How David Cameron plans to mess with your pension
Last week's coalition document revealed a raft of new proposals on pensions. Find out how these rules will affect you.
There’s no question the UK pensions system needs to be thoroughly revamped. Obvious problems have been left festering for too many years. But will the new coalition government make any positive changes?
Last week, the coalition document set out the agreements reached by the Conservatives and the Liberal Democrats following negotiations on several key issues including the pensions regime. Here’s a rundown of five new key rules, and what the changes could mean for you:
Basic state pension
The coalition has pledged to restore the link between the basic state pension and earnings, which was broken by the Thatcher government 30 years ago. From April 2011, the state pension will enjoy a ‘triple guarantee’ which means it will rise each year by the higher of earnings, prices (inflation) or 2.5%.
Right now increases in the basic state pension are linked only to the rise in inflation or 2.5% if the inflation figure is lower. But pensioners were left disappointed last month with an uplift of 2.5% - or just 34p a day, with the state pension rising from £95.25 a week to £97.65 for a single person.
State pension benefits are recalculated every April using the retail prices index (RPI) figures for the previous September. But, in September 2009, the RPI was negative at -1.4% triggering a minute increase this year.
Overall, restoring the link to average earnings is good news for pensioners, since earnings normally rise faster than inflation. This could help the state pension to rise more quickly over time. That said, many pensioners find their personal rate of inflation is far higher than any of these measures, meaning the more generous state pension will still fail to keep pace with actual increases in the cost of living.
The coalition has agreed state pension age will increase from 65 to 66, although the new rule won’t come into effect before 2016 for men and 2020 for women. This is earlier than Labour’s schedule to bring retirement age for women in line with men at 65 by 2020.
Under Labour the state pension would have increased for men and women from:
- 65 to 66 between 2024 and 2026
- 66 to 67 between 2034 and 2036
- 67 to 68 between 2044 and 2046.
Increasing state pension age is inevitable no matter which party came into power, but under the coalition the changes will take place sooner. This means the earliest age at which anyone can claim the basic state pension can be claimed will be increased, and many people will have to work longer before retiring. Further increases in state pension age are now likely to happen more quickly than they would have done under existing legislation.
That said, since average life expectancy is rising, the total number of years the basic state pension is paid for is expected to increase, despite normal state pension age being deferred. But this is of little benefit to those who don’t survive to normal life expectancy.
Forced retirement scrapped
Under existing rules, employers can force workers into retirement at 65. However, the coalition has agreed the default retirement age should be scrapped. This change has become necessary given that state pension age will be extended beyond 65 in years to come as we have just seen.
This is good news for employees giving them the right to choose when they want to retire. Although, there’s a risk this could disincentivise workers to save for retirement if they anticipate remaining in employment longer.
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Compulsory annuities scrapped
Right now anyone with a ‘defined contribution’ pension (including ordinary personal pensions) is obliged to convert it into an income using an annuity by the age of 75. Under current rules, this can only be avoided by using a more risky Alternatively Secured Pension where income is drawn down from a fund which remains invested. (Note this rule isn’t relevant to people with final salary or ‘defined benefit’ schemes.) The coalition has promised to axe compulsory annuity purchase at 75, although those who wish to buy an annuity will still be able to do so from 55.
This particular pension rule has been extremely unpopular with pension savers. Buying an annuity means pensioners sacrifice their pension pot to an annuity company, and, in return, recieve a guaranteed level of income for the rest of their lives. But annuity income only lasts until death. If that occurs shortly after buying the annuity, the company will keep the lion’s share of the pension, leaving nothing to pass on to the annuitant's family.
What's more, annuity rates have dropped steadily since the nineties, giving ever lower levels of income in retirement. But, by removing the obligation to buy an annuity at 75, pensioners will be given more flexibility. They may be able to draw an income directly from the pension fund instead without the need to buy an annuity and get locked into low rates.
Scrapping compulsory annuitisation is a long-awaited and welcome move, but it’s not without drawbacks. The government fears pensioners could, by having greater control of their pension, deplete their savings too early leaving them reliant on the state for help in the future.
Public sector pensions
The death knell is sounding for public and private final salary pensions alike, which is unfortunate for any scheme member.
The two parties have agreed to establish an independent commission to review the affordability of costly public sector pension over the long-term, while protecting benefits which have already accrued. The Conservatives have also said they want to put a cap on public sector pensions above £50,000.
There's no doubt public sector workers will be hit by pension cutbacks which will most likely mean working longer in order to achieve the same benefits. Lower accrual rates and later retirement could feature as part of the new public sector pension framework. This will clearly affect younger workers more keenly who have yet to build up much of an entitlement.
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