Background – State Second Pension and Occupational and Personal Pensions
The measures in the Act
State Second Pension
344.The State Second Pension will reform SERPS by boosting the Additional (second tier) Pension of low and moderate earners, and by providing Additional Pension for the first time for carers and some long-term disabled people with broken work records.
345.State Second Pension will be calculated by reference to the surplus in an individual’s earnings factor. An individual’s earnings factor corresponds to the whole of his earnings up to the Upper Earnings Limit and the surplus to the amount of those earnings between the Lower Earnings Limit and the Upper Earnings Limit.
346.The State Second Pension regime will provide for a new Low Earnings Threshold, which will be uprated in line with increases in national average earnings. In 1999/00 terms this Low Earnings Threshold will be £9,500. Anyone earning less than £9,500 but at or above the annual Lower Earnings Limit (£3,432 in 1999/00) will be treated for State Second Pension purposes as if they had an earnings factor of £9,500.
347.Carers, who have no earnings or earnings below the annual LEL, will be treated for State Second Pension purposes as if they had earnings of £9,500 for any year throughout which:
they receive Child Benefit* for a child under 6;
they are entitled to Invalid Care Allowance*; or
they are given Home Responsibilities Protection* because they are caring for a sick or disabled person.
348.Those entitled to long-term Incapacity Benefit* or Severe Disablement Allowance* throughout a tax year will also be treated for State Second Pension purposes as if they had an earnings factor of £9,500 in that year, provided they meet a simple labour market attachment condition when they reach state pension age. This condition requires that they have worked and paid (or are treated as having paid) Class 1 National Insurance contributions for at least one tenth of their working life since 1978, when Additional Pension was introduced.
349.There will be two stages to the State Second Pension. The first will be earnings-related for those earning above the Low Earnings Threshold. On the surplus in an earnings factor (actual or treated) of £9,500 (that is £9,500 less the prevailing annual Lower Earnings Limit), everyone will earn at least twice as much entitlement to Additional Pension as they did under SERPS. Where there is a surplus in the earnings factor corresponding to the amount of a person’s earnings above £9,500 but not exceeding £21,600, the accrual rate on that surplus will be half what it would have been under SERPS. This will have the effect of recouping some of the increased accrual that everyone will receive on the surplus in the earnings factor of £9,500. However, all employees earning between the annual Lower Earnings Limit and £21,600 will receive more than they would have done under SERPS, with the largest proportionate gains going to those with the lowest earnings. Those earning £21,600 and above will receive the same as under SERPS.
350.In the second stage, to be introduced when stakeholder pension schemes have become established, State Second Pension will become a flat-rate scheme for those with a significant part of their working life ahead of them (for example, those aged under 45 at the point of change). In the second stage of State Second Pension, everyone who is contracted-in to the state scheme will be treated as if they had earnings of £9,500 (or corresponding to the prevailing Low Earnings Threshold at that time), regardless of the level of their actual earnings. Qualifying carers and long-term disabled people with broken work records will continue to be treated as if they had such an earnings factor. State Second Pension will be calculated for everyone by reference to the surplus in an earnings factor of £9,500. National Insurance rebates to those in contracted-out pension schemes will remain earnings-related.
Contracting-out arrangements
351.The Government views the contracting-out regime as central to the success of private pension provision and is keen to ensure that any changes made to the arrangements for contracting-out reflect the introduction of the State Second Pension, supporting and encouraging private pension provision.
352.When individuals contract-out they do so on the basis that their pension arrangements will give them, broadly speaking, what they would have received from the state had they not contracted-out. As there is a reduced liability on the state, individuals and employers running occupational schemes receive a contracted-out rebate, which is calculated by reference to the value of the state benefit given up. The Government Actuary conducts a review every 5 years to determine the appropriate level of the rebate. The next review, due to take place later this year, will consider the level of rebates with effect from 2002.
353.As the State Second Pension is designed to boost the pension of low and moderate earners, the Government intends to change the contracting-out arrangements to ensure that members of contracted-out pension schemes are not better off contracting back in. Proposals on how the future contracting-out regime could be structured were the subject of a consultation exercise which ended on 14 January 2000. After giving careful consideration to all the responses, the Government has decided to introduce measures which provide for:
all rebates for contracting-out into a personal pension, including a personal pension based stakeholder pension, to be calculated to reflect the enhanced 3 part accrual rate in the State Second Pension;
rebates to continue to be calculated as they are now for all occupational pension schemes, which will not be required to change their benefits;
people in all contracted-out pension arrangements on low earnings (up to £9,500) to get a top-up from the State Second Pension; and
the top-up to be extended to people on moderate earnings (up to £21,600) in contracted-out occupational pension schemes.
354.The combination of these measures will ensure that low and moderate earners in contracted-out provision will also benefit from the extra help that the State Second Pension will give. This will simplify the choice of alternative pension vehicles available to them, without their having to contract back in to the state scheme to access that help.
355.These proposals will also apply when State Second Pension becomes a flat-rate scheme for those who are contracted-in to the State scheme. Rebates and any state scheme top-up will continue to be earnings-related. This will prevent disruption to schemes at that stage, as well as providing an incentive for moderate earners to contract-out of the state scheme into a funded arrangement and ensuring that they will continue to be better off under State Second Pension.
Contracted-out Personal Pension Schemes
356.The rebate for contracted-out personal pension schemes will be based on the different accruals within the State Second Pension. For example, as the accrual rate for those earning at or above the annual Lower Earnings Limit but below £9,500 will double in relation to SERPS, so will the rebate. Low earners will therefore get a rebate based on a 40% rather than a 20% accrual which will be paid directly into their pension fund. For moderate earners it will be based on 40% on the first band of earnings, up to £9,500, and 10% on the second band, up to £21,600.
357.However, unlike State Second Pension, which will treat those earning at or above the annual Lower Earnings Limit but below £9,500 as if they were earning that amount, the rebate for low earners will remain based on actual earnings. To ensure that they still get the extra help from the low earner’s boost, they will get a State Second Pension “top-up”. In broad terms, the top-up will operate by calculating the State Second Pension an individual would have received had he not contracted-out (which of course includes the low earner’s boost) and taking away an amount which represents the pension derived from the rebate.
358.This means that someone earning £8,000 would receive benefits from their pension scheme based on their actual earnings of £8,000 and a State scheme top-up based on £1,500 (the difference between actual earnings and £9,500). The rebate would be based on 40% of actual earnings between the Lower Earnings Limit and £8,000, and the top-up would be based on applying the 40% accrual to the £1,500.
Contracted-out Occupational Schemes
359.The system will operate slightly differently for occupational schemes in order to cater for the Pensions Industry’s desire to avoid disruption to employers. Occupational schemes will therefore continue to have their reduced rate of National Insurance contributions calculated on the same basis as now – that is, a uniform accrual rate of 20%.
360.In order to ensure that individuals in these schemes receive the extra help intended for low and moderate earners, an extended State Second Pension “top-up” will apply. It will work on the basis of calculating the State Second Pension that an individual would have received if he had not contracted-out, less a deduction equating to a pension derived from the rebate input (ie 20% of actual earnings).
361.This means that for people in occupational schemes, all the extra help is delivered by way of the State scheme, rather then partly through their scheme via the rebate, and partly through the state, as is proposed for personal pension schemes.
Reporting on the effect on the NI Fund of earnings uprating.
362.This Act requires the Secretary of State to lay before Parliament a Government Actuary report which will estimate the effect on the balance in the National Insurance Fund, and the rate of National Insurance contributions needed to keep the Fund in balance, if the basic state pension were to be increased in line with earnings. The report will project figures for each year up to and including 2005/06.
Protection of “inherited SERPS”
363.As a result of changes originally enacted in the 1986 Social Security Act, the amount of additional pension a surviving spouse could expect to inherit was due to be halved in respect of a married person who died after 5 April 2000. The Welfare Reform and Pensions Act 1999 included provision to make regulations that would provide for, among other things, the deferral of the start of the new rule to a later year, and the setting up of a scheme to determine who may suffer future financial loss as the result of incorrect information about the impending change.
364.This Act provides for the new rules to apply from October 2002 (but also provides that this date may be further postponed by regulations) and clarifies the eligibility criteria for the Inherited SERPS scheme.
Improving pensions information
365.The Act also contains a measure to improve overall pension information for individuals so that they have a clear indication of what sort of retirement income to expect and can therefore make better-informed decisions on what savings they need to make. This will:
permit state pension information to be passed to employers and pension providers so that they can issue pension statements giving details of both state and private pension rights unless individuals have indicated that they do not want the information. Because employers and pension providers will not need to gain the express consent of individuals the measure will improve the take-up of combined pension statements by employees and reduce administrative burdens; and
provide that state pension details can be passed to other third parties such as organisations which provide financial information services so that individuals who give consent can access their state pension details through these services.
Improving the framework for occupational and personal pensions
366.Besides the reform of the National Insurance rebate, there are four main parts to the reform of occupational pensions in the Act:
increased member involvement in schemes by requiring that all schemes must have one-third Member-Nominated Trustees (MNTs) by a process laid out in regulations or under procedures devised by the employer and approved by scheme members. The purpose is to increase confidence in the schemes, thereby encouraging more employees to join;
further protection of members’ pension rights by:
allowing the Occupational Pensions Regulatory Authority* (Opra) to make their register of disqualified trustees more accessible to the public; and
giving powers to Opra to monitor schemes which are in the process of winding up to ensure that winding up is undertaken as quickly as possible;
changes to the existing regulation-making powers to enable future regulations to require money purchase schemes to provide members with an illustration of the likely future value of their pension, thereby improving members’ appreciation of the value of their pension rights; and
measures to provide further clarification, simplification and flexibility for those operating schemes. These will:
increase the options for discharging contracted-out pension rights;
increase the options available to scheme members when they transfer their pension rights; and
allow a greater range of persons to make representations to the Pensions Ombudsman.
