we estimate only 2 per cent are on the National Minimum Wage. The LowPay Commission takes into account relevant costs aced by employers when makingrecommendations about the appropriate level o the National Minimum Wage. Thereore,in the uture, they will consider any impact o a national minimum employer contribution.

Supportoremployers

1.129 We have developed a package o measures to help employers manage the transitionalimpacts o minimum contributions. The key elements o our proposals are that:

• the level o the national minimum employer contribution will be set out in primarylegislation, so that employers can have conidence in the stability o this levelover time;

• the minimum employer contribution will be phased in over three years (as will theemployee contribution); and

• employers will be given due notice o the rate and timing o the introduction o

the scheme.

1.130 The priority is to design the scheme and the transition phase so that burdens onemployers are minimised. We will consult on transitional support or the smallestbusinesses, and on whether a longer phasing period is needed.

59 Research by BMRB or DWP (Marshal H and Thomas A, orthcoming in 2006, Employer attitudes to personal accounts:Report of a qualitative study ).





Choosingtocontributemoreintoapersonalaccount

1.131 The minimum levels o contribution set out above are intended to promote a minimumlevel o saving. Some employers and employees will wish to supplement this by makingadditional contributions, and we see this as a key component o personal accounts. Bysupplying scheme members with inormation and education as their savings grow, thescheme will enable people to take a view on whether they should be saving more.

1.132 However, we know that, even with good-quality inormation, all too oten membercontributions tend to remain at the minimum contribution level. People have goodintentions to increase their pension contributions but never get round to it. Onepossible way to encourage people to consider increasing the amounts they are

contributing to their pension is set out in Box 1l.

Box1l:Encouragingpeopletocontributemoretotheirpension

The Save More Tomorrow (SMarT™) scheme, pioneered in the US using behaviouraleconomics concepts, has successully increased savings rates in US employer-basedretirement programmes. US research studies encouraged employees who were alreadysaving or their pension through the workplace to save more by pre-committing to increasetheir contributions with each pay rise. Employees were given the choice to leave the plan atany time, but the majority o people who joined stayed in. Findings included:

• 78 per cent o employees who were oered SMarT™ in the rst case study joined.

• O these, approximately 80 per cent remained in the scheme or our savingincrements.

• Savings contributions increased until employees reached the maximum allowedcontribution (typically within our years).

By giving employees the choice to automatically increase their saving rate by 3 per cent ateach uture pay rise, the average savings rates, in one US research study, increased rom

3.5 per cent to 13.6 per cent in just over three years.61

61 Benatzi S and Thaler R, 2003, ‘ Save more tomorrow: Using behavioural economics to increase employee saving’. Journal of Political Economy .




Box1l:Encouragingpeopletocontributemoretotheirpension(continued)

The encouraging results in the US have prompted the Department or Work and Pensionsto work with pension providers to acilitate two case studies with employers whocontribute to pensions in their workplace to evaluate the eectiveness o this techniquein the UK. PIP (Pension Increase Pledge) is the working title o this initiative. The study willexamine i employees who are already enrolled in a workplace pension can be encouragedto save more by agreeing to have their contributions automatically increased annually.

The results o this research62 will provide us with an insight into ways in which we can

increase pension savings in the workplace. This technique may be one way o encouragingpeople to contribute more and, i eective, we will consider how it can be promotedmore widely.

Inormation and choice

1.133 We endorse the Pensions Commission’s view that it is vital that communication withmembers o the new scheme is designed to enable them, as best as possible, to make

inormed decisions about their saving.63

1.134 In the period beore implementation, we will be pursuing three distinct strands owork to meet this objective: developing the inormation and communications strategyto support the introduction o personal accounts; continuing our work on improvingpublic understanding o pensions; and working with the FSA and others on thebroader inancial capability strategy.

1.135 While the exact nature o the communications and inormation package to supportpersonal accounts will depend on the inal model or delivery, the introduction oa new national personal accounts scheme will require both a high-level awareness-

raising campaign and the provision o speciic inormation and support to employers,individuals and the voluntary sector.

62 Independent researchers have been commissioned to undertake the evaluation and it is hoped to publish initial indingstowards the end o 2006.

63 Pensions Commission, 2005, New pension settlement for the twenty-first century : The second report of thePensions Commission.




1.136 Individual members are likely to need more speciic inormation to help them make

decisions at key trigger points, including:

• joining – whether this scheme is right or their current circumstances, and theimpact o opting out;

• choice o investment – the balance o risk and return and the possible impacto choosing a particular method o unding or a particular investment portolio;

• continuing membership – assessing the growth o the pension und and whether toincrease the contribution;

• retirement – the impact o dierent decisions regarding annuitisation beoredrawing a pension; and

• choice o branded provider – which provider to choose to administer their pension(dependent on scheme design).

1.137 In developing the inormation and communications strategy or personal accounts,and our work to improve general public understanding o pensions, we will lookor lessons we can learn rom other countries. In Sweden, or instance, annual statepension orecasts are issued in a clearly branded, coloured envelope since introducing

pension reorms. Research conducted in 2005 showed very encouraging results orthis with recall levels o 90 per cent, 52 per cent reading the orecast, 18 per centcomparing it with the previous year’s statement and 68 per cent describing it astrustworthy.64

1.138 New Zealand provides another example. The Retirement Commission is an independentagency whose mission is to assist current and uture generations to have an adequateamount o income in retirement through education, inormation and promotion. Since1996, they have been running a programme designed to ensure that people in NewZealand understand retirement income policies and, in particular, are aware o thebeneits o supplementing their superannuation (the state pension) with private savings.

64 Presentation by Arne Paulsson, Inormed Choice UK EU Presidency Event 9/11/05.




1.139 We have been working to improve public understanding o pensions through the

Inormed Choice programme since 2002. We will build on the achievements o thisprogramme alongside our work on personal accounts. We will:

• continue to issue pension orecasts while exploring ways to improve their impactand eect on savings behaviour;

• look at the best way to provide people on low to medium incomes with web-basedretirement planning services to give them the inormation, education and support theyneed in the context o today’s pension system and during the transition to anychanges; and

•consider how to increase public awareness o the pension tracing service, theree service we oer to help people trace unclaimed or ‘lost’ occupational andpersonal pensions.




Next steps

1.140 This chapter has set out our proposals to ensure that low-cost, good-value, privatesaving is accessible or all. Putting the detail o these proposals together will inevitablytake time – in particular, setting up the necessary legal and administrative ramework.We intend that people will be able to start contributing to the personal accountsscheme in 2012.

1.141 We will publish a document later this year setting out the approach we intend to takeon the operation o personal accounts. This will include:

• the administration o personal accounts;• the structure and type o investments;

• the process o taking a pension;

• the exemption process or qualiying workplace schemes;

• linking the contributions band to earnings growth;

• transitional issues on implementing the new scheme; and

• urther detail on the inormation supporting personal accounts, with a detail

update on progress achieved in the Inormed Choice programme and timinguture activity.

ed

o





83

Chapter 2:Strengthening existingprovision





Chapter2 • Strengthening existing provision 85

Chapter 2: Strengthening existing provisionSummary

People are not saving enough or their retirement. The introduction o a new schemeo personal accounts, automatic enrolment and minimum employer contributions willtackle at source some o the key barriers to saving, overcoming inertia, reducing costs andsimpliying the savings decision.

But our response must also recognise the important role already played by many employersin providing high-quality pension schemes with valuable employer contributions and

high-quality support and advice or their sta. We must continue to support this existingprovision.

We will:

• reduce administrative complexity by abolishingcontractingoutordefnedcontributionpensionschemes. This will also remove a key source o conusion orindividuals;

• set in place a rollingderegulatoryreview o pension regulations;

• allow occupational schemes to convertGuaranteedMinimumPensionrightsinto

schemebenefts, oering the actuarial equivalent in exchange;

• pilot a PensionsLawRewriteProject, to establish whether there would be value orbusiness in a substantive rewrite o pensions law; and

• bring orward proposals in the autumn or a review o those organisations establishedthrough the Pensions Act 2004 to ensure they are congured in the most eective wayto achieve our long-term objectives.

• extend the Financial Assistance Scheme to ensure people within 15 years o theirscheme’s normal pension age in May 2004 may qualiy or help.

These measures will help meet the ve tests or pension reorm. They will make the systemsimpler or employers and providers by reducing regulatory burdens, and or individualsthrough clariying the choices they ace. They will make the system more aordable andsustainable.



86 Chapter2 • Strengthening existing provision

Context or reorm

2.1 The introduction o a new pension saving scheme o personal accounts will provideaccess to a high-quality savings vehicle or those without good existing workplaceprovision. Many people already have access to such provision through existingoccupational arrangements. The UK has a very successul history in occupationalpension provision – employers have traditionally treated the provision o good-qualitypension schemes as a serious priority in remuneration packages or their employees.Figure 2.i shows, as a percentage o GDP, the total pension assets under managementin the UK compared with other countries.

2.2 Personal accounts are intended to provide a new architecture or private pensionsaving or those not currently covered by alternatives provided through the workplace.Chapter 1 describes how employers already oering schemes o a certain standard will

be able to opt out o the requirement to provide access to personal accounts.




2.3 Against this background, it is thereore crucial that we continue to support the existing

occupational pensions ramework. Employees saving in workplace schemes can beneitnot only rom contributions rom their employer but requently rom low chargesand good supporting inormation. It is an eective environment or saving. We willcontinue to support work-based pension provision and protect scheme members witha regulatory regime that encourages employers to continue to play a prominent role inpension provision.

2.4 We must also ensure that individuals are well placed to be able to take the decisionsthat are right or them about pension saving. This will in part be delivered throughthe measures described in Chapter 1, such as the introduction o automatic enrolmentand the ongoing provision o inancial and pension-related inormation. But it must

also involve ensuring that there is no unnecessary legal or regulatory complexity orindividuals surrounding private pension provision.

Summary o proposals

2.5 To strengthen the system urther, we now propose:

• to revise the arrangements or contracting out o the State Second Pension intoan occupational or personal pension scheme by abolishing contracting out intodeined contribution (DC) pension schemes;

• to investigate urther ways to lighten the regulatory burden on business througha rolling deregulatory review o the rules governing pensions, which will eed intothe Department or Work and Pension’s (DWP’s) simpliication plan, to be publishedlater this year;

• to allow schemes to convert Guaranteed Minimum Pension rights into schemebeneits, oering the actuarial equivalent value in exchange;

• to pilot a Pensions Law Rewrite Project, to establish whether deregulatory gainscould be made rom a substantive rewrite o pensions legislation; and

• to bring orward proposals in the autumn or a review o those organisationsestablished through the Pensions Act 2004 to ensure they are conigured in themost eective way to achieve our long-term objectives.

• to extend the Financial Assistance Scheme to ensure people within 15 years o theirscheme’s normal pension age in May 2004 may qualiy or help.




Contracting out

2.6 Since 1978, the state pension system has included a mandatory, earnings-relatedsecond tier or employees. The system allows individuals a choice, however, on how thisearnings-related provision is made: they must either be members o the state second-tier provision (State Earnings-Related Pension Scheme (SERPS)/State Second Pension)or be contracted out into a private pension. Where people choose to contract out othe state scheme, part o their National Insurance contributions (NICs) is rebated andinvested to build up a unded pension. Box 2a describes contracting out in more detail.

Box2a:Whatiscontractingout,andhowdoesitwork?

Contracting out was introduced or dened benet (DB) schemes in 1978, when SERPSwas created, and has evolved over time to include DC schemes. It provides a private sectoralternative to the State Second Pension, allowing people to invest privately now to replacebenets that would otherwise be provided by the State at some point in the uture.

In the current contracting out system, employees orego all or part o their State SecondPension entitlement and in return pay lower-rate NICs and/or receive an annual paymentinto their pension scheme. Where the contracting out arrangement is an occupationalscheme, the employer also pays reduced-rate NICs. These reductions and payments areknown collectively as the contracted-out rebate.

For DB schemes, the rebate is currently1 a reduction in NIC levels o 5.1 per cent (3.5per cent or employers and 1.6 per cent or employees) on earnings between the LowerEarnings Limit and the Upper Earnings Limit. The rebates or contracted-out DC schemesare two-tier. For DC occupational schemes, fat-rate rebates are made through reduced-rate NICs (1 per cent or employers and 1.6 per cent or employees) and, at the end o therelevant tax year, an age-related ‘top-up’ is paid direct to the occupational scheme. Forthose contracted out through a personal or stakeholder pension, ull-rate NICs are payablebut a higher age-related rebate payment is made direct to their pension und at the end othe relevant tax year. Age-related rebates are currently capped at 10.5 per cent.

The State thereore saves the need to pay or additional State Pension out o tax/NICs inthe uture and in return receives lower NIC income now.

DB schemes that contract out must meet an overall scheme quality test, known as theReerence Scheme Test. There are no specic rules about the use o the rebate in DBarrangements.

1 A review o the rebate rates is required by legislation at least every ive years. New rates will be introduced romApril 2007. These are set out in the Regulatory Impact Assessment that accompanies this paper.




Box2a:Whatiscontractingout,andhowdoesitwork?(continued)The sponsoring employer o a contracted-out DC occupational scheme must pay amountsequivalent to the rebate into the scheme within a set period. These are known as minimumpayments. There is no requirement or the employer to contribute more than the minimumpayment. The contracted-out DC benets rom both occupational and personal pensionschemes are subject to certain restrictions.

Abriehistoryocontractingout

1978 Contracting out introduced or DB schemes.

1988 Contracting out extended to money-purchase schemes and a 2 per centincentive added to the rebate or individuals in DC schemes rom 1988to 1993.

1993 1 per cent age addition paid to people aged 30 and over in a DC personalpension scheme rom 1993 to 1997.

1997 Age-related rebates introduced or individuals in money-purchase schemes,making the rebate actuarially neutral.

Complexityorindividuals

2.7 Since contracting out was introduced in 1978, the pattern o private pension provisionhas evolved. At that time, most private sector occupational schemes were DB schemes.An estimated 24 per cent o employees belonged to a private sector contracted-out DBoccupational scheme. But this had allen to 11 per cent by 2004, largely as a result othe closure o DB schemes to new members and, in some cases, to all uture accruals.

2.8 As a result, the number o individuals contracted out in private sector DB occupationalschemes ell rom around 5 million in 1989/90 to under 3 million in 2003/04.

2.9 An increasing proportion o private pension schemes now operate on a DC basis.

Under the current DC arrangements, with an actuarially neutral rebate, it has becomeincreasingly diicult to judge (particularly or personal pensions) whether or not anindividual would be better o in the State Second Pension scheme or contracted out.There is an inevitable tension in substituting DC or DB provision because it is notcomparing like with like. Contracting out on a DC basis involves investment in equitiesand bonds and, as with all investments, there is no guaranteed outcome.2

2 The age-related rebate is capped and it is generally accepted that the majority o those aected by the cap would bebetter o contracted in.




2.10 Current trends would suggest that an increasing number o people with DC pensions

are contracting back into the State Second Pension. There is also evidence that agrowing number o providers have contracted policy holders back into the statescheme, unless the policy holder opts not to do so. Between 2001/02 and 2003/04around 700,000 people in DC schemes contracted back into the State Second Pension.3

2.11 The evidence that complexity is a key actor in putting people o any sort o long-term savings decisions is compelling. Elsewhere in this paper we have made clear thepriority we place on tackling undersaving and encouraging personal responsibility byclariying the key decisions people need to take in relation to their inancial planningor retirement.

2.12 We want people to be clear on what they can expect rom the State. In this context,we have decided that the current contracting out arrangements do not it with thenewly clariied environment in which we are asking people to take their savingsdecisions. People will not thereore be able to use personal accounts as a vehicle intowhich to contract out.

Regulatorycomplexityorpensionschemes

2.13 In addition to diicult decisions about the beneits o contracting out into DC schemes,many commentators have pointed to the associated administrative complexity and

costs. These arise because o particular conditions that apply to contracted-out rights.Requirements relating to investment, the purchase o a unisex annuity and the provisiono a survivor beneit require contracted-out rights to be tracked separately rom otherrights and treated dierently at the point o annuitisation.

2.14 Administrative complexity also arises rom rights built up in DB schemes. Part o thereason or the current complexity is that, with each past reorm, members have built upa series o dierent rights under dierent rules.

2.15 Against this background, any proposals or the reorm o contracting out must alsoaddress the past rights that individuals have built up i we are to avoid complicating

matters still urther. Later in this chapter, we introduce proposals to tackle one elemento this problem – Guaranteed Minimum Pension rights.

Proposalsorreormtocontractingout

2.16 The complexity and regulatory burdens associated with contracting out underminesaving. The Pensions Commission suggested that, i contracting out did not exist, itwould not be invented now. We accept this view and, thereore, have been consideringhow to reorm contracting out as part o a coherent pensions reorm package.

3 DWP, 2006, Second Tier Pension Provision 1978/79–2003/04.




2.17 However, we also recognise, as did the Pensions Commission, that the nature o

DB provision does not allow or sudden reorms. Consequently, any changes to DBcontracting out will need to take place over the longer term to relect changes to theState Second Pension, and as part o the evaluation o the overall pensions reormpackage.

Contracting out for DC schemes

2.18 The Government agrees with the Pensions Commission that the decisions aroundcontracting out into DC schemes have become too complicated and that the systemis poorly understood. We now propose to abolish contracting out into DC pensionschemes, both occupational and personal/stakeholder.

2.19 Abolishing contracting out into DC schemes will:

• oer greater clarity or individuals, removing the diicult judgement to be madeabout whether they would be better o contracted in or contracted out;

• enable individuals to make inormed decisions about their additional pension savingoptions by building on a clear oundation rom the State;

• avoid the complex decisions or individuals and advisers that could arise rom the

introduction o a new scheme o personal accounts, i people were able to contractout; and

• reduce costs or providers by removing the associated regulatory complexity.

2.20 We described earlier the conditions that currently apply to contracted-out DC rights.The abolition o contracting out or DC schemes raises important questions aboutthe treatment o rights already accrued in the past and whether any or all o thoseconditions should continue to apply. We intend to consult on the possibility oreorming or removing the restrictions on investment and the type o annuity that maybe purchased with savings built up through contracting out. We will examine options

in this area with a view to increasing simplicity or scheme members and reducing theregulatory burden.

2.21 The DC contracted-out rebate will end at the same time as the basic State Pension isuprated in line with earnings, which we describe in detail in Chapter 3.




Contracting out for DB schemes

2.22 In a DB scheme, the pension is calculated by reerence to the individual’s earnings, andemployer and employee contributions are set at a level to und the scheme beneits.Decisions on unding levels and contribution rates are taken on a long-term basis.Decisions on contracting out and joining the pension scheme are thereore usually moreclear cut. The Pensions Commission recognised that the abolition o contracting out orDB schemes would be more likely to spur scheme closure and reduce national savingthan to stimulate more saving. This is because it could require a major restructuring oscheme beneits and a revision o scheme rules.

2.23 The Pensions Commission concluded that, or DB schemes, rather than abolishing

contracting out, it should be phased out by 2030 when the State Second Pensionbecomes lat rate, making the lat-rate element o the State Second Pension 100 per centcontracted in. However, we do not intend, at this stage, to bring orward additionalproposals to abolish DB contracting out in the longer term. Instead, the long-termuture o contracting out or DB schemes will be subject to ongoing review as part othe evaluation o the overall reorm package.

2.24 We believe that abolishing contracting out or DC schemes and retaining it or DBschemes on the current basis strikes the best balance between the need to simpliy thesystem, where possible, or individuals and schemes, and a desire not to disturb existingDB provision.

The impact of reforms to contracting out

2.25 As a result o the abolition o contracting out into DC pension schemes, those peoplewho had previously been contracted out into such schemes will start to build up newrights to the State Second Pension. At the same time, they will no longer receivecontracted-out rebates into their pension schemes. There will be no impact on theirtake-home pay.

2.26 Given the actuarial assumptions currently used to calculate the level o the rebate,

people should generally be no better or worse o in retirement as a result o theabolition o contracting out or DC pensions.

2.27 An additional impact o this decision will be on the insurance industry and other irmsmanaging contracted-out pension unds. We recognise the need to manage this impactcareully and will take this ully into account when considering how we approach theimplementation o this decision. We welcome views on this issue.




Dealing with past rights – Guaranteed Minimum Pension conversion

2.28 Abolition o contracting out or DC schemes will simpliy private savings decisions orindividuals and reduce complexity or employers oering DC pension provision. There isalso, however, an ongoing issue o complexity within DB schemes as a result o the actthat, with each past reorm, members have built up a series o dierent rights underdierent rules. The most complex o these rules concerns the Guaranteed MinimumPensions built up on an individual basis by members o DB schemes.

2.29 From 1978 to 1997, i a DB occupational pension scheme wanted to contract out othe additional State Pension, the employer had to agree that the scheme would pay atleast a statutory minimum level o beneits – the Guaranteed Minimum Pension. While

Guaranteed Minimum Pensions ceased to accrue in 1997, past rights still exist. This is acontinuing source o complexity, particularly on wind-up and over transers. Since 1997,however, contracted-out DB schemes have been required to meet an overall test oscheme quality, the Reerence Scheme Test, which is considerably more lexible.

2.30 Against this background, any proposals or the reorm o contracting out must alsoaddress the past rights that individuals have built up, i we are to avoid complicatingmatters still urther.

2.31 The Government proposes to allow schemes to convert Guaranteed Minimum Pensionrights into scheme beneits, oering the actuarial equivalent value in exchange. This

would allow or easier (and thereore cheaper) administration in the scheme and alsomake it easier or the member to move their rights into other pension products, i theywish to do so.

2.32 We estimate that this measure would save schemes around £8 million to £15 milliona year, assuming that 25 to 50 per cent o schemes choose to make the change.There would be a one-o cost to implement the change, o between £12 millionand £24 million, to make IT sotware changes and pay associated legal, actuarial andadministrative ees.

2.33 The Government intends to bring orward legislation to enable this change as soon asa suitable opportunity arises.

2.34 One urther proposal or possible administrative simpliications relating to contractingout has been that we should allow employers to buy their sta back retrospectivelyinto the State Second Pension. We have considered this approach, but, or a number oreasons outlined in Box 2b, we have decided not to take this proposal orward.




Box2b:Buy-backintotheStateSecondPensionIt has been suggested that as part o the pension reorm package the Government shouldallow contracted-out pension schemes to ‘buy back’ their members’ rights in the StateSecond Pension. The potential benets to schemes o such a buy-back are that it wouldenable them to simpliy their administration – or example, closed DB schemes might beable to stop operating contracting out altogether – and to match their assets more closelyto their liabilities. However, it would not in itsel reduce the pension und decits acingcertain DB schemes: decits would only be reduced i scheme sponsors nanced the buy-backs, and this would consume cash that sponsors might use to reduce their decits inother ways. It would also produce a short-term cash infow to government (though this

would be oset over the longer term by increased payments o the State Second Pension).The Government is sympathetic to the aims o the buy-back proposal. It is envisagedthat orthcoming legislation will allow schemes to convert certain contracted-out rights(Guaranteed Minimum Pension rights) into scheme benets. Accordingly, we undertook apreliminary investigation o both the legal and the nancial easibility o creating a acilityor more broad-based buy-backs. This investigation suggested that buy-backs would beeasible in principle, but very complex in practice. In addition, unless signicant changeswere made to SERPS/State Second Pension, it would not be possible to guarantee thatindividuals would receive at retirement as much SERPS/State Second Pension as they hadgiven up in the pension scheme. Accordingly, the Government does not propose to include

a provision or buy-backs in its pension reorm.

Further reducing the regulatory burden

Acontinuingprogrammeosimpliication

2.35 The Government recognises the importance o security and conidence as prerequisitesto private pension saving. The Pensions Act 2004 set out a new approach. The Act

created the Pension Protection Fund (PPF), a major new institution that radicallytransormed the nature o protection oered to members o DB pension schemes. Over10 million members o inal salary pension schemes now beneit rom the security oknowing they will receive a meaningul occupational pension even i their companybecomes insolvent and the pension scheme is underunded.




2.36 The Act also established The Pensions Regulator (TPR), which now assists in protecting

members’ beneits while enabling companies to get on with running good schemes.It operates a risk-based approach to regulation in line with the recommendations othe Hampton Review.4 It promotes eective governance or all work-based pensionschemes and works with trustees, employers and proessional advisers to put thingsright where necessary.

2.37 Since the 2004 Act, the Government has been pursuing a range o simpliyingmeasures. These have included:

• changes to section 67 o the Pensions Act 1995 to make it easier or schemes toamend scheme rules, by allowing changes that aect accrued rights, provided

that the overall value o beneits is not changed (depending on take-up, potentialongoing savings o £3.5 million a year);

• key legislation in the Finance Act 2004 to replace the complex pensions tax ruleswith one simple and lexible regime. The legislation was implemented in April 2006;

• aligning some contracting out rules with tax rules (savings in the region o£9 million a year); and

• making it easier or employers who run several small schemes to bulk-transer

members with protected rights into a single scheme (expected to save schemes£10 million over the next three years).

2.38 In addition, TPR and the PPF are considering how they might contribute to thesimpliication process. TPR, or example, has already been working on reducing theburden o the scheme return, with a more streamlined version available rom thebeginning o May 2006. It is also reviewing its inormation and data requirements inthe widest sense and looking at where it can use inormation already gathered by otherorganisations – government or commercial – rather than requiring schemes to submitit. The PPF is looking at the requirements governing the provision o inormation to itsBoard with a view to identiying and eliminating duplication wherever possible.

2.39 In the light o regulatory experience, TPR is also considering whether there are partso the legislative ramework which have proved to be unnecessary or less eectivein practice than anticipated, and which could be removed – or example, some typeso notiiable event – and will make recommendations to DWP. TPR will continue toreview its eectiveness in ulilling its statutory objectives, particularly in the context oproportionate and risk-based regulation.

4 Hampton Philip, March 2005, Reducing administrative burdens: effective inspection and enforcement . This report can beaccessed at www.hm-treasury.gov.uk/hampton




2.40 TPR’s aim is to ocus on those areas where concerns are greatest, and to concentrate

on delivering better and more eective risk-based regulation relevant to its environmentand stakeholders. TPR will thereore apply a light touch to enorcing legislationthat does not contribute signiicantly to the achievement o its objectives and willdraw DWP’s attention to legislative requirements that appear to be ineective ordisproportionate.

Deregulatoryreview

2.41 The proposals contained earlier in this chapter to abolish contracting out on a DCbasis will considerably simpliy the position or DC occupational schemes. Enabling theconversion o Guaranteed Minimum Pension rights within DB schemes will help that

part o the pensions sector. Alongside the introduction o the new scheme o personalaccounts, we also propose to review the current requirement on most employers todesignate a stakeholder pension provider. Clearly, the uture o stakeholder pensions isan important issue and one that we will consider careully with key stakeholders in theindustry and with employers.

2.42 In addition, we are now launching a rolling deregulatory review o pensions regulation,which will eed into DWP’s simpliication plan, to be published later this year. It maybe possible to remove, merge or simpliy many o the layers o legal requirementsintroduced in and since the 1995 Pensions Act. This could include re-examining the

provisions on matters such as:

• mandatory indexation o pensions in payment;

• member-nominated trustees;

• administrative and internal control requirements;

• restrictions on changes to accrued rights (section 67);

• payments to employers where surplus unds exist;

• deemed buy-back; and

• internal dispute resolution.

2.43 Reorms in some o these areas (or example, urther reorm o the requirementto apply price indexation to pensions in payment) could have the scope to make asigniicant dierence to the costs o running an occupational pension scheme.




2.44 We will establish a group o external stakeholders to help us review the current

position, irst to identiy particular areas where quick wins may be possible (includingchanges that could be achieved by secondary legislation or administrative action), andthen, more comprehensively, to maintain momentum by mapping out a programme osimpliication measures.

2.45 We would welcome proposals or priority areas – in the irst instance, during theconsultation period ollowing the publication o this paper.

PensionsLawRewriteProject

2.46 The Government has also been considering the possibility o launching a Pensions Law

Rewrite Project, drawing on the experience o the successul recent Tax Law RewriteProject, which has been progressively rewriting the body o tax law with a view tomaking it simpler and easier to understand. Such a project would involve a mixedteam o public and private sector lawyers and other proessionals taking a hard lookat the complexity o pensions law to see whether it could be written more clearly, thusremoving some o the burden o compliance without changing the substance o theregulatory policy.

2.47 This would be a very major undertaking and consequently the Government proposes torun a pilot which would ocus on one or more sets o regulations which have an impact

on business, to test whether the approach is likely to produce worthwhile dividends interms o simplicity and, ultimately, savings or schemes and employers.

The institutional landscape or pensions

Theexistinglandscape

2.48 The pensions landscape has changed markedly as a result o the introduction o thePensions Act 2004 and the creation o two new independent statutory bodies, The

Pensions Regulator and the Pension Protection Fund.

2.49 These bodies – working together – have transormed the security o occupationalpension saving or members o DB schemes. The Act also established the FinancialAssistance Scheme to provide help to many o those who had lost the most in thepast. The scheme came into operation on 1 September 2005, providing help toqualiying members within three years o their scheme pension age on 14 May 2004.The Financial Assistance Scheme (FAS) will help groups close to retirement who lostout beore the PPF was established. Following the Prime Minister’s announcement toexpedite the review o the FAS planned or CSR07, the Government has decided toextend the FAS so that it will assist eligible people who were within iteen years o

their scheme pension age on or beore 14 May 2004. This should ensure that up to aurther 30,000 people who lost signiicant amounts when their pension schemes werewound up, will beneit rom the new arrangements. Under this extension, scheme




beneits will be tapered so that the Government will pay the ull 80 per cent to those

within seven years o scheme pension age, 65 per cent to those within eight to elevenyears o scheme pension age and 50 per cent to the remainder.

2.50 The establishment o these new pensions bodies has added to the existing pensionslandscape. In addition to the government departments with various responsibilities orpensions policy, there are several government-sponsored bodies charged with unctionspartly or wholly related to pensions policy, and beyond that a number o outsideorganisations whose roles include pensions to a lesser or greater extent. A number othese are described in Box 2c.

Box2c:TheexistinginstitutionallandscapeThePensionProtectionFund–a statutory und established under the provisions othe Pensions Act 2004 to pay compensation to members o eligible DB pension schemes,when there is a qualiying insolvency event in relation to the employer and where there areinsucient assets in the pension scheme to cover PPF levels o compensation.

ThePensionsRegulator–a regulatory body or work-based pension schemes, createdunder the Pensions Act 2004, which takes a risk-ocused approach to regulation.

TheFinancialAssistanceScheme–administered by DWP and managed by a nationalFinancial Assistance Scheme Operational Unit, the scheme oers help to people who have

lost out on their pension because their scheme was underunded, and the employer isinsolvent or no longer exists.

ThePensionsAdvisoryService – an independent non-prot organisation whichprovides inormation and guidance on the whole spectrum o pensions, covering state,occupational, personal and stakeholder schemes.

ThePensionsOmbudsman – an independent and impartial adjudicator who investigatesand decides complaints and disputes concerning occupational pension schemes andPersonal Retirement Savings Accounts.

Maintainingtheconsensus

2.51 The Pensions Commission recommended the creation o a government advisory body.The Commission envisaged that such a body would provide a detailed analysis o keytrends in demographics and pension provision. The overall intention was to provide anindependent and trusted voice that would spell out ‘the unavoidable trade-os’.




2.52 The Government recognises the value o the Commission’s recommendation. The

Commission itsel has been hugely successul in driving orward the debate on pensionreorm and in particular in helping convince the public o the need or change.We thereore propose to periodically commission reviews drawing on a range oindependent expert advice in the light o emerging evidence on demographic change.

Supportingthestrategyoranageingsociety

2.53 Chapter 4 sets out plans to ensure a cross-government strategic approach towards anageing society. Part o that work has implications or the institutional landscape thatneed to be considered:

• The Social Exclusion Unit promised a review to consider the establishment o anoice or ageing and older people.

• The Government committed in Opportunity Age5 to explore the scope or anobservatory on ageing that would improve the evidence base available to policymakers.

2.54 Further work remains to be done in both o these areas – the review promised bythe Social Exclusion Unit will not be complete until later this year and options existregarding how any institutional changes would take eect. An observatory on ageing,

or example, could it within an existing institution, or orm part o any oice orageing and older people.

Pensionsinstitutions

2.55 The pension reorms, particularly the new scheme o personal accounts, and the workon an ageing society, will have signiicant implications or the pensions institutionallandscape. This makes it appropriate and in line with the principles o good governanceand better regulation to review those organisations established through the PensionsAct 2004 and how they it with the reorm proposals. The aim is to ensure they areconigured in the most eective way to achieve our long-term objectives. We will be

bringing orward plans or this review in the autumn, once we have developed urtherdetail on the scheme o personal accounts.

5 DWP, 2005, Opportunity Age: Meeting the challenges of ageing in the 21st century (Cm 6466i) DWP.




2.56 This chapter has outlined a range o measures to help strengthen the existing

occupational pensions sector, and to help clariy urther the decisions individuals needto take with regard to their saving. Coupled with the measures outlined in Chapter 1– introducing mandatory automatic enrolment, a minimum level o employercontributions and a new scheme o personal accounts – these measures will helpsupport a private pensions sector delivering good outcomes or individuals inretirement.

2.57 But or these measures to be successul, it is essential that individuals receive the rightincentives rom the State Pension as a oundation on which to build savings. Theollowing chapter introduces a radical reorm to the state pension system to ensure thatit continues to perorm this vital unction.



Chapter 3:Providing a oundationor private saving

101





Chapter3 • Providing a oundation or private saving 103

Chapter 3: Providing a oundation orprivate saving

Summary

Chapters 1 and 2 outlined our proposals to tackle at source behavioural barriers to savingand to strengthen existing private pension provision. These include proposals or a new,low-cost pension saving scheme o personal accounts. But the current state pension systemis highly complex, making it dicult or individuals to be condent about exactly whatthey can expect rom the State, and many people – particularly women – will not get ull

pensions despite working or making other contributions to society or signicant periods.

The state pension system seeks to achieve two objectives – to tackle pensioner poverty,and to provide a oundation or retirement incomes or all. The Government’s reormssince 1997 have done both while maintaining long-term aordability. The objective o thereorms in this paper is to build long-term condence in this approach.

As the number o pensioners increases, the generosity o the state pension system orthose on average earnings is alling relative to the wealth o the rest o society. The reormsset out in this chapter will create a system that, over the long term and in the ace odemographic change, provides a decent minimum or the poorest and a oundation or

all upon which to plan or their retirement.This chapter outlines proposals to:

• ensure that the basic State Pension can act as a oundation or urther provision, bylinking its value to rises in average earnings;

• raise the State Pension age rom its level in 2024 o 65 or both men and women, inline with the growth in average lie expectancy;

• reorm the State Second Pension so that it becomes a simple, fat-rate weekly top-upto the basic State Pension; and

• ensure that, beore implementing the earnings link o the basic State Pension,means-tested provision continues to be ocused on those with small savings, bytaking steps rom 2008 to target the Pension Credit on this group.

We can now also announce an intention to continue to uprate the Guarantee Credit in linewith earnings over the long term.

The current system is based on outdated assumptions: its rules are rooted in an era inwhich most men were expected to work and pay contributions rom 16 to State Pensionage; and in which women were expected to rely on their husbands or support. Today’ssociety is not like that. More and more people benet rom urther and higher education

while the trends o rising numbers o unmarried partnerships and growing emaleparticipation in the labour market are expected to continue.



104 Chapter3 • Providing a oundation or private saving

Summary(continued)Many people’s working lives are interrupted by caring and other activities. The introductiono Home Responsibilities Protection (HRP) in 1978 went a long way towards improving thesituation or women. Women’s pension entitlements are, on average, catching up withmen’s. But there remains a critical cohort o women over the age o about 45 now whodid not ully benet rom HRP. They have signicantly poorer contribution records – despitethe act that most o them will have made important and valuable contributions to society.

Many people are thereore let uncertain about whether they will get a ull basic StatePension, and nd it dicult to work out what additional State Pension they will get andwhether their income will be means-tested. This chapter outlines how we will respond to

these challenges. We will:

• reduce the number o qualiying years needed or a ull basic State Pension rom 44or men and 39 or women to 30 or all those reaching State Pension age rom 2010;

• convert HRP into a positive weekly credit, aligning the rules or when it is availablebetween the basic State Pension and the State Second Pension;

• establish a new Carer’s Credit or those undertaking care or the sick and severelydisabled or 20 hours or more a week;

•abolish the minimum contribution conditions in the basic State Pension and the LabourMarket Attachment Test in the State Second Pension, to ensure that every year ocontributions or credits count; and

• urther simpliy and modernise the state pension system by abolishing outmodedelements such as adult dependency increases and National Insurance autocredits.

Taken together, the reorms outlined in this chapter contribute to meeting the key tests wehave set or pension reorm. They will promote personalresponsibility, by ensuring thatthe state pension system operates eectively as a oundation on which people can buildor their incomes in retirement. And they will aid simplicityandairness, by ensuringthat ewer people retire on less than a ull basic State Pension.

The reorms are sustainable, as they deliver a pension that maintains its value relative tonational wealth. And, through increases in the State Pension age and the withdrawal romdirect provision by the government o earnings-related pensions, we will ensure that thesystem remains aordable or the long term.




Context o reorm

Thedemographicchallenge

3.1 The overall balance within the current state pension system is under threat rom thedemographic challenges described in detail in Annex D. While the current system isaordable now, i unreormed it will remain so into the uture only by becoming lessgenerous or the average earner over time.

3.2 I spending on pensioner beneits were to remain constant per pensioner as aproportion o national income, spending would have to rise by around £80 billion per

year (in 2006/07 prices), or over 2 per cent o GDP above its orecast level in 2050. Iall current indexation policies were to be continued indeinitely, we would see a risein spending on pensioner beneits o nearly 1 per cent o GDP (£30 billion in 2050)but this would mask a all in the proportion o national income spent per pensioner oaround a quarter.

3.3 The challenge, in the ace o a growing number o pensioners, is to sustain the broadbalance o the current system, including, crucially, its successes against pensionerpoverty, while keeping it aordable and lexible into the uture. Since 1997 we haveocused money on the poorest pensioners, helping to lit 2 million pensioners out oabsolute poverty and 1 million out o relative poverty. Pensioner incomes are higher

on average than in any previous generation, while poverty among pensioners ishistorically low.

3.4 Our irst task was to tackle poverty or today’s pensioners. Our next priority is toprovide a oundation or those who have contributed which will act as a buildingblock or private saving or tomorrow’s pensioners. Incentives to save in the currentsystem remain strong. Recent research has shown that incentives or many on lowincomes have improved as a direct result o the introduction o Pension Credit.1 Problems with incentives could, however, develop i a pensions system evolvedwhere a signiicant majority o pensioners were entitled to Pension Credit in the longterm. That has never been the intention o this Government. But urther unoundedspeculation on this point could undermine the incentives o people who want to savetoday. Our reorms make it clear that this speculated urther spread o entitlement toPension Credit will not happen.

1 Seton J, van de Ven J and Weale M, 2005, The effects of means testing pensions on savings and retirement, NIESR

(National Institute o Economic and Social Research).




Providingairmoundationorprivatesaving

3.5 The state pension system must make clear the ‘deal’ between the State and thecitizen. The state system must establish the right environment or people to takeresponsibility or their security in retirement, by allowing them to plan and makedecisions today and in the uture that they can understand and that they are conidentwill not be unravelled by uture governments. The state system must provide aoundation on which people can be conident o building through the new pensionsaving scheme o low-cost, portable personal accounts. People should be clear aboutwhat the State will do, and what they must do or themselves.

3.6 The Government cannot, in the ace o an ageing population, hope to provide both a

oundation or private savings and a good-quality alternative to occupational provision.

3.7 We thereore propose to reorm the structure o the state pension system in orderto shit it to a simpler, lat-rate system that can provide a oundation or individualsaving.

Unequalentitlementsinthestatepensionsystem

3.8 The state pension system recognises unpaid social contributions through HRP, Carer’sAllowance and more recently through the introduction o the State Second Pension,which is more generous to carers and low earners. The introduction o the Minimum

Income Guarantee in 1999, and its successor the Pension Credit in 2003, have helpedlit nearly 1 million women out o relative poverty. Over 2.1 million, or two-thirds, othose who have beneited rom Pension Credit are women.

3.9 But the Government is committed to reducing remaining inequality in outcomes,particularly or women and carers. The Department or Work and Pensions’ publicationWomen and pensions: The evidence considers in detail the disadvantages women haveaced in building pension provision.

3.10 The Family Resources Survey shows that there are around 3.6 million carers below

State Pension age caring or adults in the UK. Most o these carers are building rightsto the basic State Pension either because they are making suicient National Insurancecontributions or because they receive a beneit which attracts a credit towards theirbasic State Pension. However, around 390,000 carers are not accruing basic StatePension rights. 120,000 o them are caring or 20 hours or more a week, and thisgroup o carers appears to ace more diiculties in the labour market than thosecaring or ewer than 20 hours a week and than the overall population.




3.11 The average entitlements o women both to the basic State Pension and to additional

State Pension (the State Earnings-Related Pension Scheme (SERPS) and State SecondPension) are still some way below those o men. Women’s State Pension recordsare improving, largely as a result o HRP and increased labour market participation.However, only around 30 per cent o women reaching State Pension age recently areentitled to a ull basic State Pension and by 2010 this will still be only around 50 percent o newly retired women. This is compared with around 90 per cent o men in2010. By 2025 around 80 per cent o women are projected to retire with a ull basicState Pension, but the Government believes that action must be taken to improvestate pension outcomes or women much earlier.

3.12 Reorm must address these issues. But it must do so in a way that recognises the vital

principle that with rights come responsibilities. The system must continue to oer‘something or something’. Everyone who contributes, whether through paid or socialcontributions, should expect to know what they will get rom the State in retirementso that they can better plan their retirement and the savings they need to make.Through our reorms, those who contribute can have conidence that the state willprovide a solid oundation.

Summary o proposals

3.13 In order to provide a simpler, lat-rate system that will be a oundation or individualsaving, we will:

• link the basic State Pension to rises in average earnings. Our objective, subject toaordability and the iscal position, is to do this in 2012 but in any event at thelatest by the end o the next Parliament. We will make a statement on the precisedate at the beginning o the next Parliament;

• raise the State Pension age in 2024 rom 65 or both men and women in line withthe growth in average lie expectancy. The State Pension age will be increased by

one year over a two-year period rom 2024, and then again in 2034 and in 2044.This will signal the need or a behavioural change towards working longer as welive longer;

• reorm the State Second Pension so that it becomes a simple, lat-rate weekly top-up to the basic State Pension. Accruals will start gradually to become lat rate at thesame time as we start to uprate the basic State Pension by earnings. We estimatethat the State Second Pension will become completely lat rate around 2030 orshortly aterwards; and

• ensure that, beore implementing the earnings link o the basic State Pension,

means-tested provision continues to be ocused on those with small savings, bytaking steps rom 2008 to target the Pension Credit on this group.




3.14 Taken together, these reorms will produce an aordable, sustainable and air system,

in which each generation will spend a similar proportion o their lives contributing toand receiving pensions.

3.15 Under the new system, anyone meeting the simpler entitlement conditions will receivea ull basic State Pension worth about 20 per cent o median earnings. Years spentworking or caring will boost this amount through the reormed State Second Pension,so that someone working or caring or 40 years can expect to retire on around30 per cent o median earnings – or around £135 in today’s earnings terms – beoreany private saving.

3.16 Everyone should have the opportunity to build a decent State Pension entitlement

on the basis o their own actions and in their own right. We will modernise thecontributory principle so that it relects the social and economic realities o the21st century. In order to achieve this, we will:

• reduce the number o qualiying years needed or a ull basic State Pension to 30,rom 44 or men and 39 or women;

• convert HRP into a positive weekly credit or the basic State Pension, and alignthe rules or when the credit is available between the basic State Pension and theState Second Pension so that those caring or children aged under 12 are eligible;

• align credits or oster carers across the basic State Pension and the State SecondPension;

• move rom a system o annual credits in the State Second Pension to weeklycredits, enabling people to combine credited and paid contributions in order toaccrue a year o entitlement to the State Second Pension;

• establish a new Carer’s Credit in the basic State Pension and the State SecondPension or those undertaking care or the sick and severely disabled or 20 hoursor more a week; and

• abolish the minimum contribution conditions in the basic State Pension and theLabour Market Attachment Test in the State Second Pension, to ensure that everyyear o contributions or credits counts.

3.17 These measures (which will apply to people reaching State Pension age on or ater6 April 2010) will help ensure that a ar wider range o unpaid social contributionsare recognised or the purpose o building entitlement to state pensions, resultingin a considerable and immediate increase in the number o women retiring on a ullbasic State Pension – around 70 per cent o those reaching State Pension age in 2010instead o around 50 per cent without reorm. In 2020, around 90 per cent o womenand over 90 per cent o men reaching State Pension age are projected to be entitledto a ull basic State Pension under our reorms.




3.18 As a result o the general improvement in entitlement, we will also be able to abolish

a number o the complex and oten outmoded provisions that currently exist in thestate pension system. We will:

• abolish adult dependency increases which, as we recently announced in A new deal for welfare: Empowering people to work , we do not intend to carry orwardinto the Employment and Support Allowance; and

• abolish National Insurance ‘autocredits’ awarded to those between 60 and 65,in line with equalisation o women’s State Pension age.

Earnings-linking the basic State Pension

3.19 Since 1980, the level o the basic State Pension has been ormally linked to inlationthrough the Retail Price Index (RPI).2 Since 1999, the value o the basic State Pensionhas risen aster than this through a series o higher than inlation increases. But therehas or years been a debate about whether the basic State Pension should be linked toearnings, as it was briely in the 1970s.

3.20 There are a number o reasons to think that an earnings link represents an appropriateresponse to long-term demographic change. We have outlined how our reormssince 1997 have led to pensioner incomes being at their highest-ever level. Havingsigniicantly reduced pensioner poverty, we are now able to create a long-termoundation or saving by restoring the earnings link. We can make clear or the longterm the deal between the State and the individual, to allow people to plan withconidence or their retirement.

3.21 People’s expectations or their incomes in retirement are largely based on theirearnings and standard o living during working age. I the state system is to serveas a oundation or their retirement planning, it must retain its level relative to theseexpectations. This will help to address the problem o undersaving by enabling

people to predict with conidence what they are likely to receive rom the Statewhen they retire, and thereore what they will need to save in addition to meettheir expectations.

2 Regular uprating was introduced in 1973. Legislation allowed discretion to increase the basic State Pension in line withprices or earnings. From 1975 until 1980, legislation required the basic State Pension to be uprated by the better oearnings or prices inlation. Since 1980, the legislation has required the basic State Pension to be uprated in line with

prices. However, in 2003 the Government undertook to uprate the basic State Pension by a minimum o 2.5 per cent.




3.22 It is also important to ensure that targeted beneits are just that – directed at those

in society who need them most. At present, Pension Credit achieves this. TheGovernment has successively raised the Guarantee Credit by earnings and has alreadycommitted to do so to 2008 in order to continue to tackle pensioner poverty. Weintend to continue this uprating strategy over the long term. But i Pension Creditalone continues to rise with earnings and the level o contributory beneits dritsaway rom the means-tested saety net, it could mean that more and more people allsubject to means-testing in retirement. This could aect people’s incentives to work andsave, and dilute the sense o personal responsibility or saving that we want to instil.

3.23 The Government believes that people must have the opportunity to build a basicState Pension entitlement that can give them conidence in the value o making

additional provision. This will also help to encourage people to save through automaticenrolment in the scheme o personal accounts. And we are clear that we cannot allowour progress against pensioner poverty to alter. Taken together, we believe that boththe Guarantee Credit and the basic State Pension must retain their value relative to theaverage earnings o society.

3.24 During the next Parliament, thereore, we will re-link the uprating o the basic StatePension to average earnings. Our objective, subject to aordability and the iscalposition, is to do this in 2012 but in any event at the latest by the end o the nextParliament. We will make a statement on the precise date at the beginning o the

next Parliament.

3.25 But this is a major undertaking. On its own, linking the basic State Pension to risesin earnings rom 2012 would lead to an increase in spending on pensioners o £46billion or 1.4 per cent o GDP by 2050, in addition to the costs o increasing coverageto state pensions. We have made clear that the Government’s economic policies since1997 have had speciic beneits or pensioners and uture pensioners. To risk thestability o the economy or the sake o linking the basic State Pension to earningsgrowth would be counter-productive. This element o the reorm package is thereoreinextricably linked to two others.

3.26 First, raising the State Pension age in line with increases in lie expectancy will helpto bring about a behavioural change so that people begin to work longer as theylive longer. It will slow the growth in the number o pensioners, while ensuring thatpensioners continue to be able to enjoy a roughly constant proportion o their adultlives in retirement. Maximising the impact o this increase, through the measuresdescribed in Chapter 4 to help people work or longer, will urther help to stabilise thesupport ratio, ensuring that these reorms remain aordable.




3.27 Secondly, we intend to accelerate the withdrawal rom direct provision o earnings-

related pensions to provide a simple, lat-rate oundation that rewards working andcaring, building on which will be the responsibility o individuals. Reorms to the StateSecond Pension will speed up the move to make it a lat-rate top-up to the basicState Pension and will reduce expected expenditure on the State Second Pension inthe longer term, urther helping to und linking the basic State Pension to earnings.Reorms to the State Pension age and the State Second Pension are described later inthis chapter.

Raising the State Pension age

3.28 State Pension age in the UK has varied in the past. The irst support or pensioners,introduced rom 1909, was available only at 70. From 1926 to 1940 State Pensionage was 65 or all. And only since 1940 has it been on the current basis. Not longater the current state pension scheme was introduced in 1948, the question o StatePension age was investigated in 1953–543 by the Phillips’ Committee which concludedthat State Pension age did “not represent the limit o working lie”.

3.29 Lie expectancy has improved considerably since State retirement pensions were irstintroduced, and these improvements are projected to continue. Over the last twodecades, the healthy lie expectancy o men and women aged 65 has risen by morethan two years. Despite this, men retire on average three years earlier than they didwhen the present State Pension ages were set and women two years earlier.

Consequencesochangingdemographicandretirementpatterns

3.30 Rising lie expectancy is to be welcomed. However, there are other consequences wemust ace up to. I people are spending more years in retirement, they must worklonger, increase savings or the State must ind resources to pay the State Pension tomore people or longer. The changes in the length o time an average man spends indierent periods o his lie are illustrated in Figure 3.i.

3 Report of the Committee on the Economic and Financial Problems of the Provision for Old Age, December 1954,paragraph 308.




3.31 Some o these issues could be addressed by increasing the levels o employmentamong older workers. While the average retirement age or women, 62, is above theircurrent State Pension age, men on average retire at 64, one year beore they becomeeligible or their State Pension. By contrast, ive decades ago when lie expectancy waslower, men on average retired at 67 and women at 64. This means that those whoretired in 1950, who constituted about 40 per cent o their generation, survived to aretirement which then accounted or 17 per cent o their adult lie. I the retirementage remains at the current level, those who will retire in 2050 would constitute about90 per cent o their generation and could look orward to spending on average 35 percent o their adult lie in retirement.

3.32 However, rising lie expectancy is a long-term trend and we need to raise the StatePension age in order to address the act that although we are living longer, on averagewe are not working proportionately longer. The rise in State Pension age will needto go hand in hand with cultural and behavioural change around retirement, anda corresponding rise in average retirement age. Measures already brought orwardby the Government, together with those proposed in A new deal for welfare:

Empowering people to work published earlier this year, will help us to meet ouraspiration o 1 million more older workers. This is a part o the wider goal o an




employment rate equivalent to 80 per cent o the working-age population. Chapter 4

o this paper contains a range o urther policy proposals designed to deliver still moreprogress towards this objective, and outlines the positive overall impact on pensions iwe were to meet this aspiration by 2030.

3.33 In order to maintain stability in retirement incomes, people need to take greaterpersonal responsibility or their working and saving decisions. To help them do this,the Government will provide a oundation by linking the basic State Pension withearnings. But in doing this it is imperative that we don’t pay or progressively longerretirements.

3.34 We thereore support the Pensions Commission’s recommendation that the State

Pension age should rise to 68 by the middle o the century. We propose to introducelegislation to raise the State Pension age in stages:

• the irst increase, rom 65 to 66, to be phased in over two years, starting inApril 2024;

• the second increase, rom 66 to 67, again phased in over two years, romApril 2034; and

• the third increase, rom 67 to 68, also to be phased in over two years, rom

April 2044.

3.35 By 2050, these reorms to State Pension age alone will reduce the costs o ourproposed reorms to the state pension system by around £30 billion. By doing thiswe will continue to tackle pensioner poverty, be able to sustain the generosity perpensioner o the State Pension, and sustain the balance between work and retirement.

FindingsromtheNationalPensionsDebate:riseinStatePensionage

Participants at the National Pensions Day were asked to consider a gradual increase in StatePension age as part o a package o measures or reorming state pensions. Following

their deliberations, the majority (56 per cent) agreed with a gradual rise in State Pensionage, though just under a third (32 per cent) disagreed. More people over State Pensionage agreed with the proposed gradual rise in State Pension age than any other age group.46 per cent o young people (aged between 16 and 24 years) disagreed with a gradual risein State Pension age, while 42 per cent agreed.




WhatwillraisingStatePensionagemeaninpractice?

3.36 On current projections, the increase in State Pension age will mean that men reachingState Pension age in the uture will, on average, spend about the same number oyears o their adult lie in receipt o the State Pension as now, as shown in Figure 3.ii.For women, there is a slight reduction compared with the position as it is projected tobe in 2020 (when the increase in emale State Pension age to 65 will be ully phasedin). However, there is no signiicant reduction in the actual number o years, whichremains greater than or men.

Figure3.iiNumberoyearsspentpost-StatePensionageollowingtransitiontonewStatePensionages

Years

2006Current

StatePension age

2020State

Pensionage at 65

2026State

Pensionage at 66

2036State

Pensionage at 67

2046State

Pensionage at 68

2055State

Pensionage at 68

Men 20.1 21.6 21.1 21.1 21.0 21.8Women 28.3 24.5 24.0 23.8 23.6 24.4

Source: Government Actuary’s Department’s 2004-based principal projection; median cohort figures for the UK

Note: State Pension age for women is currently 60.

3.37 Figure 3.iii shows that the proportion o adult lie spent in receipt o the State Pensionwill remain about the same. By 2055, assuming lie expectancy continues to increasein line with projections, or both men and women the number o years ater StatePension age will be broadly the same as that o those reaching 65 in 2020 – indeedor men, it would have grown slightly.

Figure3.iiiPercentageoadultliespentpost-StatePensionageollowingtransitiontonewStatePensionages

2006 2020 2026 2036 2046 2055Current State State State State State

State Pension Pension Pension Pension PensionPercentage Pension age age at 65 age at 66 age at 67 age at 68 age at 68

Men 30.0 31.4 30.6 30.1 29.6 30.4Women 40.3 34.3 33.3 32.7 32.1 32.8

Source: Government Actuary’s Department’s 2004-based principal projection; median cohort figures for the UK


3.38 Figure 3.iv shows that raising State Pension age to 68 would not, on average, reducethe numbers o people who survive to the new State Pension ages.




Figure3.ivPercentageopeopleprojectedtosurvivetoStatePensionage

ollowingtransitiontonewStatePensionages,comparedwithearliergenerations

Generation Generation Generation Generation Generation Generationborn in 1941 born in born in born in born in born in

(1946 or 1955 1960 1969 1978 1987women) reaching reaching reaching reaching reachingreaching State State State State State

State Pension Pension age Pension age Pension age Pension age Pension ageage in o 65 in o 66 in o 67 in o 68 in o 68 in

Percentage 2006 2020 2026 2036 2046 2055

Men 76 82 82 83 84 86Women 89 88 88 89 89 91

Sources: Figures for the generation born in 1941 are based on the Government Actuary’s Department’s England and Wales life tables; the subsequent figures are based on the Government Actuary’s Department’s UK life tables


3.39 As discussed in Chapter 2, we propose that the Government will periodicallycommission reviews, drawing on a range o independent expert advice.

3.40 These reviews could, or example:

• provide advice to the Government on whether the timetable or increasing StatePension age – as set out in legislation – remains appropriate;

• gather evidence on uture lie expectancy and the consequences or publicexpenditure;

• provide detailed analysis o disparities in lie expectancy between dierent socialclasses and the relative eects on dierent social groups o increases to the StatePension age; and

• monitor participation rates and levels o contributions to the personal savingsscheme as well as the labour market or older workers (including averageretirement ages).

3.41 While there is growing public acceptance o the evidence that lie expectancy overallis increasing, there is nonetheless concern that the additional years will not necessarilybe healthy years. To date, the evidence would suggest that increased lie expectancyis also resulting in people staying healthier or longer. As the Pensions Commissionhas noted, this is an area where evidence is incomplete. Another task o these reviewscould be to keep this evidence under review.




3.42 We note the Pensions Commission’s suggestion that the age at which people become

entitled to the Guarantee Credit in Pension Credit could remain at 65, in order toprotect those with the lowest lie expectancies. We think this is an issue that mustbe considered nearer the relevant time in the light o the available evidence aboutinequalities in lie expectancy and trends in working among older people. Moredetail about demographic trends in relation to dierent social groups is containedin Annex D.

Reorms to the State Second Pension

3.43 On top o the basic State Pension, many people are accruing a second tier o statepension, through the State Second Pension, which replaced SERPS in 2002.

3.44 The State Second Pension has given many people, particularly women and carers,access to an additional pension or the irst time. Currently those bringing up childrenunder the age o six, certain carers and people with a long-term disability are allcredited into the State Second Pension at a lat rate o around £1.20 a week atretirement or every year worked or credited, with those earning above the LowerEarnings Threshold (£12,500 a year) accruing some earnings-related provision on top.

3.45 The State Second Pension has also helped those on low incomes by treating anyoneearning over the Lower Earnings Limit (£4,368 a year) but earning below £12,500 asi they earned at this higher level. In addition, the rate at which the pension accruesat £12,500 has been doubled under the State Second Pension, making the scheme armore redistributive than SERPS (1978–2002).

3.46 But while the Government will this year spend £19 billion on the State SecondPension, or its contracted-out equivalents through the rebates, this aspect o thesystem is poorly understood. Few people are aware o it at all, and even ewer ohow their entitlement to it builds. Many people are building entitlement to the StateSecond Pension without even being aware that they are doing so.

3.47 The beginning o this chapter made clear that, in the ace o an ageing populationand the need or the state system to provide a oundation or people’s savings, theState should move away rom the direct provision o pensions related to individuals’earnings and concentrate on lat-rate provision in the uture. The introduction o thenew personal accounts scheme will mean that or the irst time everyone will haveaccess to a genuinely low-cost private savings vehicle. We do not want the StateSecond Pension to duplicate this, which is why we are able to reinorce and speedup its change in ocus to a lat-rate top-up beneit or years spent working, caringor parenting.




3.48 Accruals will start to become lat rate more quickly at the same time as we start to

uprate the basic State Pension by earnings. We estimate that the State Second Pensionwill become completely lat rate in around 2030, or shortly aterwards.

3.49 Some people have argued that providing a lat-rate State Pension should entail a moveto a single-tier State Pension, perhaps at the level o the Guarantee Credit – otenreerred to as the Citizens’ Pension. However, we believe that we can achieve a betteroutcome through our reorms. We will create a simple, lat-rate system which getsmost people over the level o the Guarantee Credit, but we will be able to do thismore quickly and at less cost.

Box3a:WhynotaCitizens’Pension?The Pensions Commission considered the case or an Enhanced State Pension, similar indesign to the Citizens’ Pension proposed by the National Association o Pension Funds.

Although models or a Citizens’ Pension vary in detail, the underlying proposition is afat-rate pension set at the rate o the Guarantee Credit and uprated in line with earnings.It would be paid to new and existing pensioners. Both the Savings Credit and the StateSecond Pension (and contracting out) would be withdrawn as soon as the Citizens’ Pensionwas in place.

The Government recognises the attractive simplicity that could in theory be achieved

through a Citizens’ Pension. We have thoroughly examined the Pensions Commission’sresponse to the proposition and tested alternative approaches to achieving a singlefat-rate pension.

Like the Commission, we have concluded that the complexity and expense o gradualtransitional approaches to a Citizens’ Pension are too great – the prize o simplicity wouldbe lost.

The alternative, ‘big bang’, implementation where the new system immediately replacesthe old is more plausible than gradual transition methods. However, the Government againagrees with the Pensions Commission’s ndings that a modied two-tier system provides

the most practical and sae approach.The costs o introducing a Citizens’ Pension overnight are immediate and substantial. I anEnhanced State Pension were introduced in 2010, the Pensions Commission estimates thatit would cost an additional £14 billion in the rst year. This would increase to £25 billionby 2015 and would peak at £60 billion (2.2 per cent o GDP) around 2040, beore allingback to £39 billion (1.2 per cent o GDP) by 2050. This is clearly unaordable and wouldput the stability o public nances and the viability o pension reorm at risk. It is implicit inthese costs that the preserved rights that workers have built to SERPS and the State SecondPension (and contracting out equivalents) are paid on top o the Citizens’ Pension.




Box3a:WhynotaCitizens’Pension? (continued)Moreover, many poorer pensioners would see little change in their circumstances and,unless transitional protection was applied, could lose income because o the withdrawalo the Savings Credit.

The Pensions Commission thereore examined a more complicated but less expensive modelwhich reduced costs, and tackled the regressive distributional eects o the model above.

Their revised model introduced an ‘oset’ arrangement whereby pensioners would bepaid the better o what they had built up under the previous system or the new pension.In practice this means that any accrued State Second Pension rights would be oset

against the Citizens’ Pension – so that people would get either what they had built upunder the old arrangements or the new pension set at the level o the Guarantee Credit,whichever was greater.

The Pensions Commission considered that this would be too dicult to implement becauseo the complexity o applying the oset to the many dierent types o rights people havebuilt up under the current system. People would not have a clear idea o what the Statewould provide.

Furthermore this oset method would still result in a considerable immediate increasein expenditure. Costs using the oset arrangements would be an additional £10 billionin 2010, and £8 billion in 2015. Costs would peak at 0.9 per cent o GDP around 2040,alling back to 0.3 per cent GDP by 2050.

Whatever the precise design, there are concerns about the airness o any kind o Citizens’Pension: some people would get the same pension despite having paid in very dierentamounts over the last 50 years, based on an understanding that their contributionswould aect their retirement incomes. For example, the sel-employed – who have notcontributed to the State Second Pension – would get the same outcomes as employeeswho have.

The Pensions Commission concluded, as does the Government, that – starting rom wherewe are now – a two-tier system is preerable to a single-tier pension. A two-tier system has

greater fexibility, there is public attachment to the basic State Pension and a two-tier systemavoids the transitional complexity o one tier and the risks associated with an immediatecessation o contracting out.




3.50 We thereore plan to accelerate the way in which accruals in the State Second Pension

are becoming lat rate. This beneit will be protected against rises in average earningsduring accrual, and then against inlation once in payment. Combined with a basicState Pension linked to earnings, this will produce a total State Pension that is upratedpartly by earnings and partly by prices in payment, as recommended by the PensionsCommission. Under the new beneit, each year o work, parenting or caring willeectively top up the State Pension by at least £1.20 a week at retirement in averageearnings terms.

3.51 This proposal is in line with the recommendation o the Pensions Commission to moveto a lat-rate State Second Pension by 2030 – though we extend coverage o the StateSecond Pension rom 2010 to bring in more people with lower earnings and more

carers through our coverage reorms outlined later in the chapter.

3.52 Together with our measures to increase coverage in the basic State Pension, outlinedlater in this chapter, this will mean that, ater 40 years o work or credits, a low earnercan expect to build up an additional top-up o around £60 a week. Coupled with theirbasic State Pension entitlement, this will give a total State Pension at retirement oaround £135 a week in today’s earnings terms.

Entitlementorthesel-employed

3.53 The Pensions Commission recommended that the Government investigate the

possibility o extending coverage o State Second Pension to the sel-employed ona voluntary basis. The Commission’s suggested mechanism or achieving this wasthrough the introduction o age-related National Insurance contributions.

3.54 The Government accepts that any consideration o the sel-employed becomingentitled to the State Second Pension would need to include age-related contributions.Setting a standard rate in a voluntary system could mean that the young areovercharged (they are more likely to get a better return in a private pension) andolder workers undercharged.4 Given that the young would be unlikely to join thescheme because it would not be worthwhile, other National Insurance payers wouldhave to subsidise older workers entering at what would eectively be a cheap rate.

(Because State Second Pension is compulsory or employees throughout a workinglie a standard rate can be charged without the need or age-related contributions.)However, age-related contributions are probably too expensive or most older low paidworkers to consider.

4 The State Second Pension is a deined beneit – each year o contributions buys a set amount o weekly pension (though ayounger person will have to wait longer to receive the money). But in private pensions, a younger worker’s investment hasthe beneit o many years o investment growth and interest.




3.55 We share the Pensions Commission’s own concerns that

“… the complexity o age-speciic contribution rates and the higher level requiredlater in lie, might make voluntary membership o State Second Pension unattractiveor many sel-employed.”

3.56 The Government is unable to reconcile these issues and is reluctant to committaxpayers’ money to setting up a speculative scheme where enrolment may be low.Nor does the Government wish to introduce a scheme exclusively or sel-employedpeople with only low proits. Proits rom sel-employment can luctuate year onyear, which would result in people being included and then excluded. Such a scheme

would have arbitrary cut-o points and would have to have numerous exclusionsand exceptions (or instance, someone in part-time sel-employment who had otherearnings or a large occupational pension).

3.57 A urther actor when considering scheme development is that the averageduration o sel-employment is around eight years. For many earners, whomove rom employment to sel-employment and back again, it is unlikely that aperiod out o the State Second Pension would have a signiicant impact on theirretirement income.

3.58 The introduction o personal accounts, described in Chapter 1, will bring in newarrangements to enable the sel-employed to build a second pension. On balance,the Government believes that the State Second Pension should not be extended tothe sel-employed.




Pension Credit

GuaranteeCredit

3.59 Pension Credit is made up o two elements. The irst, the Guarantee Credit, ensuresthat no one aged 60 or over need live on an income below £114.05 a week(£174.05 or couples). Pension Credit is the successor beneit to the Minimum IncomeGuarantee (MIG), both o which have risen in line with average earnings growth since1999. The Guarantee Credit is payable to people aged 60 or over, rising to 65 orover with the equalisation o State Pension age or men and women between 2010and 2020.

3.60 The Government has committed to uprating the Guarantee Credit in line withearnings until 2008. We can now announce an intention to continue this upratingstrategy over the long term. This will ensure that the gains we have made againstpensioner poverty are secure into the uture. As now, the Guarantee Credit willprovide a guaranteed minimum level o income in retirement or those who have beenunable to provide adequately or their own retirement. It will also provide a higherincome or people with severe disabilities and other speciic groups.

SavingsCredit

3.61 The second element to Pension Credit is the Savings Credit, available to people aged65 and over. This ensures that those low and moderate earners who have modestsavings or retirement over the level o the basic State Pension beneit rom theirsavings. The operation o the Savings Credit is described in more detail in Box 3b.

Box3b:TheSavingsCredit

The Savings Credit rewards people aged 65 and over (or who have a partner o that age)who have made some additional provision or their retirement, or example through asecond pension or capital assets. It applies to all those with modest incomes over andabove the value o the ull basic State Pension which or 2006/07 is £84.25 or a singleperson and £134.75 or a couple.

The Savings Credit accrues at the rate o 60p or every pound o qualiying income abovethe threshold, up to a maximum o £17.88 or a single person and £23.58 or a couple.People with income above their guarantee level (which is the standard Guarantee Credito £114.05 a week or single people or £174.05 a week or couples plus any additionalamounts payable or severe disability, caring responsibilities, and/or housing costs) willhave their Savings Credit reduced by 40p or every pound o income above that level. Thismeans that pensioners with income up to £159 a week (£233 a week or couples) canqualiy. Some, including severely disabled people and carers, will be able to qualiy i their

incomes are higher than this.




Box3b:TheSavingsCredit (continued)The maximum Savings Credit award is set at 60 per cent o the dierence between thebasic State Pension and the Guarantee Credit. The gap between these two has beenwidening as one increases with average earnings and the other increases by less. Becauseit draws momentum rom both, the maximum Savings Credit grows aster than either othese uprating actors in isolation, which means it grows aster even than the GuaranteeCredit, and thereore aster than earnings.

I current uprating policies were pursued indenitely, an increasing proportion o thepensioner population would be entitled to the Savings Credit. It has never been theGovernment’s intention that a signicant majority o the pensioner population would, in

the long term, be eligible or Pension Credit. Our reorms conrm this.

3.62 To ensure that, beore implementing the earnings link o the basic State Pension,means-tested provision continues to be ocused on those with small savings, we willtake steps rom 2008 to target the Pension Credit on this group.

3.63 We think this is reasonable because the State Second Pension has, since 2002,provided generous provision or low-paid employees. Those who earn between theNational Insurance contribution Lower Earnings Limit and £12,500 a year (and thosecredited in) accrue a pension at a lat rate as though they were earning £12,500 a

year and at twice the old SERPS accrual rate. This means low-paid employees get amore than air return on their contributions. This must, over time, inluence the designo the Savings Credit.

3.64 The Savings Credit will continue to reward people who make provision or theirretirement. However, as State Second Pension matures, more and more peoplewill have built up State Second Pension entitlement. We agree with the PensionsCommission’s assessment that the starting point or calculation o the Savings Creditshould be raised as this happens. From 2008 we will uprate the lower threshold o theSavings Credit by earnings. From 2015 the maximum Savings Credit will be rozen in

real terms.

3.65 The impact o this, alongside our reorms to the structure and coverage o the other aspectso the State Pension and the introduction o a low-cost scheme o personal accounts,will be a considerable reduction in the numbers o people whose entitlements will bemeans-tested in the uture. Under current uprating policies projected orward, around70 per cent o pensioner households will be entitled to some Pension Credit by 2050.Under our reorms, that igure will be reduced to around a third. This will urther helpto clariy people’s savings decisions and retirement planning. Figure 3.v shows howentitlement to Pension Credit is projected to develop into the uture under currentpolicy and ater the reorms to the state pension system.







Tax-beneitintegration

3.66 Since 1997 the Government has reormed Britain’s tax and beneit systems to achievethree overarching objectives: to ensure adequate inancial incentives to work and save;to reduce child poverty and increase inancial support or all amilies; and to tacklepoverty among the current generation o pensioners and support people in providingor their retirement.

3.67 In the past the tax and beneit systems ailed to address the challenges o povertyand incentives to work and save or retirement. The Government has brought orwarda series o reorms designed to bring the tax and beneit systems closer together.Taken together, the Government’s policies to modernise the tax and beneit systems

constitute the most undamental reorm o those systems since the 1940s. Forpensioners this has meant, alongside the introduction o the Pension Credit, additionalresources to raise the age-related personal allowances in Income Tax, designed tolit more pensioners out o Income Tax and ensure that most taxpaying pensionersbeneit. In 1999, and again in 2003, additional resources were used to give stepincreases in the level o these allowances, and exceptionally between 2001 and 2005the age-related Income Tax allowances were indexed in line with the rise in averageearnings.

3.68 In the light o the proposed reorms to the state pension system set out in this paper,the Government will continue to consider the potential gains rom greater tax and

beneit integration in terms o improving inancial incentives to work and save andproviding greater simplicity or pensioners.

A new contributory principle – the proposals in detail

3.69 The pension system o the 1950s and 1960s sought to provide some protectiono pension entitlements or women by allowing wives to draw on the contributionrecords o their husbands.

3.70 Reorms since the 1970s have had a dramatic and very positive impact on the pensionentitlements o women and carers. The introduction o HRP in 1978 meant that thevital contribution made to society by those caring or children was recognised or thepurposes o building entitlement to a pension. Since that time, years spent caring orchildren under 16 have counted or the purposes o building entitlement to the basicState Pension, but usually only or complete years.




3.71 The introduction in 2002 o the State Second Pension as a successor to SERPS meant,

or the irst time, that some caring responsibilities were relected not only in basicState Pension entitlement but also in access to a second pension. Each year 1.9 millioncarers, mostly women,5 are now credited in to the State Second Pension as i theywere earning £12,500 per year. Those earning above £12,500 will continue to accruesome earnings-related provision until around 2030.

3.72 There remains, however, a generation o women aged over 45 who can expect toreach State Pension age with signiicantly lower amounts o basic State Pension thanmen. The immediate issue is tackling the inequality or this generation o women whomay have missed out on the ull impact o HRP but also may have not returned to orkept in touch with the labour market in the way younger women have.

3.73 There is a widespread consensus about the need to act to counter the inequalitiesthat currently exist between men and women in state pension entitlement. In a recentsurvey almost our out o ive people thought that carers o sick or disabled relativesshould get the same amount o state pension as someone who had worked all theirlie.6 Many approaches to achieving better state pensions or women have beensuggested. The Pensions Commission proposed a residence test.

3.74 We agree with the Pensions Commission that a two-tier system is still the best wayorward but that the basic State Pension as a near universal underpin is the right

oundation on which to build and on which to encourage private saving.

3.75 We do not agree that the solution to inequality lies in moving all or part o theentitlement rules onto a residency basis. The reasons or this view are outlined in moredetail in Box 3c. But the key reason is a belie that the contributory principle promotespersonal responsibility and positively rewards people’s contributions to society.

5 Source: Lietime Labour Market Database (a 1 per cent sample o NIRS 2 data). Data relate to 2003/04 and include all

those in the UK, and those accruing the contracted-out equivalent.6 BMRB Omnibus survey, February 2006.




Box3c:Whynotaresidencetest?Our core objection to a residence test is one o principle. A new deal for welfare:Empowering people to work rearmed our view that our system o welare should bebased on the recognition that with rights come responsibilities.

The Government believes it is right or people to receive state pensions in return ormaking economic or social contributions during their working lives. We do not think it isair to recognise people or State Pension purposes purely on the basis o residence whileothers are contributing to society through working and caring.

But there are also more practical and operational concerns with a residence test. These are

set out below.

• There is noestablishedsystemorrecordingresidenceretrospectivelyoutsidethoseundertheexistingtaxandbeneftsystems, and these systems do not coverall members o the population. A residence test could only be introduced or newaccruals. As part o the EU, the UK also has signicant movement o people in and outo the country, or example to work abroad, and is subject to reciprocal social securityagreements both with other European Economic Area countries and through bilateralagreements.

• Under the sort o residence test proposed by the Pensions Commission, the impact

o the changes takes many years to make a dierence. We believe our reorms to thecontributory system have moreradicalandimmediateeects than a move to a

residence test or uture accruals, as shown in Figure 3.vi.

• A long residency test would have the best chance o excluding or minimising theentitlement o those with little connection to the UK. But too long a test would notsignicantly improve outcomes, leaving many people without a ull basic State Pension.A short test may improve outcomes but would carry a greater riskoraudorabuse.Some people could spend a relatively modest number o years in the UK yet accrue asubstantial proportion o a UK pension which would then be exportable, and payable,or the rest o their lie.

• Introducing a residence test or uture accruals would mean running both residence-based and contributory entitlements to the basic State Pension in parallel or thenext 45 years (i using the Pensions Commission proposal) and running an ongoingcontributory system or State Second Pension beyond that. This wouldmakethesystemmorecomplicated, and make it more dicult or people to predict withcondence what their entitlement would be in the uture, and thus become adisincentive to save.

• Residency is notnecessarilyanymoreeective at increasing coverage to statepensions than our reorms are. Depending on the design o the residence-based

pension, both could mean that around 95 per cent o people receive ull basic StatePension entitlement in the long term. However, a residence-based scheme or newaccruals would take longer to reach this level.




Box3c:Whynotaresidencetest?(continued)

The Pensions Commission also proposed an immediate and retrospective universal basicState Pension based on residency to the over-75s. Our analysis suggests that there wouldbe ew real gainers among the low- to moderate-income brackets, with higher basic StatePension entitlement largely just displacing Pension Credit entitlement. Yet there would behigh costs.

3.76 This section sets out a number o reorms to elements o the contributory principlein order to ensure that a greater range o social contributions is recognised or thepurposes o building rights to state pension entitlement.




ReducingqualiyingyearsoraullbasicStatePension

3.77 The Government proposes that the number o qualiying years required to achieve aull basic State Pension be reduced rom 44 or men and 39 or women to 30 yearson an equal basis. This reorm oers the appropriate balance between the need ormodernisation o the conditions or entitlement to the basic State Pension with theobjective o retaining the contributory basis o the system. Figure 3.vi shows theimpact on pension outcomes or those reaching State Pension age ater April 2010.

Why 30 qualifying years?

3.78 We want to maintain the link between the basic State Pension and contributions to

society. However, the current number o qualiying years excludes some people whohave contributed during their working lives rom the right to a state pension. Today’ssociety is one where both men and women combine work and caring, and undertakehigher or urther education. Reducing the qualiying years required or a ull basicState Pension gives these people the opportunity to build rights to a ull basic StatePension, while not diluting the contributory basis o the system.

3.79 Under the current system, women aged 45 or over today are projected to have statepension entitlements which are, on average, projected to lag signiicantly behind thoseo men or around the next 20 years. Under our reorms this critical group will receivebetter state pension outcomes in their own right. A residence-based approach or

new accruals would not help this group build up a much better basic State Pension.Outcomes under our proposals mean that over 90 per cent o women reachingState Pension age will get a ull basic State Pension by 2025, but under the modelproposed by the Pensions Commission the same outcomes would not be achievedmuch beore 2050. Up to an extra 270,000 women will be getting a ull basic StatePension by 2020 under our proposals – possibly in the region o 200,000 morethan under a residence-based scheme. Figure 3.vii shows the proportion o womenreaching State Pension age with ull basic State Pension under our reorms and undera residence-based system.




ConvertingHRPintoapositivecredit

3.80 HRP was introduced in 1978 to assist people who have caring responsibilities, andare either not in paid employment or have low earnings, to build entitlement to basicState Pension. It also helps protect entitlement to certain bereavement beneits or thecarer’s spouse or civil partner.

3.81 However, it is not widely understood, can be inlexible and it is diicult to determinewhether the HRP recipient will qualiy or a ull basic State Pension until they reachState Pension age. In particular, or reasons explained in Annex B, women havelost out because only ull years can be recognised or state pension purposes, andthereore periods shorter than this where caring has been undertaken do not count

towards their basic State Pension.




3.82 We thereore plan to replace the system o HRP with new weekly National Insurance

credits or care o children (where there will remain a link with Child Beneit) untilthe youngest child turns age 12. These changes will make it easier or recipients tounderstand their entitlement and make inormed choices about working and savingor retirement.

3.83 The credits will be aligned to allow those caring or children up to the age o 12 toreceive both basic State Pension and State Second Pension. Currently entitlementsto State Second Pension are only given to those caring or children up to the ageo 6, whereas in basic State Pension they are given to those caring or children upto the age o 16. Moving to age 12 could be perceived as making entitlements orparents less generous rom 2010 as we are removing the opportunity to gain credits

or our years o a child’s upbringing. However, our reduction in the required numbero qualiying years to 30 or a ull basic State Pension means that we are reducingthe number required or women by nine years.

3.84 Aligning credits or care o children up to the age o 12 should mean around anadditional 780,000 women and 30,000 men will be accruing State Second Pensionentitlements. Moving to age 12 is also consistent with Working Age initiatives toencourage lone parents to take steps into the labour market as their children reachsecondary school age.7

3.85 Foster carers have only been able to protect their basic State Pension entitlement byapplying or HRP since 2003. We propose to bring them into State Second Pension,again by application, rom 2010 through the new crediting arrangements.

3.86 We plan to introduce transitional arrangements to ensure that any period o childcareundertaken beore the reorms are implemented which would qualiy or HRP underthe existing rules o the scheme will be preserved, but converted into the new, moregenerous credits.

CombiningcontributionswithcreditstogetaqualiyingyearorState

SecondPension

8

3.87 Currently a person can build up entitlement to State Second Pension through theaward o credits with certain beneits.9 However, these beneits must normally beawarded over a complete tax year in order to get State Second Pension. It is notpossible to be eligible or State Second Pension through a combination o credits rombeneits or with contributions rom earnings in any single tax year.

7 The employment rate or lone parents (LP) with a youngest child aged 0–5 is 39.1 per cent, and or those with a youngestchild aged 0–11 it is 50.1 per cent. For LPs with a youngest child aged 12 and over it is 71.1 per cent. The 12 and over

category includes those with a youngest child aged 16–18 as long as that child is in ull-time education. Source: Labour Force Survey , spring 2005.

8 Currently either earnings equivalent to 52 weeks o the Lower Earnings Limit or credits are required to obtain a year o

State Second Pension accrual.9 Child Beneit in respect o a child under age 6, HRP while looking ater a sick or disabled person, Incapacity Beneit or Severe

Disability Allowance (subject to the labour market attachment test), Carer’s Allowance (or an underlying entitlement to it);

or a tax year in which they have reckonable earnings equivalent to 52 weeks at the Lower Earnings Limit.




3.88 We propose to move rom the current system o annual credits in the State Second

Pension to weekly credits. This will provide more lexibility, enabling people to combinecredits and paid contributions during a tax year to build up a year o State SecondPension. It ensures that we are recognising social contributions and earnings equallyor the purposes o state pension entitlement and consistently in both tiers o theState Pension.

Anewcreditorcarers

3.89 The introduction o Carer’s Allowance has helped recipients build up entitlement tothe basic State Pension since 1976.10 Recipients have also been able to get StateSecond Pension rom 2002. Around 440,00011 people, caring or 35 hours a week or

more, are receiving Carer’s Allowance.

3.90 Carer’s Allowance is awarded to those who:

• do not earn above a set limit (£84); and

• provide regular and substantial care, that is or 35 hours or more; and

• care or one severely disabled person receiving the middle or highest rate oDisability Living Allowance care component, Attendance Allowance, or the

equivalent rates o Constant Attendance Allowance.

3.91 While Carer’s Allowance and HRP12 provide comprehensive cover, they only do thisor people who are eectively ull-time carers – those who would have most diicultyengaging in the labour market. Those caring or less than 35 hours or or more thanone disabled person are not recognised and we know that some caring responsibilitiescan compromise an individual’s ability to work and build up a state pension.

3.92 Women and pensions: The evidence reported that employment rates o carers lookingater someone or more than 20 hours a week are signiicantly lower across all agegroups.13 Additionally, those caring or more than 20 hours a week are more likely

to suer disadvantages rom caring in terms o their health or other aspects otheir lie.14

10 The predecessor to Carer’s Allowance, Invalid Care Allowance, was irst payable in 1976.11 440,000 people were receiving Carer’s Allowance at November 2005.

12 Those caring or 35 hours or more not entitled to Carer’s Allowance may apply or HRP, and Income Support recipientswho are caring are automatically awarded HRP. (See Annex B or more detail.)

13 Family Resources Survey .14 Maher and Green, 2002, analysing General Household Survey 2000.




3.93 The Government now proposes that people who undertake care or the severely

disabled or 20 hours or more a week should become entitled to credits or bothbasic State Pension and State Second Pension. We estimate that around 70,000people a year could gain a credit or basic State Pension rom this proposal, and overhal o these will be women. The new credit or those caring or 20 hours or moreshould mean around 110,000 more women and 50,000 more men will be accruingentitlements to State Second Pension.

3.94 A system o certiication will be required to claim the new credits. We will consultwith key stakeholders on the most eective way to implement the new arrangementsor those reaching State Pension age rom 2010. We propose that the new creditingarrangements or carers, including the replacement o HRP with a weekly credit and

the introduction o a new carer’s credit, will apply to bereavement beneits.

FindingsromtheNationalPensionsDebate:extendingcoverage

Proposals to increase entitlement or carers accords well with the public’s view o theprinciples on which an additional State Pension should be based. At the National PensionsDay, participants were asked to give their views on what should count towards the StateSecond Pension. The majority believed that paid work, voluntary work, caring or children,caring or the sick, elderly or disabled and time spent long-term sick or disabled and unableto work, should count towards the State Second Pension. O these, people agreed most

strongly that paid work and caring or the sick, elderly or disabled should count.

3.95 The more generous crediting arrangements will mean up to 1 million more individuals(around 90 per cent o which are women) will be accruing State Second Pensioncredits in a given week – which should eed through to higher State Second Pensionentitlements in retirement. Figure 3.viii shows the numbers accruing State SecondPension beore and ater changes to coverage.




Ensuringthateveryyearcounts

3.96 Currently, to build up any entitlement to basic State Pension a person must satisytwo National Insurance conditions o entitlement. The irst is satisied through havingearnings over the Lower Earnings Limit or by paying Class 2 or Class 3 contributionsto make one qualiying year. The second is that they must then have at least 25 percent o the number o qualiying years required or ull basic State Pension – generallythe equivalent o a urther nine (or women) or ten (or men) qualiying years. This

entitlement condition is known as the ‘25 per cent de minimis rule’.




3.97 These rules mean that small numbers o people have no entitlement to basic State

Pension despite having up to nine years o contributions or credits. The two conditionso entitlement are more likely to aect some ethnic minority women who may eelor ace cultural barriers to participating in paid work. Those women in this positionusually contribute to society in other ways, such as through childcare or care oseverely disabled people.

3.98 The Government proposes that the two conditions o entitlement are abolished. Upto 100,000 people a year reaching State Pension age could beneit rom this.15 Thesereorms underpin the other changes we are making to broaden the coverage o statepensions and in the context o the overall reorm package – which includes moreobvious recognition o caring responsibilities – they will have a ar greater positive

eect.

3.99 In State Second Pension there is no de minimis rule equivalent to that in the basicState Pension. There is however a ‘labour-market attachment test’. The test applies tolong-term Incapacity Beneit recipients in respect o entitlement to additionalState Pension.

3.100 The test requires that a long-term sick or disabled person must have paid, or betreated as having paid, Class 1 National Insurance contributions or at least one-tenth o their working lie since 1978 (when additional State Pension through SERPS

was irst introduced). For example, a person reaching State Pension age in 2005/06would have a working lie o 27 years since 1978 and would have needed to haveworked and paid Class 1 National Insurance contributions or three years (one-tentho 27 years rounded to the nearest whole year) in order to receive entitlement toState Second Pension.

3.101 We propose to remove this complex procedure rom 2010.

Abolishingtheadultdependencyincrease

3.102 The state pension system includes provision or a man or woman’s state pension to be

increased i another adult is inancially ‘dependent’ on him or her. These increases areknown as adult dependency increases (ADIs) and have their origins in the immediatepost-war period where single breadwinner households were the norm. We proposethat ADIs will no longer be awarded rom 2010. Annex B sets out in detail ourproposals or abolishing ADIs.

Autocredits

3.103 Since April 1983, National Insurance credits – known as ‘autocredits’ – have beenavailable to men aged 60 to 64. They were introduced in 1983 as a response to highunemployment alongside the ending o the requirement that men aged 60 or overhad to register as unemployed to qualiy or Supplementary Beneit.

15 This igure includes overseas cases, some o which beneit rom reciprocal agreements.






3.110 Importantly, these reorms taken together will see more people, especially women,

building up entitlement in their own right, on the basis o their own actions. This willallow us to sweep away some o the complex and oten outmoded rules that existwithin the state pension system.

3.111 This chapter has set out how we will reorm the structure o the state pension systemand increase coverage o the state pension to address inequalities in order to providea oundation to private savings. The next chapter goes on to look at working longeras an integral part o our reorms to meet the pensions challenge.



137

Chapter 4:Extending working liein an ageing society





Chapter4 • Extending working lie in an ageing society 139

Chapter 4: Extending working lie inan ageing society

Summary

We are living longer – something that we should celebrate, but which also raises challengesor individuals and or society in how we support an ageing population. As a key part oour response to these challenges, we must enable and encourage people to work longer.Higher employment will sustain national wealth, while longer working provides a greateropportunity or people to build provision or their retirement through private saving.

Signicant progress towards increasing the number o older workers has already beenmade. Employment rates or older workers have increased steadily since 1997, and over1 million people are now working ater State Pension age. But more needs to be done tochange the culture and behaviour surrounding retirement.

We will, thereore, bring orward urther measures to address the key barriers whichprevent people staying in work or longer, and encourage more people to work up to andbeyond State Pension age:

• enabling greater fexibility to allow people to choose a phased approach to retirement;

• providing improved communications and inormation in support o longer working; and

• working in partnership with employers to encourage them to retain older workers,and to oer them greater fexibility around retirement.

We also recognise that an ageing society raises wider challenges than simply those relatedto pensions and older workers. This chapter also develops urther our strategy or anageing society.

These elements o our policy will aid the sustainabilityandaffordability o the pensionssystem, by contributing to our aspiration or an employment rate equivalent to 80 per cento the working-age population. And through acilitating and encouraging longer working,they will help people to take personalresponsibility or their security in retirement.



140 Chapter4 • Extending working lie in an ageing society

Context or reorm

4.1 Despite improvements in longevity, average retirement ages have been alling – a trendthat has only recently begun to reverse (see Figure 4.i). The average percentage oan adult male’s lie spent in retirement has increased rom 17 per cent in 1950 to31 per cent in 2005 (see Figure 4.vii).

Addressingthepensionschallengethroughemployment

4.2 Working or longer not only provides a direct means by which people can supplementtheir income in later lie, but also a way o building up greater state and privatepension entitlement or the uture – thus helping them to maintain their standardo living in retirement.




4.3 Longer employment is the logical response to an ageing population: the more people

who are in work and contributing to the growth o the economy, the more unds therewill be available to support those people who are in retirement.

4.4 Recent years have seen a signiicant increase in the employment rate o 50 to69-year-olds, which has risen by 6.1 percentage points rom 48.7 per cent in 1997to 54.8 per cent in 2005. However, the employment rate or people aged 50 to thecurrent State Pension age (70.7 per cent) is still lower than or the overall workingpopulation (75 per cent), and considerably lower than or the 25–49 age group(over 80 per cent). More needs to be done to reduce the gap.

Achievingan80percentemploymentrate

4.5 In January 2006, A new deal for welfare: Empowering people to work 1 described

the Government’s long-term aspiration o an employment rate equivalent to 80 percent o the working-age population. Realising this aim represents a substantial, yet

1 DWP, 2006, A new deal for welfare: Empowering people to work (Cm 6730), DWP.




achievable, challenge. It would break all UK employment records. To move towards it,

the Government aims to:

• reduce by 1 million the number o people on incapacity beneits;

• help 300,000 more lone parents into work; and

• increase the number o older workers by 1 million.

4.6 Improving employment or these groups will increase opportunity and decrease poverty,and will support an ageing population in the longer term. Figure 4.iii shows how theeconomic dependency ratio would dier rom current projections in 2030 and 2050 i

we were to meet our 80 per cent employment aspiration by 2030.




4.7 Reaching 80 per cent would lead to a signiicant increase in GDP, perhaps by as

much as 2.7 percentage points by 2050.2 Higher GDP would make total governmentexpenditure more aordable and would increase the income available to supportpensioners through the state pension system.

4.8 In addition, the reduction in the number o people receiving incapacity beneits andthe additional lone parents and older people in work would reduce expenditureon beneits, while increased employment would also result in increased pensioncontributions, leading to reduced spending on Pension Credit, though with someincrease in State Second Pension spending. Taken together, the reduction in beneit andpension spending could be up to 0.5 per cent o GDP in 2030.

4.9 Increasing the number o older workers by 1 million is a long-term aim and will needto take account o a number o actors. It will require a continued concerted eort tochange the culture and behaviour surrounding retirement.

CurrentGovernmentapproach

4.10 Signiicant progress has already been made. In addition to the steady increases inemployment rates or older workers since 1997, over 1 million people are now workingater State Pension age.

4.11 The employment programme to help older workers, New Deal 50 plus, has supportedover 150,000 entries into work since its launch in April 2000, and back-to-work helpis now available to people claiming Pension Credit (rom age 60). Our Age Positivecampaign has inluenced employers by promoting the business case or age-diverseworkorces, and every year sees increasing interest rom employers in adopting non-ageist employment practices.

4.12 We have taken action to ensure that those already choosing to work or longer aregiven the opportunity to do so. In October this year, new legislation will come intoorce, which, or the irst time, will give people the right to challenge age discriminationin the workorce. We will also be introducing a deault retirement age o 65, below

which employers will not be able to orce people to retire on the grounds o age (unlessit can be objectively justiied).

4.13 The deault retirement age will be careully monitored and ater ive years, in 2011,we will undertake a ormal, evidence-based review. The deault retirement age will beabolished i this review concludes that it is no longer appropriate. O course, employerscan operate without a retirement age and many are already realising the beneits odoing so.

2 This based on a comparison between HM Treasury’s Long-Term Public Finance Report and reaching employment equivalentto 80 per cent o the working-age population, assuming that the additional workers have weekly productivity that is halthat o the remainder o the working population.




4.14 The Commission or Equality and Human Rights, due to be established by late 2007,

will provide guidance to employers and individuals on good practice relating to age inemployment and support implementation o the age discrimination legislation. Our BeReady promotional campaign, launched in May last year and delivered in partnershipwith business groups and trade unions, has already begun to inluence employmentpractice and raise awareness o the orthcoming legislation.

4.15 In April last year, more generous options or delaying taking the State Pension began,including or the irst time the option o taking a lump sum. An individual who delaysclaiming their State Pension o £84.25 a week or two years could now get about£17.50 extra per week when they do claim, or they could receive a one-o taxablelump sum o around £9,300 plus their £84.25 a week pension. In April this year, we

introduced changes to the rules o occupational pensions or those wishing to workmore lexibly in the transition to retirement, so that (where schemes allow it) peoplecan draw part o their pension while continuing to work or the same employer.

4.16 In the medium term, structural changes are also planned, including raising theearliest age rom which a (non-state) pension can be taken rom 50 to 55 by 2010.Equalisation o State Pension age, due to take place between 2010 and 2020, will seewomen’s State Pension age rise gradually to 65 in line with that o men.

Helpingolderworkers

4.17 The Government’s recent publication, A new deal for welfare: Empowering people towork , proposed a series o measures to boost support or older people returning towork, and to improve the inormation available about options or work and retirement.These measures are now moving towards implementation:

• Aligning our additional employment support or long-term unemployed olderpeople with that o younger age groups by requiring people aged 50 to 59 to takeup the additional jobseeking support available through New Deal 25 plus. Phasednational roll-out will commence rom April 2007.

• Requiring unemployed older people to participate in New Deal 50 plus activitiesater six months claiming beneits, including attending work-ocused interviews anddeveloping action plans. We are planning towards piloting this measure.

• Improving back-to-work support or Jobseeker’s Allowance claimants and theirdependent partners who are over 50. This is already required or couples claimingJobseeker’s Allowance who were born ater 1957, and keeps both partners incontact with the work-ocused help and support available through Jobcentre Plus.This will happen rom April 2007.

• Piloting ace-to-ace guidance sessions tailored to help people approaching or over50 and in work to understand the options available to them or work, training andretirement, and to support them in planning or later lie. The pilots are due tobegin in 2007.




• Working with employers to promote the extension o lexible working opportunities

to older workers. Research ound that, or 50 to 69-year-olds, many o those whowere retired would have liked to have worked or longer i there had been part-time or lexible work options available.3 Our Be Ready campaign will begin thisactivity this year, and beyond that we will seek other vehicles or promoting thisagenda.

• Increasing the involvement o the inormation, advice and guidance services inpromoting the New Deal 50 plus In Work Training Grant and supporting thosepeople over 50 interested in taking it up.

Enabling longer working

Overcomingbarrierstolongerworking

4.18 The irst step towards extending working lie is to overcome the barriers that weknow prevent or discourage people rom working or longer. Poor health and disabilitystatus are the most signiicant actors pushing people in their 50s and 60s out o workand reducing the likelihood that they will return. Promoting healthy workplaces andsecuring good management o occupational health is thereore crucial to increasinghealthy outcomes throughout lie and helping older people work to a later age i theywish to do so.

4.19 In October 2005, the Government launched a strategy or the health and well-beingo working-age people, Health, work and well-being – Caring for our future.4 The newNational Director or Occupational Health will lead this ambitious programme o work.

4.20 We also recognise that working patterns and the barriers to longer working are notthe same or everyone aged 50 or over. While there are common eatures that aectolder workers o all ages, when we look at employment patterns by age we see somespeciic actors at work or dierent age groups.

3 Do employers need older workers? Brieing Paper 5, October 2005, Centre or Research into the Older Workorce at the

University o Surrey.4 DWP, DH and HSE, 2005, Health, work and well-being – Caring for our future.




50–59: O those people over 50 but under the State Pension age, we know that moreare economically inactive due to ill-health than are out o work due to retirement orunemployment. We also know that hal o those people claiming Incapacity Beneit are

over 50. Early intervention is critical to ensure that people do not become dependenton beneits and move into early retirement. We set out proposals in this area in A new deal for welfare: Empowering people to work .

60–65: The most common time or change rom employment to economic inactivity(especially to retirement) is between age 60 and 65, as shown in Figure 4.iv. Around45 per cent o men and 67 per cent o women in the 60–64 age group are economicallyinactive. We know that those who work up to State Pension age are most likely to beworking beyond State Pension age. Supporting this group in work or longer will bekey to sustaining work up to State Pension age and beyond, particularly as women’sState Pension age equalises. Thereore i we are to achieve our aspiration o 1 million

additional older workers, we need to address some o the barriers aced by this group.




StatePensionageandover: Over 1 million people over State Pension age are

working today, many in part-time work. The employment rate or those over StatePension age has increased rom 7.9 per cent in autumn 2000 to 10.2 per cent inautumn 2005. The average age o retirement or women is currently about 62, whichis above women’s State Pension age. However, urther growth is vital or the uture,which may involve people working increasingly lexibly in a way that suits their personalcircumstances ater State Pension age.

4.21 In Chapter 3, we discuss proposals or raising State Pension age rom 2024 onwards,in order to ensure a more generous State Pension in the ace o rising average lieexpectancy. Individuals under the age o 47 (on 5 April 2006) will have to wait longerto receive their State Pension, and or some this will mean working or longer than they

might have originally planned.

Age on 5 April 2006 Eligible or State Pension rom

Women Men

56 60th birthday

51–55 between 60th and 65th birthday

47–50 47 or older 65th birthday

46 between 65th and 66th birthday

38–45 66th birthday


29–36 67th birthday


27 or younger 68th birthday

Figure4.vFutureeligibilityforStatePension

Note: Women’s State Pension age is already due to gradually increase to 65 between 2010 and 2020.

4.22 Figure 4.vi shows that the current State Pension age is important in determining whenpeople retire; there are quite sharp increases in the move to inactivity at 65 or menand 60 or women. However, the current average age at which people leave the labourmarket is 64 or men and 62 or women, which shows that, although State Pensionage has an inluence upon when people retire, it is not perhaps as powerul in decidingwhen people leave the labour market as some might think.




4.23 The rise in State Pension age will thereore need to go hand in hand with behavioural

change around retirement, changes to the beneit system, as set out in A new deal for welfare: Empowering people to work , and a corresponding rise in averageretirement age.

4.24 In 1950, the average male retired at age 67 and could expect to live or another10.2 years, thus spending 17 per cent o his lie in retirement. Today the averageretirement age or men is 64, and lie expectancy at that age is another 20.9 years,meaning that 31 per cent o lie is spent in retirement. I we were to achieve anaverage retirement age o 65 or men by 2020, rising lie expectancy could still meanthat the same proportion (31 per cent) o lie would be spent in retirement as now– see Figure 4.vii.






Flexibleworkingandphasedretirement

4.28 Increasing choice and lexibility around retirement will enable people to continueworking who might otherwise leave the workorce, due to other demands on theirtime and energies or their inability to cope with ull-time working in their current job.Flexible working consistently eatures in research and reports as a key elementto any strategy to encourage and help older people to stay in work. It enablespeople to manage health conditions, balance caring responsibilities, and achievea smooth transition into an active retirement by allowing the pursuit o other activitiesalongside working.

4.29 Recently published DWP research5 with people aged 50–69 highlighted that the

attitudes o individuals and employers aected the ability to extend working lie.Where health problems and caring responsibilities had been taken into account bytheir employer, some people were able to remain in work. However, others elt thatthey were a burden and so did not want to ask or their needs to be accommodated.Respondents elt that government had a role in supporting lexible working practices.Other research ound that, among 50 to 69-year-olds, hal o those in work wantedto carry on working and many o those who were retired would have liked to haveworked or longer i there had been part-time or lexible work options available.6

4.30 We introduced the right to request lexible working or parents with young childrenin 2003 and this has proved successul at helping parents to combine work with

caring or their amilies, with 90 per cent o requests agreed. We are extending thisright to include carers o adults rom April 2007. As the peak o caring responsibilityalls between the ages o 45 and 65, this new right will be o signiicant beneit toolder workers, who will have greater opportunity to balance caring with working. TheGovernment has committed to a ull, evidence-based review in 2011 o the deaultretirement age being introduced in October this year. As part o this review, we willconsider the working patterns o older people.

4.31 We have already announced in A new deal for welfare: Empowering people to work that we will work with employers through Age Positive to promote best practice and

encourage more opportunities or lexible working and retirement. However, there arealso ways in which the pensions and beneits systems can support lexible retirementand make lexible working more aordable or people on low incomes. Doing so wouldmirror the opportunities available to better-o people, who can take advantage o thelexibility in occupational pension schemes that supports part-time work leading upto retirement.

5 Irving et al, 2005, Factors affecting the labour market participation of older workers: Qualitative research , DWP ResearchReport 281.

6 Do employers need older workers?, Brieing Paper 5, October 2005, Centre or Research into the Older Workorce at theUniversity o Surrey.




4.32 The Pensions Commission has suggested that State Pension deerral could be beneicial

to people on lower incomes who want to continue to work, by allowing them to drawpart o their pension while deerring the rest. We are keen to see how the changesintroduced last year to make State Pension deerral more generous will increase thenumbers o people working and deerring, and will be undertaking research on this indue course.

4.33 We will consider how State Pension deerral might in the uture oer greater lexibility,both in terms o the amount drawn and deerred, and in terms o allowing peoplemore lexibility to move in and out o work ater State Pension age. This secondlexibility would mean oering people the chance to draw their pension when theyneed the income and deer it again when they can support themselves through work.

However, this would increase complexity and will need careul consideration onceresearch indings are available.

Supportinginformeddecisionmaking

4.34 We already have well-developed communications campaigns in place, ocused onraising awareness o age diversity in the workplace and promoting the interests o olderworkers, but these are aimed at employers. Age Positive has been running since 2000to promote the business beneits o an age-diverse workorce. The campaign includesemployer case studies and guidance on a dedicated website, as well as events, awards

initiatives, research and generating media coverage in the leading national, regional andtrade press.

4.35 Announced in the 2004 Budget, the Government’s Be Ready campaign was launchedin May 2005, in partnership with employer lobby groups and trade unions, and is in theprocess o targeting promotional material at all 1.4 million employers in Great Britain.It aims to promote good practice relating to age in employment, and to encourageemployers to move towards age diversity in advance o the implementation o agediscrimination legislation in October 2006.

4.36 In A new deal for welfare: Empowering people to work , we announced that we will

conduct pilots o ace-to-ace guidance with people approaching or over 50, to helpindividuals to understand their options in relation to work, training and retirement,and to plan constructively or later lie. We hope to learn rom these pilots about thetype o inormation and support people need, and to use this to improve governmentcommunications to this group, as well as developing best practice or others whoprovide help to the over-50s.




4.37 However, we know that a considerable shit in opinion is needed to change behaviour

towards later retirement, and so more eort will be needed over the next decade.Research tells us that many people are not aware o the beneits o working longerand the links between work and their retirement income. For example:

• People do not realise by how much lie expectancy has increased. Theyunderestimate the age to which they can expect to live and anticipate becomingsick and dying in a similar timescale to that o the previous generation. They alsohave low awareness o the general demographic structure o the UK and theeconomic and social impacts this will have in the uture.7

• There is still a commonly held attitude among employees that older people

remaining in work prevents younger people rom getting jobs.8

• Individuals have unrealistic aspirations or early retirement, which are unlikely tobe realised without sensible planning and signiicant saving.9

• Only around a third o people who had retired voluntarily beore State Pensionage had considered the inancial implications o doing so.10

• People tend to have ixed ideas about the nature o work, viewing it as ‘ull time’and ‘ixed or permanent’ and rarely considering that work could be part time or

lexible and could it around other interests and commitments.11

4.38 The indings rom the National Pensions Debate suggest that when people are givenmore inormation to counteract some o these misconceptions, their understanding othe importance o working longer grows and they are more prepared to accept thatretirement should happen later than they might have previously assumed. At the starto National Pensions Day, 42 per cent o the participants agreed that people wouldhave to work longer to solve the pensions issues in the UK; at the end o the day, thisigure had risen to 57 per cent.

4.39 Better inormation is vital to raise awareness and assist decision making in planning

or later lie. The Government will actively pursue a long-term strategic approach tocommunication with its audiences, integrating all relevant elements o communicationsor uture pensioners, including State Pension deerral, equalisation o State Pensionage and extending working lie, to ensure the delivery o joined-up and relevantcommunications to customers.

7 Mayhew V, 2002, Pensions 2002, Public attitudes to pensions and planning for retirement , DWP; Robinson P, 2005,

Working later: Raising the effective age of retirement , IPPR.8 Irving et al, 2005, Factors affecting the labour market participation of older workers: Qualitative research , DWP;

Gosling and Lewis, 2005, Trust no-one? Public attitudes to raising the age of retirement , IPPR.9 Mayhew V, 2002, Pensions 2002: Public attitudes to pensions and planning for retirement , DWP.

10 Humphrey et al, 2003, Factors affecting the labour market participation of older workers , DWP.11 Irving et al, 2005, Factors affecting the labour market participation of older workers: Qualitative research , DWP.




4.40 There are a number o speciic steps we will take to ensure that messages are

communicated consistently to the over-50s, to help them understand the optionsavailable to them. We will:

• include inormation on the opportunities and support available to extend workinglie and provide signposting in Pension Service lealets to people approaching StatePension age and planning or retirement;

• oer inormation about the opportunities and support available on extendingworking lie and provide signposting to more detailed sources o inormation andguidance in pension orecasts that are issued to people over 50;

• increase public awareness o State Pension deerral by more prominently publicisingits availability in the State Pension application process, in State Pension orecastsand in any other relevant materials; and

• provide general awareness training or all Pension Service ront-line sta and morein-depth training or sta most likely to deal directly with customers who areapproaching State Pension age.

Workingwithemployers

4.41 We cannot deliver increased employment rates and higher average retirement ageswithout the support o employers. Much good practice already exists, and manyemployers operate employment policies that actively support older workers and oerlexibility around retirement. Our research12 shows that around two-thirds o employershave equal opportunities policies and perormance appraisal systems which can helpguard against discrimination.

4.42 However, there are still many that operate policies and practices that are potentiallydiscriminatory – indeed, one-ith o employers say that some jobs in theirestablishment are more suitable or some age groups than others, with a tendencyto avour workers between 25 and 49 years o age. Building on our current employer

engagement programmes, we will work in partnership with employers to bettersupport longer working.

12 Metcal with Meadows, 2006, Survey of employers’ policies, practices and preferences relating to age , DWP ResearchReport 325.




Thepublicsectorasanemployer

4.43 The Pensions Commission recommended that public sector employers should beexemplars in deining and encouraging best practice or older workers in the areas orecruitment, retention, retirement, occupational health and education and training. Inthe ourth quarter o 2005, the public sector accounted or one in ive workers in theUK, and thereore its employment practices will have a big impact on the workorce ingeneral. The Government can play a vital role in leading the way and we propose tobegin by introducing change across government departments.

4.44 Government departments are committed to improving working practices to supportolder workers and to using their inluence across other areas o the public sector to

ensure non-discriminatory practices. We will identiy the best practice that already existsand consider ways to encourage more good practice across the public sector.

4.45 The Department or Work and Pensions has already taken the decision to operatewithout a compulsory retirement age or its sta. This decision is based on the evidenceo successully operating with a retirement age o 65 with a right or employeesto request working longer, or the past two years, even in the light o signiicantreductions in sta numbers to improve eiciency during this period.

4.46 We want the public sector to become an exemplar o health and well-being at work.The Ministerial Task Force or Health, Saety and Productivity, which was set up to drive

improvements in sickness absence management in the public sector, will support theHealth, work and well-being strategy by ensuring that the public sector responds andleads by example.

4.47 The measures outlined here and in A new deal for welfare: Empowering people towork will take time to have an eect on employment rates and average retirementages, especially where we are seeking to eect a culture change. We will monitorprogress careully and work with employers and partners to understand howemployment practices and retirement behaviour are changing. Given the importanceo this agenda in securing both higher employment and security in retirement, we will

keep it under periodic review to consider in the uture whether urther governmentinterventions are needed.

The wider context: a strategic approach to an ageing society

4.48 Achieving a culture change with respect to the length o working lives and raisingaverage retirement ages are crucial to orming a response to an ageing society that isair, aordable and sustainable. But our response to an ageing population stretches arwider than just ensuring inancial security in retirement. We need to ensure that quality

o lie, respect and dignity in older age are also secure.




4.49 In March 2005, the Government published Opportunity Age,13 our strategy or a

successul ageing society. The strategy aims to promote a wide culture change, endingthe perception o older people as ‘dependent’, and to ensure that longer lie is healthyand ulilling, with older people playing a ull part in society. We set out how all partso government, central and local, are organising themselves more eectively to delivera wide range o initiatives – not only to improve inancial security and extend workinglie, but also to combat discrimination, promote active ageing and improve services topromote the well-being and independence o older people.

4.50 We have now taken account o responses to the consultation on Opportunity Age14 and are taking action to:

• establish a set o indicators o well-being and independence, which will enableus to track progress. We will report on a biennial basis starting with a baselinedocument in summer 2006;

• consider the scope or setting up an Oice or Ageing and Older People to promotethe ageing agenda, together with an Observatory to improve the co-ordination anddissemination o inormation about ageing;

• promote active ageing and tackle health inequalities, particularly ocusing on themost socially excluded;

• put together a cross-government approach to the needs o older people and anageing society or the 2007 Comprehensive Spending Review; and

• launch the LinkAge Plus pilots in eight areas, rom July 2006, to test the mosteective way o delivering holistic services or older people.

This programme o work also builds on the recent Social Exclusion Unit report onexcluded older people15 and the Department o Health’s White Paper.16 In order to driveit, we will develop existing structures, such as the Cabinet Sub-Committee on Ageingand its supporting mechanisms.

13 DWP, 2005, Opportunity Age: Meeting the challenges of ageing in the 21st century (Cm 6466i), DWP.

14 A summary o responses to the consultation on Opportunity Age will shortly be available on the DWP websiteat www.dwp.gov.uk/opportunity_age/

15 Social Exclusion Unit, 2006, A sure start to later life: Ending inequalities for older people, ODPM.16 Department o Health, 2006, Our health, our care, our say: A new direction for community services (Cm 6737).




Establishingasetofindicators

4.51 In Opportunity Age, we committed to develop a set o indicators o older people’swell-being and independence so that we could see what eect central and localgovernment strategies on ageing were having on the lives o today’s and tomorrow’solder people. With the help o stakeholders across and beyond government, we haveagreed a baseline set o indicators on which we intend to publish our irst report inthe summer. Figure 4.viii shows these indicators.17 We intend to develop additionalmeasures, which we need in order to reach a balanced assessment based on the directexperience o older people, to add to or reine this original set, and to publish progressreports biennially, starting in 2008.

Figure4.viiiIndicatorsofolderpeople’sindependenceandwell-being

Material well-being

Support and care

Healthy active living

Independence in supportivecommunities

Fairness in work and later life

Independence andwell-being

• Employment and inactivityof older people

• Work-relatededucation/training

• Voting

• Median net income• Wealth• Relative/absolute low

income• Persistent low income• Non-state pension

• Satisfaction with home care• Direct payments recipients• Older people helped to live at

home• Home adaptations/equipment• Care for carers• National standards in older

people’s services

• Healthy and generallife expectancy

• Mental and physicalhealth

• Access to treatment• Older learners• Participation in

sport/leisure/ volunteering

• Quality of home• Ownership of consumer

durables• Fear and experience of

crime • Contact with

family/friends• Access to goods and

services• Access to transportation• Number of trips • Overall subjective

well-beingquestionnaire

17 Full details o the indicators, with their data sources, will be available shortly on the DWP website atwww.dwp.gov.uk/opportunity_age/



157

Chapter 5:Consultationarrangements





Chapter5 • Consultation arrangements 159

Chapter 5: Consultation arrangements5.1 An electronic version of this document can be found at

www.dwp.gov.uk/pensionsreform.

5.2 The proposals for reform set out in this paper are informed by an extensive programmeof Government consultation with key stakeholders and the National Pensions Debate– involving nearly 10,000 members of the public in face-to-face debate and via ourwebsite. A list of those consulted is available on the website alongside this paper.

5.3 Our proposals are accompanied by Regulatory Impact Assessments and technical

appendices which are also available at the above website address.

5.4 We welcome comments on any aspect of our proposals. Our consultation arrangementsare in line with the Cabinet Office’s Code of Practice on Consultation. A copy of theCode can be found at www.cabinetoffice.gov.uk/regulation/consultation. The sixconsultation criteria set out by the Cabinet Office are:

• Consult widely throughout the process, allowing a minimum of 12 weeks forwritten consultation at least once during the development of the policy.

• Be clear about what your proposals are, who may be affected, what questions arebeing asked and the timescale for responses.

• Ensure that your consultation is clear, concise and widely accessible.

• Give feedback regarding the responses received and how the consultation processinfluenced the policy.

• Monitor your department’s effectiveness at consultation, including through the useof a designated consultation co-ordinator.

• Ensure your consultation follows better regulation best practice, including carryingout a Regulatory Impact Assessment if appropriate.

Howtorespond

5.5 When responding, please state whether you are responding as an individual orrepresenting the views of an organisation. Where possible, please supply evidencein support of your views. If you are responding on behalf of an organisation, pleasemake clear who the organisation represents and – where applicable – how the views ofmembers were established.



160 Chapter5 • Consultation arrangements

5.6 The closing date for receiving comments isMonday11September2006. Please

ensure that your response reaches us by this date. Your response can be submitted byletter, fax, or email to:

Pensions Reform White Paper TeamDepartment for Work and PensionsLevel 3, The Adelphi1–11 John Adam StreetLondon WC2N 6HT

Telephone: 020 7712 2855Fax: 020 7962 8591

Email: [email protected]

5.7 We will publish a summary of the comments we receive, along with a response fromthe Government on how we intend to proceed, within three months of the close of thisconsultation.

Additionalcopiesandalternativeformats

5.8 Additional printed copies of this document can be ordered from:

The Stationery OfficePO Box 29Norwich NR3 1GN

Telephone: 0870 600 5522Fax: 0870 600 5533Email: [email protected]

5.9 The Welsh version of this document can be found at www.dwp.gov.uk/welsh/ pensionsreform.

5.10 The Executive summary of this document is available in English, Welsh, Braille,large print, and on audio cassette. These are free of charge and can be ordered bycontacting:

Pension GuideFreepost RLXH-JUEU-GZCHNorthampton NN3 6DF

Telephone: 08457 31 32 33Textphone users: 0845 604 0210



Chapter5 • Consultation arrangements 161

Confidentiality

5.11 The information you send us may need to be passed to colleagues within theDepartment for Work and Pensions and published in a summary of responses receivedin response to this consultation, along with a response from the Government.

5.12 Because of the Freedom of Information Act (2000), all information contained in yourresponse, including personal information, may be subject to publication or disclosure.By providing personal information for the purposes of the public consultation exercise,it is understood that you consent to its disclosure and publication. If this is not thecase, you should limit any personal information which is provided, or remove itcompletely. If you want the information in your response to the consultation to be kept

confidential, you should explain why as part of your response, although we cannotguarantee to do this. We cannot guarantee confidentiality even if your IT system claimsit automatically. The contact point to discuss this is:

Geoff AshtonDWP Consultation Co-ordinator5th Floor East, Trevelyan SquareLeeds LS1 6EB

Telephone: 0113 23 27 107Email: [email protected]

5.13 More information about the Freedom of Information Act can be found on the websiteof the Department for Constitutional Affairs at www.dca.gov.uk/foi/index.htm.

Helpwithyourqueries

5.14 Our proposals do not affect your current state pension entitlements. If you have queriesabout your future state pension entitlements, you should contact The Pension Serviceon 0845 30 001 68.

5.15 If you have any queries about the proposals set out in this paper, and would like todiscuss these before sending us your comments, please contact the Pensions ReformWhite Paper Team.

5.16 DWP values feedback on how well it consults. If you have any comments on theprocess of this consultation (as opposed to the issues raised) please contact the DWPConsultation Co-ordinator. In particular, please tell us if you feel that the consultationdoes not satisfy the criteria set out at paragraph 5.4. Please also make any suggestionsas to how the process of consultation could be improved further. Please contact:

Geoff Ashton

DWP Consultation Co-ordinator5th Floor East, Trevelyan SquareLeeds LS1 6EB

Telephone: 0113 23 27 107Email: [email protected]





163

Annexes





Annex A: Measuring undersaving orretirementA.1 Chapter 1 describes the barriers to saving that individuals ace, and a number o

patterns in existing private pension saving. It concludes that a considerable numbero people may be saving less or their retirement than they need in order to avoidunexpected or unwelcome drops in their standards o living once they reach retirement.This will mean that as they near retirement they will be aced with a choice betweenneeding to save more or to work longer than they had intended.

A.2 The chapter gives a range or the number o people or whom retirement undersavingmight be a problem. This annex describes in more detail the actors that aect thisrange, and who the people might be who all within it.

How many people are undersaving?

A.3 Previous estimates o undersaving have been based on individuals’ current membershipo a pension and their pension saving rate. Simplicity, security and choice: Workingand saving for retirement (published by the Department or Work and Pensions in

2002) estimated that 3 million people o working age were ‘severe’ undersavers, whowere predicted to have a replacement rate o less than hal, and that between 5 and10 million people with projected replacement rates o hal to two-thirds might wishto consider working longer or saving more. The Pensions Commission, using theirbenchmarks or target replacement rates, suggested that around 12 million wereundersaving.

A.4 New data1 on wealth, current savings and retirement plans means we can improve ourestimates or those aged rom 50 to State Pension age. This analysis is summarised inFigure A.i.

1 The English Longitudinal Study of Ageing 2002. This is a survey o those aged over 50 which collects detailed inormationon the health and wealth o individuals and their partners.

AnnexA • Measuring undersaving or retirement 165



A.5 These estimates are lower than those given by the Pensions Commission, whichestimated that 38–43 per cent o people aged 46 to State Pension age wereundersaving or retirement. Two major reasons or the dierences are:

• The Institute or Fiscal Studies (IFS) igures are based on households, the PensionsCommission’s on individuals. This means that an individual with low pensionthemselves, but whose spouse has enough pension or both, would be counted asan undersaver by the Pensions Commission but not by the IFS.

• The IFS igures had inormation on pension wealth accrued to date – the PensionsCommission had to assume that people had saved at a constant rate in the past.

166 AnnexA • Measuring undersaving or retirement



A.6 Based on pension income alone, 30 per cent o this age group are undersaving. But

evidence2 shows that many people are saving or retirement outside a pension, orhave other assets which could be used to provide retirement income. It is unrealistic toassume that none o these assets will be used, but equally unrealistic to assume that allavailable assets will be used to produce retirement income. I we deine an undersaveras someone who does not have enough wealth to meet their benchmark with assetsexcluding their main house, and excluding any inheritances they may receive, we seethat around 23 per cent o this age group are undersaving.

A.7 For younger age groups we do not yet have data on accrued wealth. I we assumethat 23 per cent o this group are also undersaving or retirement, this gives a totalo 6.5 million people o working age undersaving. However, data on alls in private

pension membership, and the implication o the reduction in employer contributions topensions, suggest that today’s younger cohorts are less likely than previous cohorts tobe saving or their retirement. In particular, the proportion o people aged 25–49 whoare saving in a non-state pension has allen by 7 per cent.3 To relect this drop, wehave adjusted upwards slightly the percentage o undersavers below 50, resulting inan overall estimate o 7 million undersavers across the working-age population. Giventhat contributions to pension schemes have also allen, this is likely to be anunderestimate o the true position.

A.8 Not all o these pensions undersavers will in act end up with insuicient retirement

income. For younger people in particular, there is time to increase pensioncontributions, or work longer. But it does show that on current trends a signiicantproportion o the population, while not necessarily heading or absolute poverty inretirement, may see an unwelcome all in living standards in retirement.

A.9 We will continue to monitor these igures using the English Longitudinal Study of Ageing (ELSA) and the new Wealth and Assets Survey,4 in order to provide the bestestimates o the extent o undersaving on an ongoing basis.

Who is undersaving or retirement?A.10 Figure A.ii divides the over-50s population into iths by income level. Those most likely

to be undersaving are those on middle incomes, but there is a signiicant amount oundersaving across most income groups. Those in the poorest ith (roughly equivalentto a single person earning less than £8,000 a year) are at the lowest risk because mosto these will reach an 80 per cent replacement rate rom their state pension rights.5

2 IFS, 2005, Prepared for retirement?: The adequacy and distribution of retirement resources in England, IFS. 3 Family Resources Survey 2002/03–2004/05.

4 The Wealth and Assets Survey is a new, cross-government survey that DWP has been developing with ONS and otherdepartments. It will collect data on household wealth and assets, providing a rich data source on people’s saving

behaviour, and allowing us to understand and track trends in undersaving much more accurately.5 IFS analysis o ELSA (to be published 2006).

AnnexA • Measuring undersaving or retirement 167



A.11 One in our o those undersaving or retirement did not join an oered employerscheme, and one in our had never had a private pension.

A.12 Some characteristics are associated with a greater likelihood o undersaving orretirement. For middle earners, those with qualiications below degree level were morelikely to be at risk o undersaving. Low/average levels o numeracy, irrespective o

educational level, also increased the risk o undersaving. For middle and high earners,the sel-employed were also likely to be more at risk than the employed. Finally, coupleswere at less risk than individuals.

168 AnnexA • Measuring undersaving or retirement



Annex B: Improving airness in the statepension system – technical detailB.1 This chapter explains in more detail our proposals or addressing inequalities and

reducing complexity in the state pension system. It speciically gives more detail on:

• Home Responsibilities Protection (HRP) and our plans to replace it with a system oweekly credits or childcare, which will be aligned within the state pension scheme;and

• adult dependency increases (ADIs), and our decision to abolish them, which willreduce some o the complexity within the state pension system.

How does HRP work?

B.2 HRP was introduced on 6 April 1978. It protects the basic State Pension and certainbereavement beneits o men and women who are precluded rom regular employmentbecause they care or children or provide care or someone who is sick or disabled.

B.3 HRP protects the basic State Pension position or complete tax years throughout whicha person:

• cares or a child under the age o 16 or whom the parent receives child beneit;

• receives Income Support and is not required to be available or employment so thathe or she can look ater an ill or disabled person at home; or

• regularly looks ater someone throughout the tax year or at least 35 hours a weekwho has been getting Attendance Allowance, Constant Attendance Allowance orthe highest or middle rate o the care component o Disability Living Allowance,normally or at least 48 weeks in each tax year; or

• is a registered oster carer (since April 2003).

B.4 In order to qualiy or a ull 100 per cent basic State Pension, a person must normallyhave qualiying years or about 90 per cent o the years in their working lie. Normallythe amount o years needed is 44 or men and 39 or women. Unlike credited NationalInsurance contributions (NICs), HRP does not treat the recipient as i they have madeactual NICs. Instead it operates by reducing the number o years needed to qualiy or abasic State Pension. So when calculating a person’s entitlement, the number o years

or which they were covered by HRP is taken away rom the number o qualiying yearsrequired or a ull basic State Pension. HRP cannot reduce the number o qualiyingyears to less than hal o the maximum or 20, whichever is the lower. (This rises to22 or men rom 2010 and gradually rises to 22 or women rom 2020 when StatePension age or men and women is equalised at 65 years.)

AnnexB • Improving airness in the state pension system – technical detail 169



B.5 HRP is only available on an annual basis and can only be awarded i a person has

been caring or a ull tax year. The intention was that HRP should protect a person’spension over substantial periods o time spent caring, not short periods o a ew weeksor months.

WhychangeHRP?

B.6 HRP is clearly working. The signiicant improvement in the number o women aged45 or below today who are projected to reach State Pension age with a ull basicState Pension is, to a large extent, due to the positive eect that HRP has had onpension outcomes.

B.7 However, it is not widely understood1 and its eventual eect – whether a woman willneed HRP years in order to get a ull State Pension, or example – is only apparent atthe point when the State Pension is calculated. This lack o transparency does not helppeople to make inormed decisions about planning and saving conidently or theirretirement. By replacing HRP with credits, we will enable people to better plan theirretirement in conjunction with their savings.

B.8 HRP can also be inlexible and, at times, unair. An individual cannot build up basicState Pension entitlement through HRP alone, or example. This means that thosepeople who spend a substantial proportion o their working lie caring may gain

nothing unless they have at least ive years o (paid or credited) contributions, oneo which must be a paid year. There is also an upper limit on the number o yearsspent caring which can be protected through HRP: an individual can build up only amaximum o 19 years o HRP over their working lie.

B.9 We thereore plan to replace the system o HRP with new weekly National Insurancecredits. This will remove the inlexibilities in the current scheme, thereby enablingcarers to combine paid work. This more transparent, beneicial and understandablearrangement will provide higher pensions, thus making it easier or recipients tomake inormed choices about working and to take personal responsibility or savingor retirement.

B.10 The crediting arrangements or state pensions or parents with care o children will bealigned. Entitlement o HRP depends on the child being aged under 16 years or basicState Pension and under 6 or credits in State Second Pension. Under the new creditingarrangement it will be 12 or both. This supports labour market incentives and, takentogether with the other improvements in coverage, means that people will have greateropportunity to build a ull basic pension than under the current scheme. The reductionto 30 qualiying years or ull basic State Pension, and other changes to contributionconditions, will compensate the reduced generosity in HRP.

1 Women and pensions helpline, Pensions Advisory Service, March 2005.

170 AnnexB • Improving airness in the state pension system – technical detail



Transitionalarrangements

B.11 Our intention is that any periods o care undertaken beore reorms are implemented,which would qualiy or HRP under the existing rules o the scheme, will be preserved,but converted into the new, more generous credits. So six years o HRP or caring or adisabled adult prior to ‘A-Day’, or example, will be converted into six years o creditsor basic State Pension and State Second Pension accrual.




B.12 People below State Pension age who had childcare responsibilities prior to ‘A-Day’

may have a reasonable expectation that years o HRP/State Second Pension protectionthat they have built up have been ‘banked’ or their State Pension – and this mayhave inormed their additional savings decisions. We do not propose to disturb this.Thereore, we intend to retain the existing age limits in respect o childcare undertakenbeore these reorms are implemented, so theoretically a person could have a numbero credits already accrued at the point o change or children up to the age o 16 inthe basic State Pension and age 6 in State Second Pension.

B.13 Figure B.i shows the basic State Pension outcomes or three hypothetical individuals,to illustrate the type o career patterns which will result in gains rom thecoverage reorms.

B.14 Case 1 works ater higher education beore she has two children, and cares or themuntil they are age 7. She returns to work until around age 50. Thirty qualiying yearsand turning HRP into a credit means that her entitlement increases rom around 70 percent o the ull rate to 100 per cent.

B.15 Case 2 has three children at age 19, and cares or them until age 40. Ater this sheworks or ten years, and then cares or an elderly relative. She gains ull rate ater thereorms as a result o the reduction in qualiying years, changing HRP into a credit andextending the provision o adult carers credits.

B.16 Case 3 again cares or three children rom age 19 until age 40. But she doesn’t workat all, so ails the irst contribution condition and receives nothing under the currentsystem. Her time spent caring or children and an elderly relative gives her over 80 percent o the ull rate under the reorm.

B.17 These improvements will increase protection or carers and provide greater transparencywithin the system.

Abolishing the ADIB.18 The state pension scheme includes provision or a man or woman’s State Pension to

be increased i another adult is inancially ‘dependent’ on him or her – these increasesare known as ADIs and have their origins in the immediate post-war period whensingle breadwinner households were the norm. We propose that ADIs will no longer beawarded rom 6 April 2010.

B.19 Originally ADIs o State Pension were available or a range o amily members, butsince the 1980s, availability has been restricted to the recipient’s spouse or a personhaving care o the recipient’s children, with restrictions in the case o women claiming

in respect o their husbands. The test o dependency is that the spouse or other persondoes not have earnings or an occupational or personal pension above the standard rateo Jobseeker’s Allowance – currently £57.45 per week – and is not receiving beneit

172 AnnexB • Improving airness in the state pension system – technical detail



in their own right. The rate o the ADI is set at around 60 per cent o the recipient’s

entitlement to basic pension – currently £50.50 per week where the recipient is entitledto a ull basic State Pension.

B.20 Under the current provisions, in order or a woman to become entitled to an ADI obasic pension in respect o her husband she must also have been entitled to an ADI olong-term Incapacity Beneit immediately beore reaching State Pension age. As part othe package o equalisation measures in the 1995 Pensions Act, rom 6 April 2010 ADIsare set to become available to women in respect o their husbands and to people incivil partnerships in respect o their civil partners on the same basis as they are currentlyavailable to men.

B.21 As emale participation in the labour market has increased, the number o ADIs inpayment has steadily declined rom around 100,000 in 1997 to around 66,000 inNovember 2005. However, the number o ADIs payable with State Pension is projectedto increase rom 2010 as emale State Pension age rises to 65 between 2010 and 2020and coverage is extended to men and civil partners rom 2010.2

B.22 In developing our proposals or reorming the state pension system, we have consideredwhether the current provisions or ADIs are relevant to, and compatible with, a systemor the 21st century. Our conclusion is that the concept o ‘dependency’ on which theADI provisions are based has little relevance in today’s society in which partnerships

o equals are the norm. There is a powerul argument that the expenditure would bebetter invested in providing improved state pensions, particularly or women.

B.23 We thereore propose that ADIs will no longer be awarded rom 6 April 2010. Allexisting entitlements will be protected up to 2020. This means that any ADI payablein respect o a dependent aged 55 or over will, subject to the current rules, remainin payment up to the point she reaches State Pension age and becomes eligible or aState Pension either in her own right or based on her spouse’s contributions. Based onthe current caseload, we estimate that around three-quarters o ADIs in payment at2010 will be in this category. Those or whom ADIs would otherwise have been payableand who are unable to work will, o course, be eligible or the usual range o working-

age beneits. In the minority o cases where there is an ADI still in payment in 2020,we will ensure that the individual and his or her spouse receive advice on other possiblebeneit entitlements. We recently announced in A new deal for welfare: Empowering people to work that we do not intend to carry orward ADIs into the Employment andSupport Allowance.

2 Currently, with unequal State Pension age, in order or an ADI to be payable, the wie must normally be more than

ive years younger than the husband. Once State Pension age is equalised at 65 in 2020, an ADI would potentially beavailable in any case where the wie is younger than the husband. On average, a wie is around two years younger thanher husband.




Annex C: Adequacy in pensions outcomesC.1 The proposals outlined in this paper are intended to tackle at source the barriers that

people ace to saving and to clariy the environment in which they make decisionsto save and work. The starting point o the analysis in this paper is that adequacy opension saving is best understood in terms o the levels at which people would needto be saving to avoid unwelcome or unexpected alls in their standards o living as theymove into retirement.

C.2 Understanding pension adequacy in this way is dierent, and represents a move away,rom the previously articulated aspiration to reverse the ratio o pension incomes rom

60 per cent delivered by the State in 1998, when this target was announced, to 60 percent rom private provision by 2050. We now judge that the time is right to revisethis aspiration.

C.3 In the 1998 Comprehensive Spending Review (CSR), the Government adopted a PublicService Agreement (PSA) target to “promote policies consistent with a change in theratio o spending on pensions by the State to spending on pensions by the privatesector rom around 60:40 to 50:50 by 2025 and 40:60 in 2050”. This target was basedon the policy regime set out in the 1998 paper, A new contract for welfare: Partnershipin pensions, in particular the introduction o State Second Pension and stakeholderpensions. In view o the changes to the policy regime since 1998, o those proposedin this paper, and o technical issues with the target itsel, we believe that now is anappropriate time to reconsider its relevance.

C.4 The policy changes that have had the most direct impact on the target since 1998are the increases in state spending on pensioners as a result o the introduction andpromotion o Pension Credit and o above-inlation uprating o the basic State Pension.These have meant that – despite quite rapid increases in average private pensions– the ratio between state and private spending had only allen rom 57:43 in 1996/97to 56:44 in 2004/05.1 The policy changes set out in this paper, in particular thebroader coverage and more rapid indexation o basic State Pension, will have a similar

eect. Perversely, a less generous approach to State Pension reorm would help theGovernment meet the target.

174 AnnexC • Adequacy in pensions outcomes

1 Pensioners Income Series, based on the Family Resources Survey .





Annex D: The extent and impact odemographic and societal changeD.1 The pensions system today is being asked to perorm a very dierent role to when it

was irst established. When the irst state support or pensioners was introduced, soonater the turn o the last century, people reaching 65 (only about 6 per cent o thepopulation at the time) could expect to live or around a urther ten years. Today, morepeople reach 65 (over three-quarters o the generation now retiring), and they canexpect to live into their 80s and beyond, with average lie expectancy or a 65-year-oldtoday having reached around 20 years. Those reaching 65 by the middle o this century

will represent over 90 per cent o their generation and will have a lie expectancy oaround another 24 years.

D.2 Increased longevity is something we should celebrate. But it raises serious questions orindividuals and societies as to how they continue to support themselves and an ageingpopulation in an ever-growing period o retirement.

Demographic trends

D.3 The structure o society today is very dierent rom when the current pension systemwas designed, and tomorrow’s society will look dierent again.

D.4 It is well documented that people are living longer and that ertility rates are alling,and the rapid pace o advances in medical treatments and the better state o healtho the general population is such that the extent o improvements in lie expectancy iscontinually being revised upwards. The 1994-based population projections had orecastthat a man aged 65 in 2006 would have a lie expectancy o a urther 17 years.However, the latest set o projections, made just a decade later, show that the sameindividual in 2006 can look orward to another 20 years, an upward revision o a ith. 1 Similar patterns can be seen or the average 65-year-old woman, with lie expectancyup to 23 years, compared with 18 or her equivalent 25 years ago.

D.5 Lie expectancy at age 65 has risen at a rate o three months a year over the lastquarter o a century. And more people now reach 65 than ever beore – 83 per cent othose aged 20 in 1961 are still alive and reaching 65 today.

1 The Government Actuary’s Department’s (GAD’s) 1994 population projections had been based on the assumption that,by 2032, the rate o mortality improvement would reach 0.5 per cent a year at all ages, thereater halving every 10 years.By contrast, the latest projections assume that mortality improvement will reach 1 per cent a year by 2029, and then

remain constant at this rate.

176 AnnexD • The extent and impact o demographic and societal change







Dierencesintrendsordierentgroupsinsociety

D.17 The Pensions Commission highlighted the act that, while lie expectancy has risen orall groups o society, some groups, in particular those who work in manual proessions,have lower lie expectancy than the average.

D.18 However, while these groups have seen lower increases to their lie expectancies, theyhave still seen signiicant improvements. For social class I, mortality rates are down to

just a third o those aced by the beginning-o-the-century generation; or class V theyare down to just three-iths.4

D.19 Looking back, available evidence rom the ONS’s Longitudinal Study would suggest

that, had the State Pension age increased by two years between 1981 and 2001, allsocial classes o men and most o women would still have seen an increase in thenumber o years spent in retirement (as shown in Figure D.i). Equally as important is theact that increasing the State Pension age by one year per decade in these years wouldnot have decreased the proportion o those in any social class reaching State Pensionage. Figure D.ii compares the probability o those in social classes I to V reaching65 in 1977–81 and 67 in 1997–2001 and shows that, in all cases, because o theimprovements in lie expectancy in this period, the probability o reaching the age o 67was greater than the probability o reaching 65 had been 20 years earlier.

FigureD.iPeriodlieexpectancyatselectedages

Years I II IIIN IIIM IV V All

Men

1977–81 At 65 15.5 14.2 13.3 12.6 12.2 11.9 12.7

1997–2001 At 67 16.7 15.6 15.2 13.8 12.9 12.3 14.3

Women

1977–81 At 65 19.9 17.8 17.6 16.9 16.8 16.3 16.7

1997–2001 At 67 18.8 18.4 18.2 16.7 16.3 15.4 17.2

Source: Detailed life tables by social class provided by the ONS’s Longitudinal Study.

4 Class I includes people in proessional/managerial jobs, while class V includes unskilled workers. Around 5 per cent o

the population are in the lowest social class, down rom 8 per cent in 1971. I past trends persist, this is projected toall still urther, to 3 per cent by 2050. Figures based on a sample o 1 per cent o the population o England and Wales(ONS’s Longitudinal Study , 1972 to 2001).

AnnexD • The extent and impact o demographic and societal change 179






D.20 Looking orward, i we base projections on the existing (1997–2001) dierentials in lie

expectancy by social class and assume that they remain static over time, a man in socialclass V would see an increase o more than two years in lie expectancy at age 65between now and 2020, and a urther slight increase even with the proposed increasein State Pension age to 68 over the ollowing three decades. For women, there wouldbe only a slight reduction (o between our to six months) compared with the situationin 2020, and lie expectancy or women beyond State Pension age would still exceedthat o men.

D.21 It should be noted, however, that this analysis is based on England and Wales, andcomparable analysis o dierential lie expectancy by social class in Scotland andNorthern Ireland is not available. Across the population as a whole, lie expectancy on

average or both men and women in Scotland is about one year less than in Englandand Wales; in Northern Ireland the igures are much closer to the average or Englandand Wales. Future projections do not show any signiicant change in this disparity.

Implications or individuals

D.22 People’s expectations or their incomes in retirement tend to be linked to their incomeswhile in work. This idea, characterised by the concept o replacement rates, is whatgives rise to the measurement o undersaving as a phenomenon.

D.23 This is an inexact science. But what is clear is that, all other things being equal,longer living has an impact on the sorts o replacement rates people might expectin retirement. The natural response to longer lie expectancy ought to include somecombination o longer working and/or higher saving to secure a similar income levelin retirement. Put simply, i people are now living or 20 per cent longer ater 65, theywill need a pension pot that is at least 20 per cent larger in order to provide the sameweekly income as previous generations received, or they will need to work suicientlylonger to keep the number o years saving and the number o years drawing on thosesavings in balance.

D.24 Yet this is not what is happening. Elsewhere in this paper we have made it clear thatmany people are not saving at suicient levels to meet their expectations or incomesonce they retire. Longer lie expectancy has been accompanied in recent years bychanges in the patterns o work that people undertake, so that, while living longer,people are starting work later and, until recently, leaving it earlier.




D.25 This is perhaps at least in part because people consistently underestimate their own lie

expectancy. Recent survey evidence5 suggests that, while the probability o a womancurrently aged 60–64 living to reach her 75th birthday is over 80 per cent, only 65 percent o women asked believed that they would live this long. For men the story is littlebetter, with an actual likelihood o 75 per cent as opposed to a reported expectationo less than 65 per cent.

Implications or society

D.26 At a macro level, whether through direct, ‘pay as you go’ provision rom the State or

rom private savings, ultimately all pensioner incomes are driven by the wealth createdby those in work.6 And as average lie expectancy increases and ertility remains low,the proportion o those in work compared with those in retirement is alling.

D.27 In recent years, the underlying downward trend in the old-age ‘support ratio’ has beenmasked by the eects o the ‘baby boom’ generation born in the years ollowing theSecond World War. The resulting large cohorts have maintained the ratio against therise in lie expectancy as they have moved through working age.

D.28 But the irst o these people are now starting to move into retirement. Coupled withsharp decreases in the birth rate in the 1960s and early 1970s, the ratio will now riserapidly to catch up to where it otherwise would have been.

D.29 Figure D.iii shows the pensioner population as a percentage o the working-agepopulation. Today, it is around 27 per cent – there are just under our people oworking age or every pensioner. By 2050, when the ratio has caught up with theunderlying trend, this will be 47 per cent – there will be only just over two people oworking age to every pensioner. These support ratios matter. State pensions are paidor by today’s taxpayers. And private pension incomes, via annuity rates, are drivenby the purchasing power o people o working age buying the assets that retireesare decumulating.

D.30 Today’s pension system is working well. Average incomes or pensioners are high.Pensioner poverty is historically low, and getting lower. Economic stability means thatthere will be no repeat o dramatic inlation wiping out pensioner savings, and highemployment means that people have a greater opportunity to build entitlements whilein work.


5 Banks, Emmerson and Oldield, 2005, Seven ages of man and woman, Economic and Social Research Council (ESRC).Note that this study was based on the 2003-based GAD population projections. Updated lie tables, consistent with

the 2004-based GAD projections, indicate that the ‘true’ probability o a woman aged 60 going on to reach 75 is over

85 per cent, while or a man the probability now stands at 78.4 per cent.

6 Individual countries can break this strict relationship between the number o pensioners and the working-age populationby taking advantage o dierent demographic trends internationally, or example by investing abroad and by consumingthe returns at a later stage.



D.31 But i this position is to be sustained in the ace o the declining support ratio,

something must be done. I state pensions were to maintain their value relative to thewealth o the rest o society, the burden on those in work through taxation would haveto rise signiicantly. State spending on pensioners7 would need to rise rom its currentlevel o 6.3 per cent o GDP to around 9.7 per cent o GDP by 2050.


7 Reerences in this annex to ‘state spending on pensioners’ dier rom those or ‘state pension spending’ in the 2005

Long-term public finance report , due to the inclusion o ‘housing-related beneits’ and ‘Attendance Allowance/DisabilityLiving Allowance’. These are included under ‘other spending’ and not ‘state pension spending’ in the Long-term public finance report .






D.32 In act, as Figure D.iv shows, spending is currently projected to rise to only 7.2 per

cent o GDP over this period. This contrasts well with other countries. Recent analysis,carried out jointly by Member States and the EU Commission, revealed that, despitethe impact o ageing, the level o state spending on pensions as a percentage o GDPin the UK will remain around two-thirds o that across the 25 Member States o the EU(EU25).

D.33 Due to their higher level o spending, most European countries are let with littlealternative but to make their systems less generous in order to ace the challengeo ageing. The latest projections o pension spending within the EU25 made by theEuropean Commission suggests that beneit generosity will on average decline by morethan 10 per cent by 2025 and by nearly 25 per cent by 2050.8 Despite this, average

spending will still have risen rom 10.6 per cent o GDP in 2004 to 12.8 per cent oGDP in 2050, an increase o just over a ith in the burden o state pensions on theeconomies o these countries.

D.34 As described later in this annex and at Figure D.v, projected increases in state pensionexpenditure in the UK compare well with other countries. But, without reorm, therelatively modest projected increase in the UK will be manageable only i state pensionsbecome less generous over time relative to the incomes o those in working age as thenumber o pensioners increases.

8 Economic Policy Committee, 2006, The impact of ageing on public expenditure: Projections for the EU25 Member Stateson pensions, healthcare, long-term care, education and unemployment transfers (2004–2050) .







D.35 The gains made against pensioner poverty must be sustained. In practice, this would

mean that levels o targeted support to protect pensioners against poverty must rise inline with earnings growth in the long term. But, combined with contributory beneitsthat are alling in value relative to this targeted support, this is unsustainable i ourpolicies to reverse the decline in pension saving are to be successul. Otherwise:

• an increasing proportion o state pension incomes will come rom income-relatedbeneits, to which an increasing proportion o the population will be eligible; and

• the savings decision will become more complicated or people, whose savingsbehaviour will have to respond not only to longer lie expectancy but also to theneed to oset a declining oundation o income rom the State.

D.36 This is a deeply complex picture. Reorms to introduce greater simplicity and stabilityinto the state pension system will help people to make decisions about saving.

International experience o demographic change

D.37 The ageing o societies is a long-term and widespread trend, and in many developedcountries is predicted to be more rapid than in the UK. EUROSTAT, the EU’s statisticalagency, estimates that the old-age dependency ratio9 in the EU will rise rom 25 percent in 2004 to 53 per cent in 2050 (while or the UK, which at present has a similarratio to the EU average, the rise will be to less than 50 per cent).10 Throughout Europethe ratio today is below 30 per cent. By 2050, it will be above 30 per cent acrossEurope. Outside Europe, in developed and developing countries, the trend is the same.Figure D.vi shows the trend in the dependency ratio in a sample o countries.

D.38 While demographic patterns are similar, pensions systems vary widely. In much oWestern Europe, pensions systems are dominated by state pensions based on pastearnings. In contrast, the New Zealand pensions system gives a lat rate to all pensionerssatisying a residence condition, while in Australia employers have to contribute to

private pension plans or their employees and the state pension is means-tested.

D.39 Given these dierences, it is not surprising that dierent countries have chosendierent approaches to demographic change. The need to extend working lives is,however, widely recognised. Many countries are increasing their state pension ages,either directly (Austria and the Czech Republic), by increasing women’s state pensionage to match men’s (Germany and Belgium) or by toughening early retirementconditions (Germany, Denmark, Italy, Austria and Australia). Iceland and Norway alreadyhave retirement ages o 67, and the US and Israel are increasing theirs at present.Germany and Denmark have also announced that they will increase the retirement agebeyond 65 over the coming decades.


9 Deined as the number o people aged 65 and over per person aged 15 to 64.10 EUROSTAT, 2005, Baseline scenario of 2005 EUROSTAT projections, EUROSTAT.



D.40 Similar proposals are being discussed elsewhere in Europe. Sweden and Finland havelexible retirement ages that go up to 67 or 68, with better treatment or those whoretire towards the end o the age period. Bonuses or later retirement have been

introduced in several countries (or example Germany, Austria and France). Socialcontributions or older workers have been reduced (or example in Spain) and somecountries no longer require people to give up employment in order to receive a pension(such as Slovakia).11

D.41 Some countries have also introduced more undamental reorms. Sweden, Italy andGermany have built in mechanisms to their pensions systems to oset increases in lieexpectancy through lower pension beneits and/or later retirement. Similarly, in Francerom 2009 the number o contribution years needed to be entitled to a pension willincrease in line with lie expectancy.

11 http://europa.eu.int/comm/economy_inance/about/activities/sgp/country/countryiles/sk/sk20032004_en.pd




D.42 Ireland and New Zealand have sought to build up buer unds to help pay or the

pensions o the baby-boomers, much o Eastern Europe and Latin America have movedto privately-unded pension systems,12 and Sweden and New Zealand have introduceda new tranche o unded provision through some orm o individual accounts. Somecountries – such as the Czech Republic and Estonia – have either increased levels ocontributions to state pensions or reduced their generosity, or example through lowerindexation.

D.43 All the countries aected by ageing have realised that there are essentially only ourdierent choices beore them – people work more, they save more, or else taxesincrease or beneits decrease. The choices they have made and are continuing to makerelect the size o their ageing problem and the particular characteristics o their current

pension regime.

12 http://europa.eu.int/comm/employment_social/social_protection/docs/2005/sk_en.pd




Annex E: Outcomes under the reormed systemE.1 This annex assesses outcomes under the new system and demonstrates how the

reorms to the state and private systems interact to improve overall pensions outcomes.

The shape o the new system

E.2 Figure E.i shows the incomes that people retiring in 2010 might receive rom statepensions and private saving. It assumes that people save 5 per cent o their income

in a personal pension. A median earner can expect a replacement rate includingprivate saving o around 40 per cent. For a lower earner earning at the LowerEarnings Threshold, this is more like 68 per cent, and or a higher earner it is around30 per cent. This, coupled with other assets and urther savings, could be expectedto take them to an income in retirement that meets their expectations. The PensionsCommission suggested that those lower down the income distribution might expecta higher replacement rate than those with higher incomes during working age. Theigure shows that the current system perorms well in helping people to achieve theseexpectations.

190 AnnexE • Outcomes under the reormed system



AnnexE • Outcomes under the reormed system 191



E.3 However, the shape o the pensions system is changing over time. The value o

contributory beneits is alling relative to earnings. Assuming that all current indexationwithin the state system remains the same, Figure E.ii shows outcomes under the systemas it might look by 2050. It assumes no change in the level o private saving.




E.4 I current uprating policies continued, by 2050 the shape o the system would change

considerably. While replacement rates at the lower end o the income distribution,up to around median earnings, would have remained similar or even grown slightly,an increasing proportion o this income is rom means-tested beneits. Further up theincome distribution, replacement rates would have allen due to the decline in the levelo the State Pension, and targeted beneits would have spread so that a majority o thepopulation were entitled to Pension Credit. Under this approach, by 2050 we would bespending an additional 0.9 per cent o GDP compared with today.




E.5 It has never been the intention o the Government or a signiicant majority o the

pensioner population to be entitled to Pension Credit. Figure E.iii shows how thereormed system will look by 2050. The level o contributory state support will haveretained its value relative to earnings. And the introduction o personal accounts willhave increased the value o that saving as a result o lower charges and the presenceo an employer contribution. Most people will see a higher replacement rate, and thosewho see a lower replacement rate will already have a replacement rate o around 100per cent.

Longerworking

E.6 It is also important within this analysis to recognise the impact o longevity. Figure E.iii

assumes that people retire and annuitise their private pension savings at age 65. Thiswould mean that people’s savings would have to cover them in a longer period oretirement than today, and they would get a correspondingly lower annuity rate.

E.7 A key element o our proposals or reorm is to engender a culture change in respecto people’s attitudes towards longer working, something which we are signalling nowby announcing our intention to increase the State Pension age in line with growinglie expectancy rom 2020. I these increases in State Pension age are accompanied bycorresponding increases in average retirement ages, the impact on pension incomeswill be considerable. Figure E.iv shows the outcomes under the assumption that people

have worked and saved or a urther three years (by 2050, the State Pension age willhave risen by three years to 68). Private incomes will be higher – both as a result o morehaving been saved, and because they will be drawn down over a shorter period.

E.8 The rise in State Pension age and any accompanying increase in average retirementages are also critical to the aordability o reorm. Increasing the State Pension age isexpected to save almost 1 per cent o GDP by 2050. This will considerably oset thecosts o the rest o the reorms. As described earlier in this annex, without reorm weexpect to be spending almost 1 per cent more on state pensions by 2050 than we dotoday. At the same time, average incomes rom state pensions would have allen byalmost a quarter. With the reorms outlined in this paper, we will be spending around

1.4 per cent o GDP more than today – at 7.7 per cent1 still considerably less than mostindustrialised nations – having maintained spending per pensioner at almost its currentlevel.

1 Excludes spending on working-age beneits as a result o State Pension age changes. Reerences in this annex to

‘spending’ and ‘spending on state pensions’ dier rom those or ‘state pension spending’ in the 2005 long-term publicinance report, due to the inclusion o ‘housing-related beneits’ and ‘Attendance Allowance/Disability Living Allowance’.These are included as ‘other spending’ and not ‘state pension spending’ in that report.




E.9 Success in our policies to extend working lives, as part o our aspiration to meet an80 per cent employment rate, will help still urther. Increasing the employment ratewill result in greater national productivity and a higher tax yield, making pensionsrelatively less expensive. Today, state spending on pensioners is 6.3 per cent o GDP.By 2050, with no reorm, this will be 7.2 per cent. With our planned reorms, it will be7.7 per cent. But were we to reach an 80 per cent employment rate by 2030, the igure

might be lower.




How the new system will aect individuals

CoveragewithinstatepensionsE.10 The analysis in the previous sections ocuses on the replacement rates that people can

expect rom the new pensions system as it evolves into the uture, assuming peoplehave relatively ull working lives (and thereore ull state pension entitlements). Butthis obscures another dimension o our reorms – those which will ensure increasedcoverage within the state pension system. These reorms mean that most people willbe able to plan or their retirement in the conidence that the oundation incomethey receive rom the State will provide them with an income above the level o theGuarantee Credit, and will thus ensure that they achieve a higher eective rate oreturn on any additional private saving that they make.

Outcomesorindividuals

E.11 The combined impact o reorm or individuals can be illustrated by demonstratingincomes in retirement or illustrative individuals with simulated employment andearnings histories, beore and ater reorm. In this section, we ocus on a lietimemedian earner case study – someone who is employed rom 25 until State Pension ageand receives median earnings throughout his or her working lie.

E.12 Figure E.v compares the outcomes or a median earner retiring in 2050 under:

• the system with all current indexation policies persisting into the uture, and theimpact on their income i they saved 5 per cent o earnings in a personal pension;and

• the reormed system, and the impact on their income i they saved 5 per cent oearnings in a new personal account.

E.13 In the current system, this individual sees an improvement in their income rom havingsaved. But in the reormed system, the lower charges and presence o an employercontribution within personal accounts results in a higher private pension income and

a higher income overall, with less displacement o state pension income as a result ohaving saved.




E.14 This comparison represents only part of the story. While lower charges should be an

outcome specific to the new scheme of personal accounts, many employers alreadyoffer a contribution into their employees’ pensions. But one of the key characteristicsof many of those who are currently undersaving for retirement is that they do nothave access to such a contribution. Figure E.v therefore shows the sort of benefit thatsomeone in this group might experience as a result of reform.

AnnexE • Outcomes under the reformed system 197



Acohesivesetopolicies

E.15 Some commentators have suggested that we do not need action to increase savingwithin the private pensions sphere and state pension reorm to respond to the pensionschallenge. This argument would suggest one o two things. Either:

• that the introduction o a scheme o automatic enrolment into personal accountsalone would overcome inertia in inancial decision-making, leading to betteroutcomes in retirement. Reorms to the state pension system are not thereore anecessary condition or a successul response to the undersaving problem; or

• that a simpliied and bolstered State Pension, under which people could be

conident o the value o additional saving, would in itsel be enough to overcomeremaining barriers to saving, even within the existing private pensions ramework.

E.16 We do not accept either argument. The key proposition underpinning the introductiono personal accounts is that people must have access to a low-cost, high-qualitypension-saving vehicle, and that the decision to save in that vehicle must be ramed inthe right way. Evidence suggests that the most eective way to rame this decision isthrough opting people into the scheme automatically, giving them the right to opt outi they wish.

E.17 We need to be conident in requiring employers to enrol their sta into the scheme.

I this were not the case, and individuals or their employers did not think membershipwas in their interests, the resultant reduction in the numbers o people with personalaccounts would reduce the low o unds in the scheme and result in higher charges.This would urther reduce the numbers or whom it would make sense to remain in thescheme and, just as crucially, impact on people’s perceptions o the trade-o betweencurrent and uture consumption as it was then being presented to them.

E.18 Earnings uprating o the basic State Pension provides the solid oundation or privatesaving so that we can have this conidence. We are aware o the argument that, hadcurrent uprating policies persisted indeinitely, a majority o pensioners would have

become entitled to Pension Credit; and that there is a perception that such a scenariocould have damaged incentives. As is made clear above, this was never the intention.Our reorms make this clear.

E.19 Essentially, without accompanying reorm o the state pension system, the objectives oa low-cost savings product utilising automatic enrolment to overcome individual inertiamight not have been possible.




E.20 We also do not believe that state pension reorm alone is suicient to prompt

individuals to voluntarily save more in the numbers required to meet the challengesraised by current levels o undersaving. As outlined earlier a considerable volume oevidence suggests that even in an environment o ully available inormation, andwhere saving would be ‘worthwhile’ or the individual concerned, people oten ail tomake the decision to start saving.

E.21 We thereore judge that an adequate response to the undersaving problem, whichplaces responsibility or saving on the individual in an environment that is conduciveto their taking that responsibility, requires the introduction o a scheme o personalaccounts underpinned by a reormed state pension system.




Annex F: DWP research and evidence

DWP-commissioned research already published

Pensions2002:PublicattitudestopensionsandsavingorretirementResearchReportNo.193By Victoria MayhewJuly2003ISBN 1 84123 599 7

FactorsaectingthelabourmarketparticipationoolderworkersResearchReportNo.200By Alun Humphrey, Paddy Costigan, Kevin Pickering, Nina Stratord and Matt BarnesNovember2003ISBN 1 84123 626 8

CombinedPensionForecasts:AreportontheexperiencesandviewsoCPFprovidersandrecipientsResearchReportNo.212By Karen Bunt, Lorna Adams and Catherine MottramJuly2004

ISBN 1 84123 695 0

EectivemeansoconveyingmessagesaboutpensionsandsavingorretirementResearchReportNo.239By Emma Green and Clarissa WhiteJune2005ISBN 1 84123 797 3

Micro-employers’attitudestowardspensionsorthemselvesandtheiremployees:Areportonsmall-scalequalitativeresearchwithemployersResearchReportNo.266

By James NobleOctober2005ISBN 1 84123 854 6

Financialeducation:AreviewoexistingprovisionintheUKResearchReportNo.275By Jude England and Papiya ChatterjeeAugust2005 ISBN 1 84123 870 8

Factorsaectingthelabourmarketparticipationoolderworkers:QualitativeresearchResearchReportNo.281By Pat Irving, Jennier Steels and Nicola HallSeptember2005ISBN 1 84123 880 5

200 AnnexF • DWP research and evidence





Employers’PensionProvisionSurvey2005

ResearchReportNo.329By Stephen McKayMarch2006ISBN 1 84123 980 1

ThePensionServiceCustomerSurvey2005ResearchReportNo.331By Nicholas Howat and Lorraine SimsMarch2006ISBN 1 84123 982 8

Theimportanceoincentivesininfuencingprivateretirementsaving:KnownknownsandknownunknownsBy Richard Blundell, Carl Emmerson and Matthew Wakeield (IFS Working Papers series)April2006

DWP-commissioned research to be published in 2006

PensionsandsavingsBy Karen Bunt, Lorna Adams, Zehra Koroglu and Eoin O’Donnell (IFF research)

PublicattitudestopensionreormomnibussurveyBy Michael Kelly (DWP)

Publicattitudestopersonalaccounts:ReportoaqualitativestudyBy Suzanne Hall, Nick Pettigrew and Paul Harvey (Ipsos MORI)

Employerattitudestopersonalaccounts:ReportoaqualitativestudyBy Helen Marshal & Andrew Thomas (BMRB)

Employerattitudestopersonalaccounts:ReportoaquantitativesurveyBy Keith Bolling, Catherine Grant, Alice Fitzpatrick (BMRB)

RevieworesearchrelevanttoassessingtheimpactotheproposedNationalPensionSavingSchemeonhouseholdsavingBy Jonathan Hawksworth (PriceWaterhouseCoopers)

This research is part o a larger continuing programme o economic and social research,which is contributing to the Government’s eorts to improve the evidence base. These widereorts include the development o a new Wealth and Assets Survey which will provide keylongitudinal data on pensions and savings, housing, debt, inancial planning and attitudes.

We will publish details o our plans and research activities to improve the quality o theevidence base later this year.

202 AnnexF • DWP research and evidence



Annex G: GlossaryActive members Current employees who are contributing (or having

contributions made on their behal) to an organisation’soccupationalpension scheme. The scheme may be open orclosed but cannot be rozen.

Additional Pension (AP) The earnings-related state pension paid in addition to thebasicStatePension. From 1978 to 2002 it accrued underthe StateEarnings-RelatedPensionScheme (SERPS) androm 2002 under the StateSecondPension (S2P) scheme.

Additional VoluntaryContributions (AVCs)

Personalpension contributions made by someone who isalso a member o an occupationalscheme as a top-up totheir occupational entitlement. AVCs can be made into theoccupational scheme or to a stand-alone product called aree-standing AVC plan.

Annual managementcharge (AMC)

The charge generally applied to personalpensionplanswhere the ee is levied as an annual charge on the value othe und. This charge covers the sales, administration andund management costs o the und.

Annuity Purchased with an individual pension pot, which has been

built up in a deinedcontributionpensionscheme , toprovide an income that is usually payable or lie. A single-lieannuity pays beneits to an individual. A joint-lie/survivor’sannuity pays beneits to the spouse/dependent partner aterthe death o the irst. A level annuity pays constant payments,whereas an index-linked annuity pays beneits relating to anindex (or example, the RetailPriceIndex).

Automatic enrolment A system whereby an individual is made a member o apension scheme by deault and has to actively decide toleave the scheme.

Average earnings terms Figures have been adjusted to remove the eect o increasesin average earnings over time. Thus, i something shownin average earnings terms increases, it is rising aster thanaverage earnings, whereas i it is constant, it rises at exactlythe same pace as average earnings.

Baby boom A temporary marked increase in the birth rate. There weretwo baby booms in the second hal o the 20th century:immediately ollowing the Second World War and in theearly 1960s.

AnnexG • Glossary 203





The system by which individuals can choose to opt out

o StateSecondPension and use a proportion o theirNationalInsurance contributions to build up a unded pension. There are our types o schemes into which anindividual may contract out. The rules and rebate levels aredierent or each. These are: Contracted-out Salary-RelatedScheme, Contracted-out Mixed Beneit Scheme, Contracted-out Money Purchase Scheme and approved personal pension.

Contracting out

Council Tax Beneit A means-tested beneit through which the UK Governmenthelps qualiying individuals meet their Council Tax payments.Qualiication criteria include income, savings and personal

circumstances.Decumulation The drawing down o pension assets to und retirement.

In the UK it is permitted to access pension assets partiallyas a tax-ree lump sum and partially as an income stream(i.e. annuity or income draw down).

Deault und In compulsory or auto-enrolleddeinedcontribution pensionschemes, some members do not make a choice o investmentund. These members will have their contributions paid into adeault und, designated or the purpose.

Deined beneit (DB)pension scheme

A pension scheme where the pension is related to themember’s salary or some other value ixed in advance.

Deined contribution (DC)pension scheme

A scheme where the individual receives a pension based onthe contributions made and the investment return that theyhave produced. They are sometimes reerred to as moneypurchase schemes.

Disability Living Allowance A non-means tested beneit which is mainly paid to peopleunder StatePensionage i they have additional needsbecause o illness or disability.

Earnings-related provision The pension rights accrued in the scheme are linked to

earnings. In a state pension scheme, the ormula may takeaccount o average earnings over the working lie or bebased on a certain number o years as well as the numbero contribution periods. The alternative to earnings-relatedprovision is lat-rateprovision.

European Economic Area The European Economic Area consists o all 25 MemberStates o the European Union as well as Iceland, Liechtensteinand Norway.

Equity Share or any other security representing an ownership interest.

Final salary scheme A deinedbeneit pensionscheme that gives individuals a

pension based on the number o years o pensionable service,the accrual rate and inal earnings as deined by the scheme.




Flat-rate provision The pension rights accrued in the scheme are on a lat-

rate basis. Thus, the level o earnings is not taken intoaccount by the ormula, which is based on the number ocontribution years. The alternative to lat-rate provision isearnings-relatedprovision.

Free-standing AdditionalVoluntary Contribution

An AdditionalVoluntaryContribution plan which isseparate rom the individual’s occupationalpension und.

Funded Pension schemes whereby pension contributions are paid intoa und which is invested, and pensions are paid out o this pot.

Gross Domestic Product(GDP)

A measure o economic activity in a country, calculated byadding the total value o a country’s annual output o goodsand services.

Guarantee Credit A means-testedbeneit which is part o PensionCredit and provides pensioners with a minimum level o income. In2006/07 the standard level o Guarantee Credit or a singleperson is £114.05 per week. For a couple the level is £174.05per week.

Guaranteed MinimumPension

The minimum pension that must be provided by aContracted-out Salary-Related Scheme or pensions accruedbetween 1978 and 1997. The GMP is roughly equivalent to

the SERPS oregone rom contractingout.Her Majesty’s Revenue andCustoms

The new department responsible or the business o theormer Inland Revenue and HM Customs and Excise. It isthe department responsible or NationalInsurance.

Home ResponsibilitiesProtection (HRP)

This helps protect the NationalInsurance records o peoplewho have caring responsibilities by reducing the number oyears o contributions or credits they need to qualiy or a ullbasicStatePension.

Inertia People oten accept the situation with which they arepresented as a given. As a result, automaticenrolment

increases participation rates, and the Save More Tomorrowschemes lead to an increase in saving over time.

Inormed Choice The Inormed Choice programme is a Governmentprogramme o initiatives, which aims to oster an increasinglyproactive approach by individuals to saving or retirement.

206 AnnexG • Glossary



Lie expectancy Lie expectancy (or the expectation o lie) at a given age, x, is

the average number o years that a male or emale aged x willlive thereater, and is calculated using age- and gender-speciicmortality rates at ages x, x+1, x+2 etc. Period lie expectancyis calculated using age-speciic mortality rates or the periodunder consideration and makes no allowance or changesin age-speciic mortality rates ater that period. Cohort lieexpectancy is calculated allowing or subsequent known orprojected changes in age- and gender-speciic mortality ratesater that period as he or she gets older. For example, a periodlie expectancy calculation or a male aged 50 in 2000 would

use male mortality rates or age 50 in 2000, age 51 in 2000,age 52 in 2000 (and so on). The cohort lie expectancy wouldbe calculated using male mortality rates or age 50 in 2000,age 51 in 2001, age 52 in 2002 (and so on). The cohortdeinition is the better measure o true lie expectancy.

Long-dated gilts/bonds Gilts or bonds with many years (or example, 20) let untilmaturity.

Longevity Length o lie.

Longitudinal study A research study which ollows a group o individuals overa period o time.

Lower Earnings Limit (LEL) The level o earnings at which an individual is treated asi they have made NationalInsurance contributions.In 2006/07 the limit is £84 per week or £4,368 per year.

Lower Earnings Threshold(LET)

For the purposes o calculation o StateSecondPension ,anyone earning less than the Lower Earnings Threshold(£12,500 in 2006/07) and above the LowerEarningsLimit is treated as i they had earnings at the Lower EarningsThreshold.

Macroeconomics The study o aggregate economic activity ocusing onvariables such as GrossDomesticProduct, economic growth,unemployment and inlation.

Means-tested beneits State beneits where the amount paid depends on the levelo income and capital and other personal circumstances.

Median The median o a distribution divides it into two halves;thereore, hal the group are above the median value andhal below.

Minimum IncomeGuarantee

The orerunner o GuaranteeCredit.




National Insurance (NI) The national system o beneits paid in speciic situations,

such as retirement, based on compulsory or voluntarycontributions. There are our main classes o contributions:

Employmentstatus

Contributionlevel

Incomeband

Class 1 Employed 12.8 per cent or theemployer and 11 percent or the employee

unless contractedout

Pay rom PrimaryThresholdtoUpperEarnings

Limit butcredited rom LowerEarningsLimit to UpperEarnings Limit

Class 2 Sel-employed Flat-rate paymento £2.10 a week(2006/07)

I earnings below£4,465, eligible orcertiicate o smallearningsexemption

Class 3 Voluntary Flat-ratecontribution o£7.55 a week

(2006/07)

Voluntary or thosenot contributingthrough Class 1or 2

Class 4 Sel-employed 8 per cent Between LowerProits Limit(£5,035 in2006/07) and Upper ProitsLimit (£33,540 in

2006/07)

There are special rates o Class 1 contributions or mariners and o Class 2 or shareishermen and volunteer development workers. In relation to pensions, Class 1contributions accrue rights to basicStatePension and StateSecondPension , whileClass 2 and 3 contributions accrue rights only to the basic State Pension. Class 4contributions do not accrue rights to any beneit.

Occupational pension A pension that is provided via the employer, but the pensionscheme takes the orm o a trust arrangement and is legallyseparate rom the employer.




The gain or loss o an investment over a speciied period,expressed as a percentage increase over the initial investmentcost. Gains on investments are considered to be any incomereceived rom the asset, plus realised capital gains.

Old-age dependency ratio Used in this paper to measure the number o people above

age 65 compared with the number o people aged 20–64 inthe population.

Pay As You Earn (PAYE) A mechanism used to collect Income Tax, NationalInsurance and some other statutory payments (or example, StudentLoan repayments) rom employees and employers at source.The employer makes the appropriate deductions rom weeklyor monthly earnings and sends the contributions to HerMajesty’sRevenueandCustoms. The payments are usuallymade monthly, on an aggregate basis, with annual returnso individual inormation to enable the reconciliation o

individuals’ contributions and accounts. PAYE is not normallyused as a collection method or the sel-employed.

Pay as you go (PAYG) A pensions system in which the pension is paid out ocurrent revenue and no unds are accumulated to pay uturepensions. The NationalInsurance system is PAYG.

Pension accrual The build-up o pension rights. In a deinedbeneit schemethis may be based on the number o years o contributions.

Pension Credit The main means-testedbeneit or pensioners, whichcombines GuaranteeCredit and SavingsCredit.

Persistency Where someone continues to make contributions to a pensionscheme over time.

Personal pension A pension which is provided through a contract betweenan individual and a pension provider. The pension producedwill be based on the level o contributions, investmentgrowth and annuity rates. A personal pension can eitherbe employer-provided (a Group Personal Pension) orpurchased individually.

Price-indexation Increasing each year in line with inlation.

The point at which employers and employees become liable

or NationalInsurancecontributions. In 2006/07 thethreshold is £97 per week or £5,035 per year.

Primary Threshold

Protected rights The element o thedeinedcontribution pension arisingrom contracted-outrebates.

Rate o return




Real terms Figures have been adjusted to remove the eect o increases

in prices over time (inlation), usually measured by the RetailPriceIndex. Thus i something shown in real terms increases,then it is rising aster than prices, whereas i it is constant, itrises at exactly the same pace as prices.

Replacement rate This measures income in retirement as a percentage o incomebeore retirement.

Retail Price Index (RPI) This is an average measure o the change in the prices ogoods and services bought or consumption by the vastmajority o households in the UK.

Savings Credit Part o PensionCredit. It is a means-testedbeneit orpeople aged 65 or over, which accrues at the rate o 60por each pound above the equivalent o the ull basicStatePension up to a maximum o £17.88 or a single person(£23.58 or a couple).

Stakeholder pension A personalpension product which complies withregulations which limit charges and allow individuals lexibilityabout contributions.

Stakeholder price cap A 1.5 per cent annualmanagementcharge(AMC) or theirst ten years o the policy, and thereater a 1 per cent AMC.

State Earnings-RelatedPension Scheme (SERPS)

The orerunner o the StateSecondPension , which providesan earnings-related NationalInsurance pension basedon contributions.

State Pension age The age at which an individual can claim their State Pension.It is currently 65 or men and 60 or women. The StatePension age or women will gradually increase to 65 between2010 and 2020.

State Second Pension The earnings-related NationalInsurance pension paid on topo basicStatePension – gives a more generous pension thanwould have been provided by SERPS or: low and moderate

earners; carers who are looking ater young children or adisabled person; and long-term disabled people with brokenwork records.

Tax relie Individuals making contributions to tax-approved pensionschemes receive tax relie at their marginal tax rate (orexample, a standard-rate taxpayer will receive tax relie at 22per cent). Individuals contributing to stakeholderpensions receive tax relie at a minimal rate o 22 per cent. Individualswith very low or no tax liabilities can also receive ‘tax relie’at 22 per cent on contributions o up to £2,808 per year.

Employers’ contributions are made rom gross proits and thusare both tax- and NationalInsurance-privileged.




Upper Earnings Limit (UEL) The upper limit on earnings or the purposes o calculating

entitlement to the StateSecondPension . Also the upperlimit or most employee NationalInsurance contributions. In2006/07 it is £33,540 per year or £645 per week.

Upper Earnings Threshold(UET)

An intermediate point prior to the UpperEarningsLimit ,which aects the accrual o the StateSecondPension .

Withdrawal rate The rate at which a means-testedbeneit is reduced or anadditional pound o pre-beneit income.

Working-age population Generally deined today as those aged 16–59 or women and16–64 or men.


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