The Government has ruled out changes to the basic state retirement pension – except for people who want to work past pension age. It is remarkable that a pension system introduced at the end of World War II is continuing without significant change into the 21^st century. Many of the people who devised it were born when Queen Victoria was on the throne. In another decade, people who claim it will have been born in the reign of Queen Elizabeth.

There are two big problems with the state pension. First it is too little to live on. After a full working life paying National Insurance contributions you get just £79.60 a week. That is only around 16 per cent of average pay of £476 a week and less than half the £180 a week earned by someone on the National Minimum Wage. For a lifetime’s work it is seen by many pensioners as an insult.

Second, not everyone gets even this amount. More than one in three pensioners gets a reduced pension because they have not paid enough National Insurance contributions. Most of them, around 3,250,000, are women. The other 350,000 are men. Reduced pensions can be as low as £19.90 a week. Some get nothing at all.

To get a full pension you need to have worked and paid full National Insurance contributions for around nine tenths of your working life. For a woman that means working for 39 years. But many women who bring up families work for less time than that. And even when they did work they were encouraged to pay the reduced married woman's National Insurance contribution which was – and is – a complete waste of money. It gives no entitlement to the state retirement pension or any other benefits.

Since 1978 women at home looking after children or caring for disabled people have been able to qualify for a full pension with fewer years contributions. But many of the women retired today had already done the bulk of their child rearing and were already back at work by 1978.

Means-test army
As one army of civil servants spends its time doing the complex calculations to take some state pension away from more than three and a half million pensioners, another army does even more arcane arithmetic to dole out means tested benefits to retired people who have too little to live on.

Because the state pension is so little, a complex system of extra benefits has developed to help older people manage. The latest is the pension credit which about half of all people over 60 can claim. But there is strong resistance. Figures from the Department for Work and Pensions in February showed that nearly six months after the new benefit started, fewer than half those entitled were getting it. New claims were coming in at only 80,000 a month.

No wonder the House of Lords Economic Affairs Committee recently recommended the whole archaic system should be swept away and everyone paid a decent pension at 65. The committee concluded

"We therefore recommend that as a top priority the Government should consider introducing a non-means-tested state pension paid on the basis of citizenship to all persons of pension age."

It explained why.

"Virtually all citizens make positive contributions to the economy and society through their paid and unpaid work in the period between the end of their formal education and their retirement….Thus there seems little reason to operate a complex accounting system to track NI contributions and credits over each person’s working life in order for them to qualify for a full or partial basic state pension which, in any case, will be supplemented in retirement by means-tested benefits for between a half and three-quarters of all retirees."

The Government has not yet responded to the Committee’s proposals. But it has consistently rejected similar suggestions. In a paper setting out its plans for pension published in December 2002 it stated bluntly "Some argue that the state structure should be reformed…in favour of a single payment to all pensioners. The Government could not provide such a pension system without substantially reducing the support for poorer pensioners or greatly increasing state spending."

But that need not mean extra taxes – at least in the short term. The Government Actuary has just published his latest report on the National Insurance Fund. This year he estimates its surplus will grow by more than £2 billion to reach a shade under £30 billion and he says "the general trend is upwards". The Fund needs a surplus of only £10 billion to cope with contingencies. The remaining £20 billion is enough to give every pensioner in the UK a one off payment of nearly £2000.

Despite the Government’s reluctance to make major changes in the Basic State Pension, there is a better deal on the horizon for anyone approaching pension age but feeling young enough to carry on working.

From April 2005 the Government will keep your pension, pay you interest of at least 6 per cent on it and give you the whole lot as a lump-sum when you finally do retire. It could mean a lump sum on retirement of up to £30,000. And for some people that would be tax-free.

There has always been a scheme to give people an enhanced pension if they put off drawing their retirement pension once they reach pension age. At the moment you can put it off for up to five years. For each year you defer claiming your pension, it will be enhanced by almost 7½ per cent when you finally do retire. So if you defer for the maximum five years the full pension of £79.60 would be raised to about £109 a week.

But next year that scheme will be improved. If you defer drawing your pension from April 2005 you be able to choose a bigger increase in your pension of more than 10 per cent for each year you delay. Or you can have a lump-sum which will be equal to the pension you have not claimed plus at least 6 per cent a year growth on that money.

For someone on the basic state pension, which is now £79.60 a week, who defers drawing their pension for two years that would mean a choice between an increase in their pension of £16.56 a week making £96.16 altogether or a lump sum of £8785. After deferring for five years the choice would be a pension increased by £41.39 to £120.99 a week or the regular pension plus a lump sum of £24,039. In future there will be no limit on how long you can defer claiming your state pension. So if you could bear ten more years at work, your pension would be doubled to around £162 a week. Or you could have a lump sum of £56,210.

The lump sum calculations are based on your pension money growing by 6 per cent a year. The Government has said the rate of growth used to calculate the lump sum will be at least 2 per cent on top of the base rate set by the Bank of England, which is currently 4 per cent. When the scheme begins next April it could be higher.

Although the lump sum seems attractive, in the long-term it is probably better to take the enhanced pension – which will be paid for life and increased each year with inflation. In a note to Parliament the DWP says "Increments are in actuarial terms more costly than lump sum payments" and it estimates that the changes will eventually save money as more people take the lump sum option.

One problem with getting extra income – or a lump sum – is the effect it might have on means-tested benefits such as pension credit or help with your council tax or rent. The Government has said that the lump-sum will "be ignored when most people claim those benefits" but it is not clear exactly how that will work. The lump sum will be taxable – but it will only be taxed if you already pay tax in the year you get it. So if your income is less than around £6800 you should pay no tax and the lump sum will also be tax free. If your income is less than around £8800 it will be taxed at only 10 per cent.

Pensions and other benefits rise from Monday 12 April. This is 53 weeks after the last increase as the Leap Year has pushed the first Monday in the tax year on by a week. The rise is in line with the retail prices index which rose 2.8 per cent in September 2003. Pension credit rises in line with average earnings, 3.3 per cent in the third quarter of 2003.

                                                                                                2003                2004

State pension                                                                            per week          per week

on your own contributions                                             £77.45             £79.60

on your husband’s contributions                                    £46.35             £47.65

Pension credit                                                                           per week          per week

guarantee credit - single                                                £102.10           £105.45

guarantee credit – couple                                              £155.80           £160.95          

savings credit maximum – single                                    £14.79             £15.51

            savings credit maximum – couple                                   £19.20             £20.22

            max income to get any savings credit single                    £139.08           £114.23

            max income to get any savings credit couple                  £203.80           £211.50

April 2004

e-mail Paul Lewis on paul@paullewis.co.uk