Changes that will affect us all

Why is the Government reforming the state pension system?

The number of people of pensionable age will rise from 8.9 million in 1991 to 13.5 million by 2030. Meanwhile, there will be a falling proportion of people in work to support them.

How are pensions affected?

The state pension scheme, funded by National Insurance Contributions (NICs), is a Pay-As-You-Go system. We pay for those who are already retired. In turn, we hope our pensions will be met by future NICs. If fewer people are in work, it costs more to fund pensions. This either means higher taxes or smaller pensions.

What is the Government doing?

Over the past 15 years, the Government has cut the real value of state pensions. This has mainly been done by linking benefits to inflation rather than earnings, which rise faster. The change has been applied to the state pension and to the State Earnings-Related Pension scheme (Serps), introduced by Labour in 1978.

The original aim had been that the basic state pension plus Serps, which requires 20 years' earnings for a maximum payout, would make up to 45 per cent of an average wage. When the maximum Serps becomes payable next year, 20 years after being introduced, it is likely that the maximum state pension will be about 35 per cent of the average wage. This will fall to about 20 per cent by 2020.

The Government has encouraged people to opt out of Serps by paying generous "rebates" either into company pension schemes or personal pensions.

What is the latest change?

Peter Lilley, Social Security Minister, is proposing to abolish Serps and pay a flat-rate rebate of 5 per cent of earnings into people's personal pensions instead.

He also wants to scrap the basic state pension, now worth about pounds 61 a week, replacing it with a guaranteed pounds 9-a-week payment into a personal pension while people are in work.

The theory is that by doing so, we will move away from Pay-As-You-Go towards a pre-funded pension system, run by the private sector. The personal pension would give a better payout at retirement, claims Mr Lilley. If a fund underperformed, the state guarantees a minimum pension. Meanwhile, he hopes to cut the state's pension bill by pounds 40bn to pounds 10bn or so by 2040.

Will I be affected?

Probably not. People in their late 20s would continue as now. Those affected are today's teenagers, who would come under the new regime in the next five years.

Is there anything wrong with the proposal?

There could be. One must wonder whether anyone can guarantee to meet a promise to pay pounds 9 a week forever into a youngster's pension plan.

Second, Mr Lilley has said the scheme will pay for itself because payments into personal pensions won't receive tax relief as they do at present - although the pensions themselves won't be taxed, he promises. But minimum state pensions aren't taxed at the moment. And which cash-strapped Government could resist a bite out of people's retirement income in 40 years' time, when memories of today's promises have faded?

But if only young people are affected and I'm not, what does it matter?

The main impact for the rest of us will be in the area of public finance. In other words - taxes. The DSS claims the cost of the changes will rise by pounds 160m a year, reaching pounds 7bn by 2040. It hopes the extra bill will be paid by better economic performance. But if something goes wrong, today's taxpayers will end up paying for those already retired, for their own retirement, plus the retirement of those younger than themselves.

Will these proposals ever see the light of day?

Highly unlikely, unless a miracle puts John Major back into 10 Downing Street. Their main effect, however, has been to focus attention on the issue. Labour's knee-jerk hostility to the plan is only the beginning of what should be a much more serious debate over the future funding of state pensions.