New Labour, new pensions

It is no secret that the state is finding it increasingly difficult to meet our pension bill. In the past the government has got round this by reducing the value of the pension, but at last it looks as though the real issue of how we can fund decent levels is to be tackled. Labour committed itself to overhauling the pension system and now Frank Field, its pensions guru, has been appointed social security minister with responsibility for pension development. While sketchy on details, Labour's plans are expected to be fleshed out later this year, leading to Green and White Papers next year and the introduction of legislation.

Labour is essentially proposing a three-tier pension system: the first layer is the basic state pension to which everyone will remain entitled; the second will be a top-up; and the third will be voluntary arrangements.

The basic state pension will stay in its current form and will continue to rise in line with inflation. Labour has said it will be "retained as the foundation of pension provision". There are political reasons why Labour wants to keep the basic pension, says Matthew Demwell, for the Association of Consulting Actuaries. He said: "The basic state pension provides a flat amount for all which gives it a certain social acceptability, it also acts as a safety net for the low paid. There is a certain political sensitivity around the state pension so that no party would want to be seen to get rid of it."

Currently, the second tier of pension is the state earnings-related pension scheme (Serps). But this has not worked well. Many people are contracted out of it into private plans and most will not receive the full benefit. Under Labour plans, the type of second-tier scheme and the way contributions are made will depend on individual circumstances. Serps will remain an option for those who wish to stay within the state scheme. Those who contract out will continue to invest their contributions in a private plan. Citizenship pensions, equivalent to Serps, will be introduced for people who have not been earning, such as the unemployed, carers and the disabled and infirm. Contributions will come from the state and so, presumably, will be funded through the tax system. Just how much the extra cost will be and who will pay has not been made clear. "Stakeholder" pensions will also be introduced for employed people who wish to opt out of Serps but want to make extra pension provision.

Both citizenship and stakeholder pensions will be available from pension providers who have been approved by the Government. Labour hopes to encourage all sorts of groups, including small firms in the same area or profession, and trade unions, to club together and set up a pension scheme. Private sector pension companies are also expected to run schemes.

Labour's third tier would consists of company pension schemes and private pension plans. There is speculation that compulsory saving could be introduced. In the past Labour has always said that it will not increase the level of employee compulsory pension contributions. But some believe that with the value of the state and Serps dwindling, where no occupational scheme is provided, Labour may make it compulsory for employees and employers to make contributions into private pension funds. Joanne Hindle, the director of pension development at NatWest Life, believes Labour will have to make additional contributions compulsory if people are to have adequate pensions in the future. Others believe the Government will opt for attractive tax breaks to encourage saving for old age. Ian Overgage, the marketing manager at Flemings, points to Labour's plans to introduce individual savings accounts to encourage long-term saving. The tax breaks on these could be generous for long-term savers and could run alongside pension provision.

If the Government is to maintain the basic state pension and provide a citizenship pension for people not working, where will the revenue come from? There is speculation that it could scrap higher-rate tax relief on pension contributions, though there are disadvantages to this as it could put people off investing in their pension. And while it would be simple to administer with private pensions, it could turn into a nightmare with company schemes.