The policy agreement published by the Conservatives and Liberal Democrats contains a number of pension reforms that older workers should be aware of.
Towers Watson says the commitment to review the State Pension Age is more significant than bringing forward the earnings link for the Basic State Pension by another year, that higher rate tax relief appears safe at least for now, and that the review of public sector pensions should focus on what is the most cost-effective way of rewarding public sector employees.
State Pensions – early earnings link
The agreement says: “We will restore the earnings link for the basic state pension from April 2011 with a ‘triple guarantee’ that pensions are raised by the higher of earnings, prices or 2.5%, as proposed by the Liberal Democrats.”
John Ball, head of defined benefit pensions consulting at Towers Watson, said: “During the election campaign, the Conservatives committed to restoring the earnings link in 2012. With price inflation high and earnings growth subdued, doing it a year earlier is likely to have little or no extra cost. It was ruling out the option to delay the earnings link until 2015 which removed the little fiscal leeway the new Government had. It is also hard to believe that a future government would actually have increased pensions by less than inflation in the rare circumstances when the legislation allowed it to, so the ‘triple lock’ reflects what would probably have happened in practice anyway.”
State Pension Age
The agreement says: “The parties agree to…hold a review to set the date at which the state pension age starts to rise to 66, although it will not be sooner than 2016 for men and 2020 for women.”
John Ball said: “The Conservatives always said this was the tough choice which made their promise to restore the earnings link credible.
“Before hostilities were called off, the Liberal Democrats called this an ‘attack on the state pension’ which would turn retirement planning ‘upside down’. However, this is an area where politicians are used to performing U-turns even when they don’t have to compromise with each other: all three parties supported a higher State Pension Age in the last Parliament without saying they would do so before the election!
“Since the State Pension system was last reviewed, the public finances have deteriorated and life expectancy has improved, so something has to give. If it’s not going to be the value of State Pensions, it will have to be the age when people start receiving them. As important as when the State Pension Age rises to 66 is when it rises to 67 and beyond, so we’d expect the review to cover that as well.”
Tax relief – safe for now?
The Liberal Democrat manifesto proposed restricting tax relief on pension contributions to the basic rate to help pay for a higher personal allowance. In practice, this would have meant levying a 20% tax charge on the money that higher rate taxpayers or their employers pay into pensions. The agreement lists other measures which will be used to pay for a higher personal allowance, but not this.
John Ball said: “Higher rate taxpayers can breathe a sigh of relief. Having spent 13 years attacking Gordon Brown for taxing pensions in his first Budget, it would have been very hard for George Osborne to do the same thing in his. There were also lots of details which the Liberal Democrats had not filled in – such as whether employer pension contributions would count as income for the purposes of determining whether someone earned enough to pay the tax and how the tax charge on final salary benefits would be calculated. This looked like a policy for opposition rather than for government and the Liberal Democrats may be secretly relieved that they don’t have to implement it.
“There is no mention of the restriction of tax relief for people with incomes above Ã‚Â£130,000. As both parties voted for that legislation, this looks set to go ahead. The question now is whether more people will get sucked into the net each year if the thresholds are not indexed properly.
“Both coalition partners have talked about relaxing the requirement to buy an annuity and both having floated the idea that people should be allowed to access pension savings before retirement. This could lead to the justification for tax-privileged pension savings being queried in future.”
Public sector pensions – a review
The agreement says: “The parties commit to establishing an independent commission to review the long-term affordability of public sector pensions, while protecting accrued rights.”
John Ball said: “No one has seriously suggested cutting the pensions promised in return for work already carried out – that would be akin to defaulting on a debt. The question is whether future promises should be as generous as those made in the past and whether we should continue to offer people in their 30s and 40s pensions that can be taken in full from the age of 60.
“The last Government got into the bizarre situation of providing its employees with very generous pensions while constantly downplaying how much they’re worth, which cannot give the taxpayer value for money. The test should be whether pensions are a cost-effective way of rewarding people, not whether they allow that cost to be passed to future generations of taxpayers. When Labour’s cost-sharing agreements kick in, we should get an idea of whether employees really value the current level of pension provision more than they value money in their pockets.”
Default retirement age
The document says: “The parties agree to phase out the default retirement age…”
John Ball said: “Committing to this now is a small concession to the Liberal Democrats. During the campaign, George Osborne said his instinct was to do this but that he would need to consult with business first. With the post-war baby boomers approaching 65, pressure for this change was only going to grow. However, there will be some practical difficulties for companies if they offer benefits like life insurance and health insurance which providers may not supply for all employees regardless of age.”
The parties say: “We agree to end the rules requiring compulsory annuitisation at 75.”
John Ball said: “This is no surprise as both parties have had this policy for a decade or so. Although most people who are responsible enough to have saved in the first place will be careful in retirement, the parties are alive to the danger of ‘double-dipping’ – spending your pension savings and then falling back on the means-tested benefits. Drawing up rules to prevent this proved too tricky for the parties in opposition and it won’t be straightforward in government.”