What is the state pension for?

David Kingman argues that the UK needs to radically rethink the role of its state pension, for the good of both young and oldretirement dictionary

The state pension is widely regarded as a central pillar of the British welfare state. The idea that the government should provide some kind of basic safety-net to protect all its citizens from falling into poverty because of old age seems to be firmly ingrained in the British cultural mindset.

Although it has been reformed many times since it was first introduced in 1908 – including the substantial recent changes that have been implemented by the Coalition Government, such as the switch to the flat-rate state pension of £140 per week – any serious discussion of overhauling the design of the state pension (or questioning of its purpose) seems to be absent from British political debate.

On one level, this can be seen as a sign of social progress; proof that Britain is fundamentally committed to protecting people from poverty in old age. Yet it can also be viewed as a sign of failure – not least because the noble aim of protecting all our citizens from poverty in old age hasn’t been achieved, and the design of the universal state pension is arguably partly to blame for this.

“Minimum wage” Pensions

A new set of figures released by the insurance company Prudential on 22 May pointed to the stark financial challenges which face many of this year’s retirees. They revealed that 1 in 7 of the people who are planning to retire this year have no retirement savings and will be relying entirely upon the state pension to fund their “Golden Years”. Almost a fifth will have an income of less than £8,254, the figure which research by the Joseph Rowntree Foundation has calculated is the minimum income standard a single pensioner needs to meet in order to be able to live comfortably.

For today’s retirees who have full national insurance records, the full basic state pension will only provide an annual income of £5,720 (although they can still access the various means-tested top-ups which are being absorbed into the flat-rate state pension when that arrives in 2016). This is less than half the amount someone over the age of 21 would currently earn if they had a full-time job which paid the minimum wage of £6.19 per hour.

This is the crux of the problem with the state pension – it is infamously stingy. This can be seen particularly in comparison with other developed countries. In 2007 the UK government published a comparison of the state pension schemes in Britain and other developed countries,* which compared them on their “replacement rate” (the percentage of average earnings which the state pension will replace in retirement for the typical person). The UK came 4th from bottom out of 30 countries, with an average replacement rate of just 41%.

A universal problem?

One way of analysing the state pension is to say that it doesn’t give enough people an adequate income in retirement because its resources are spread too thinly.

The state pension is popular partly because it is a universal benefit which goes to everyone, regardless of means; yet this appears to have resulted in a situation where it fails to provide the poorest retirees with an adequate income in retirement, while at the same time it provides an expensive handout to large numbers of wealthier pensioners who could easily survive without it.

If the state pension was means-tested in some way, as it is in Australia, then this would allow poorer pensioners to receive more, creating a stronger old-age safety-net, while also limiting the amount which is needlessly given to wealthier pensioners who are capable of funding their retirements through other means (such as private pension schemes or by turning asset wealth into income).

Strikingly, a survey of 50 of the UK’s leading economists conducted by IF found last year found that almost half of them thought that the British state pension would need to be means-tested by 2040.

Ultimately, this comes back to the question in the title of this article: “What is the state pension for?” It seems Britain can afford to have a state pension which gives a little bit to everyone, or one which provides enough to adequately protect poorer pensioners, but not both.

Of course, from a political point of view changing state pension entitlements would be what is often referred to in America as a “third rail” issue: something which electrocutes anyone who touches it. There are also two practical reasons why any reforms would need to be very carefully designed.

Incentives and contributions

The first is that there would be a danger of completely removing the incentive for individuals to make their own personal savings for retirement if they knew it could leave them with a smaller state pension. However, to some extent the decision to be a saver is something which people come to intuitively, based on their attitudes towards life and risk-taking, without pondering all of the advantages and disadvantages, so this might not have such a big effect. This danger could also be nullified if the means-testing was fine-tuned enough to affect mainly the pensioners whose accumulated wealth is substantially above the amount they would lose in state pension.

The second problem is the contributory principle. In a nutshell, people feel that they are entitled to a state pension because how much they receive is related to the number of years for which they have been making National Insurance contributions; so telling people who have spent their working lives contributing that they can’t have a full state pension would be unpalatable politically.

In truth, these contributions have always been a purely notional, rather than financial – NICs are not saved into a fund related to any individual which then pays their pension specifically, but rather they go into one big current account run by the government (The National Insurance Fund) and are paid out again straight away to fund the pensions of existing retirees. Nevertheless, in order to avoid voters feeling that they have been cheated out of pensions which they have paid for, National Insurance would probably have to be combined with income tax (something the government has explored doing before on several occasions) – and since this would simplify the tax code and reduce bureaucracy, it could be argued that this would be worthwhile anyway.

The overall financial position of pensioners has improved a great deal during the last 30 years, as data from the ONS demonstrates. Yet a number of pensioners continue to have financial problems which re-designing the state pension could solve. The benefits of reducing pensioner poverty would be felt by people of all ages, as it would lower demand on the NHS and on other means-tested benefits, for example. Ultimately, it comes down to what we, as a society, believe the state pension should be for.

*Link downloads as a PDF

Posted on: 31 May, 2013

4 thoughts on “What is the state pension for?

  1. George Morley

    The article says :
    “The state pension is popular partly because it is a universal benefit which goes to everyone, regardless of means; yet this appears to have resulted in a situation where it fails to provide the poorest retirees with an adequate income in retirement,”
    Not absolutely true in that a pensioner retiring to most Commonwealth countries is discriminated against by having no annual increases ever for no justified reason. This is a passport to poverty thanks to the unwarranted policy of the government.
    When will we get honest politicians with a right sense of justice and fairness ( a word copied from David Cameron who said he wants it for all pensioners) Hollow words don’t feed anyone. Discriminative and irrational said Steve Webb when in opposition – since nothing has changed from that time, it it still just that and what does he do ? Nothing. The really cruel thing about this is the way that it is implemented. There is a regulation 3 tucked away in the small print and included in the Social Service Benefits Uprating and so it is voted on as a whole and immediately freezes the few pensioners involved – just 4% worldwide – while the 96% all enjoy the fully indexed pension.
    All organisations should be pressing the government to come clean and stop this discrimination. If you have just found out about this injustice then please do something about it. If not then just doing nothing condones this discrimination.

  2. Darnell R. Garrett

    The beginning of the modern state pension was the Old Age Pensions Act 1908 , that provided 5 shillings (£0.25) a week for those over 70 whose annual means do not exceed £31.50. It coincided with the Royal Commission on the Poor Laws and Relief of Distress 1905-09 and was the first step in the Liberal welfare reforms to the completion of a system of social security, with unemployment and health insurance through the National Insurance Act 1911 .

  3. barbara baldwin

    As I watched the Big Question programme on the BBC today I was appalled at the attitude and comments by Hangus Hanton As a 74 yr old I am far from well off. I have never been in receipt of benefits throughout my life. THE PENSION IS NOT A BENEFIT. I worked from the age of 16 to 64 yrs full time, whilst also bringing up a family and doing unpaid voluntary work. Then part-time for a futher 10 yrs. During which time I continued to pay all my taxes. I paid full national insurance throughout my life and also I contributed to a pension scheme. in the 1960/70’s basic income tax was 33% on top of that we paid NI and then on top of that we paid into a company pension scheme. So to say that our generation took everything out and put nothing back is insulting and shows and ignorance beyond belief. Yet despite all my contributions I come nowhere near the £20,000 per annum that was suggested on the programme. I receive so little now that for the first time in my life I come below the tax threshold. No-one ever takes into consideration all the voluntary work done by pensioners, let alone the free caring for relatives and loved one’s. Without the voluntary workers the NHS, the voluntary sector etc., would collapse. Leaving many vulnerable and older people to be cared for by the State, without the care given voluntary, many more older people would be hospitalised, costing billions of pounds. Next time you see the Air Ambulance picking up and helping all generations who do you think has stood for hours in charity shops on charity events helping to raise money? MOSTLY PENSIONERS.Your organisation is constantly demonising pensioners and creating a rift between young and old, for which you should be ashamed. Our generation paid for the pensions of the previous generation via the taxes we paid. Ever since the welfare state came into being it was ever thus., there was never any lump sum investment to set up the welfare state, each government has always had to pay for pensions etc,. out of current day receipts. Regarding the winter fuel allowance I struggle to pay my fuel bills which are over £100 per month. Yet thousands of older people are still dieing because of cold in this country, but you would have this paultry sum denied them. Our metabolism slows down as we get older and we therefore feel the cold more. Re the bus pass, it is used extensivley by many older people. Isolation actually kills people. The bus pass allows them to get to do the voluntary work in the charity shops etc., that helps ALL generations, it helps them get to the library and the pensioners club in their local community or church hall. I still pay my council tax which is £111 per month. So after my fuel bill and my council tax is paid, there is nothing left for luxuries. I don’t receive expenses of any kind, but I still do voluntary work because I realise the importance of keeping active. So before you tell us how well off and protected we all are again. I suggest you visit some pensioner Forums, have the guts to visit the Pensioners Convention which is held annually in Blackpool. Talk to real pensioners, thousands of us are far, far from being well off. There is a very simple solution to not giving rich pensioners the fuel allowance etc., if they are paying 40% tax then then the allowance could be witheld or it could be put as a taxable benefit. Problem solved. But the politics of envy which you are spreading between the generations will not solve anything. Just because one section of society is suffering as a result of poor governance, to take from another section of society doesn’t make it right. It just creates two wrongs. The solution is to conscentrate on the problems of the younger generation and come up with solutions, not steal from their grandparents.

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