New Bill seeks to ensure it pays to save for retirement

It is hoped that the savings credit, a new means-tested state retirement benefit, will mitigate the worst of the disincentive effects that are caused by the current means-tested minimum income guarantee. We look at how this benefit will work.

In the UK there is broad agreement that everyone needs to be assured of a minimum level of retirement income, irrespective of their circumstances. However, a perverse consequence of such provision is that there may be little, and in some cases no, financial incentive for those with modest means to save for their retirement. It is that disincentive effect that the measures contained in the State Pension Credit Bill¹ seek to mitigate.

Few people question the need to reform the present interaction of the state's means-tested retirement benefit, the minimum income guarantee (MIG), with the compulsory and contributory state retirement pension, with voluntary provision made through occupational or personal pensions, and with other forms of private saving. Example 1 demonstrates the disincentive effects of the current system on those with modest incomes.

Not the only solution

The government's proposal is not the only solution to the problem. If the combined effects of compulsory provision (either all from the state or from state and private provision combined) were that the income of a pensioner always exceeded the MIG threshold, the disincentive effect would be removed.

It is argued that the solution should be achieved more quickly both for those about to retire and for those already retired by raising the full basic state pension so that it exceeds the MIG threshold. To have done so in April 2002 would have meant not a 4.1% increase for the basic state pension but rather a 35.4% increase for all single pensioners and a 29.2% increase for all pensioner couples where the wife's entitlement derives from her husband's national insurance record. The government has made it clear that such a policy is not being contemplated, even in a series of annual steps. An additional problem is that very many people are not entitled to a full basic state pension. Means-testing will, therefore, have to remain an integral part of state retirement provision for some time to come.

It is hoped that future income from the new state second pension (S2P), beginning on 6 April, coupled with income from the basic state pension, will accelerate the move to a situation where the newly retired will invariably have a combined state pension entitlement in excess of the MIG threshold.

How the pension credit will work

The proposals in the State Pension Credit Bill are close to the original proposals set out in the consultation paper (OP, January 2001). The original timetable for the introduction of the pension credit is still in place with the target being April 2003.

It should be noted that, like the MIG, the pension credit can be claimed by a single person or by only one member of a couple. The pension credit remains a means-tested benefit and, in the case of a couple, entitlement will depend on an assessment of their joint income and savings.

There are two components to the pension credit: the "guarantee credit" and the "savings credit". An analysis of these two components follows.

The guarantee credit

The guarantee credit plays the same role as the current MIG (which it will directly replace) by bringing the claimant's income up to a guaranteed level. For illustrative purposes, the guaranteed level in April 2003 may be £100 pw for a single person and £154 pw for a couple. These levels will be known as the "standard minimum guarantee".

Like the MIG, the guarantee credit will also take into account the additional premiums above the standard minimum guarantee payable in special cases, for example to carers and severely disabled people. In the case of any particular claimant, therefore, there will be an "appropriate minimum guarantee", which may be the same as, or higher than, the standard minimum guarantee.

The guarantee credit will be payable to both men and women on an equal basis from the date when the claimant, whether a man or a woman, reaches what is at that time the state pension age for women. In 2003, therefore, it may be claimed when the claimant has reached age 60. During the period 2010 to 2020 the state pension age for women will rise so that it will be 65 for all men and women born after 5 April 1955. The minimum age for payment of the guarantee credit will therefore also rise for men and women. There will also be a condition that the claimant is a UK resident.

The income used to calculate the amount of guarantee credit payable to a claimant with savings will be assessed differently from the current method used for the MIG. Currently a "tariff" income is assumed at the rate of £1 pw for each £250 (or part of £250) of savings over £6,000, equating to a "deemed" interest rate of 20.9% pa on £250.

From April 2003 it is proposed that a 10% rate of return will be applied to any capital in excess of £6,000 held by the claimant (above £10,000 in the case of a claimant resident in a residential or nursing home). Capital of less than either threshold will not be taken into account in the assessment.

From the same date, a change will also be made that will reward those who have managed to build up a higher level of savings. Currently, no MIG is payable to those with savings of £12,000 or more. This ceiling will be abolished when the pension credit is introduced.

The savings credit

The savings credit component of the pension credit is a new kind of state benefit, and this component aims to reward modest levels of saving.

For the savings credit to be payable, the claimant must meet a number of conditions. Unlike what will initially be the case for the guarantee credit, the savings credit will be payable only when the claimant, or the claimant's spouse, has reached age 65. Also the claimant must have "qualifying income" that is more than the amount set by the "savings credit threshold".

"Qualifying income" will be defined in Regulations. It is sure to include those parts of claimants' incomes that are derived from contributions or credits in his or her national insurance record (so taking in the basic state pension and additional pension from either SERPS or S2P, and possibly also graduated retirement pension). Qualifying income will also include income derived from private retirement provision, in particular from occupational and personal pension schemes as well as from capital. However, it seems that income in the form of earnings will not be taken as qualifying income.

The "savings credit threshold" will also be defined by Regulations. It will be equal, in the case of a single claimant, to the full rate of the basic state pension (taken as being £77 pw in 2003/04 for illustrative purposes only) and, in the case of a couple, equal to the aggregate amount of the full rate of the basic state pension and the rate payable to a married woman when based on the national insurance record of her husband (taken as being £123 pw).

Calculating the savings credit

In all cases the savings credit will be subject to a maximum entitlement known officially, and logically enough, as the "maximum savings credit". It will be 60% of the amount by which the standard minimum guarantee exceeds the savings credit threshold.

Given the illustrative figures cited above, the maximum savings credit would be £13.80 pw in the case of a single claimant: 60% of (£100 less £77). It would be £18.60 pw in the case of a couple: 60% of (£154 less £123). The maximum will therefore be the same for all single claimants and the same for all couples.

If the claimant has income above the savings credit threshold but below his or her appropriate minimum guarantee, the amount of the savings credit will be 60% of the amount by which qualifying income exceeds the savings credit threshold, subject to the maximum set by the maximum savings credit.

If claimants' total income is above their appropriate minimum guarantee, the amount of savings credit payable will be the maximum savings credit less 40% of the amount by which their total income exceeds their appropriate minimum guarantee. If this is less than zero, no savings credit is payable.

Example 2 shows how the pension credit will work in relation to the individual considered in Example 1.

Five-year assessments

As part of an effort to ensure high take-up of the pension credit, claimants will not continuously have to report all changes in income as is currently the case for those in receipt of income support under the MIG. Under the new system, once a claimant (or the claimant's partner) has reached age 65, when entitlement to the savings credit component can begin, the assessment process will switch and normally become based on a five-year "assessed income period". The claimant will be under no obligation to report changes in income from "retirement provision" during the assessed income period. Here, retirement provision will mean any income from a private pension or from an annuity or income from capital, but not state retirement pension.

During the assessed income period, the claimant's retirement provision will be treated as remaining the same, subject to routine automatic adjustment for inflation. Regulations will provide for the amount of retirement provision to be deemed to increase from time to time in line with the terms of a claimant's pension or annuity arrangements. The amounts a claimant is deemed to receive and the amounts actually received may differ. If this works in the claimants' favour, the actual amounts need not be reported and will not result in an overpayment of pension credit. Similarly, the claimant need not report any further elements of retirement provision acquired later in an assessed income period. It can simply be disregarded. However, the government's stated intention is to introduce Regulations that will treat claimants as having notional income if they have decided to defer taking an annuity. In practice this may be difficult for the government to formulate.

A claimant can, however, initiate a new assessed income period at any time and if this results in a higher entitlement to pension credit, that higher rate will be brought in immediately.

In most cases, the only types of changes that will have to be reported are those that already apply to people claiming the state retirement pension. They include significant life events such as marriage, divorce, separation or the death of the claimant's spouse or partner.

At the end of the assessed income period, entitlement to the pension credit will be reassessed and where appropriate a new assessed income period will be set, again normally for five years.

Encouraging take-up

The major problem that has dogged the MIG, as a means-tested benefit, has been its relatively poor take-up among the target population. It is hoped that the five-year assessed income period will play an important role in lessening the deterrent effect represented by constant monitoring of one's financial affairs. We have also drawn attention (when we reported the Bill's publication, in Will the pension credit encourage saving for retirement? ) to changes being made to other means-tested benefits to avoid receipt of the savings credit leading to certain claimants being little or no better off.

However, attention is turning to the future role of the government's Pension Service, which will replace those parts of the Benefits Agency dealing with pensioners' affairs. The aim is to move progressively to a system whereby state pensioners will receive all their state entitlements together.

The Pension Service will be expected to calculate the pension credit of new pensioners at the same time as it arranges payment of their state retirement pension. The Department for Work and Pensions (DWP) emphasises that it wishes to build up the current telephone claims service so that claimants can provide details over the telephone to enable the Pension Service to calculate their pension credit entitlement as well as putting their basic state pension entitlement into payment.

Inevitably, however, there will be a two-stage process for women, who until 2010 will qualify for their state retirement pension and any guarantee credit at 60 but must wait until 65 before being able to receive any savings credit entitlement. However, since the normal pension age for many occupational pension schemes is 65, there may often be a need for revision of a claimant's retirement provision between 60 and 65 in any case.

Four components

After 2003, the state pension system will comprise four separate components, each of which can be payable independently of the others. These will be: