Losers who never knew in the switch to single-tier pensions

Under major reforms of the state pension, the current complicated arrangements where different people qualify for different amounts will be replaced with a single payout from April 2016. But while the new approach will benefit many, a particular group of people will lose benefits worth up to £23,000.

Those likely to be hit most will be individuals retiring in the financial year 2016-17 who were “contracted out” of the state earnings-related pension scheme (Serps) between 1978 and 1988 and who were members of final salary or other “defined benefit” schemes. In total, a million or more people could find themselves adversely affected by this issue.

Although the Department for Work and Pensions (DWP) says it has “published a raft of technical papers” on the switch to the so-called single-tier pension in 2016, few are aware of this particular change. Neither the GMB nor the ATL teachers and lecturers’ union, for instance, knew of it until briefed by Your Money – even though they are in regular contact with the DWP.

Deborah Cooper of the actuary Mercer said: “I am sure some people are aware of it, but as the effects of the changes are quite complicated to model, perhaps not as aware as they should be.”

The danger, then, is that the issue will go largely unquestioned and be accepted, almost by default, even though some individuals will probably miss out significantly.

“That could be a big deal for those affected,” said Phil McEvoy, national pensions officer at GMB, as he digested the implications. But he knows that opportunities for renegotiation are all but spent since the Pensions Bill – which sets up the new pensions structure – is close to the end of its passage. And Suzanne Beckley, pensions policy adviser at the ATL, feels unions have to be pragmatic in their negotiations. “We recognise there will be winners and losers,” she says. “We find ourselves fighting on numerous fronts and deciding where to put our energy.”

What is particularly difficult about this issue is that very few individuals know enough about pensions to understand it. The problem is that the new single-tier pension – worth a maximum of £145.40 a week in today’s money – will replace all the different strands of state pension that we have had in the past. Specifically, people who had entitlements built up between April 1978 and April 1997 under the old Serps system have some of that entitlement paid by the DWP. This means that anyone who reaches state pension age before 6 April 2016 will still receive that entitlement for the rest of their life, but those arriving at state pension age on or after that date will go without the increases. Actuaries at Mercer have calculated that the worst-hit women will lose benefits worth £23,000 and the worst-hit men will miss out to the tune of £17,000. The figures are higher for women as they live longer – and so receive pensions for longer – and also because they used to accumulate state pension rights over a shorter period than men.

People who contracted out might even have been unaware that they did so, as many employers did this en masse for their staff. Contracting out meant they left the state system for the purposes of building up an additional state pension (they remained part of the system for the basic state pension). To encourage them to opt out, the Government reduced annual national insurance (NI) contributions. The current NI reduction levels are 1.4 per cent for employees and 3.4 per cent for employers.

Having contracted out, members of defined benefit schemes built up the same amount of additional pension as they would have had they stayed in the state additional scheme.

However, the Government was eager to ensure that they never ended up with less additional pension than they would have had in the state scheme. The portion of the pension that was equal to what they would have earned in the state scheme was labelled the guaranteed minimum pension (GMP).

Strict rules were set down to ensure that, from the date of retirement onwards, the GMP would be increased each year in line with inflation for people who had been members of a defined benefit scheme. Some of those increases – particularly those relating to service between 1978 and 1988 – are borne by the DWP, rather than the pension scheme. It is these DWP-paid increases that will be lost after 6 April 2016.

The people most likely to be hit are those who, probably aged 56 and over, have been contracted out in such schemes. These will be teachers, police officers, nurses, doctors and others in the public sector, as well as many in the private sector. The difference that the increases make can be quite significant over time. For instance, Chris Thompson, who used to work in financial services, and who retired in 2005, says he used to get £6 a week for his GMP pension. Since then it has risen to £25 a week. It was Mr Thompson – probably one of the UK’s leading state-pension experts – who alerted Your Money to the issue. He is concerned that people, especially those on low pensions, will be caught unawares. “People can’t work out what is happening,” he said. There is no booklet, for instance, explaining this change.

The calculations from Mercer show how much high earners (with incomes the equivalent of about £50,000 today) could lose for the decade from 1978 to 1988. In total, about 9 million people were contracted out into defined benefit schemes in this period, but the extent to which they lose out varies according to their earnings in those years and their retirement date. Because of the way the new system is designed, people in this group who retire after 2020 are far less likely to be disadvantaged.

If they had also been contracted out from 1988 to 1997, high-earning women could lose another £1,100 and their male counterparts £800. The figures are lower for the second period because responsibility shifted to occupational pension schemes to pick up most of the inflation increases. These schemes will continue to pay their share of the inflation rises.

The picture is brighter for people who have a gap between 2016 and their retirement date as the new system will allow them to build up other entitlements that will compensate.

“You wouldn’t have to do anything,” said Sally West at the charity Age UK, explaining that the new entitlements will accrue automatically without individuals having to apply for them.

Looking at all pensions, contracted out or not, the DWP has calculated that “over 70 per cent of pensioners by 2020 are [set to be] receiving on average £4 a week more than they would have under the current system”.

However, the particular problem outlined here is the price that will be paid by a minority of people so we can all move gradually to a fairer system.

Ms West welcomed the clarity of the single-tier approach. “One of the reasons for moving to the new system is that it will be clearer what people will get,” she said. But the transition will be confusing for many.

Case study: ‘Andy’

Andy groaned when the impact of the change was explained to him – even though he will not be affected as he reaches state pension age this April.

“I think it’s very important,” he said, imagining how someone born two years after him would be affected. “The price of food is a serious concern. Utility bills go up all the time.”

A professional who is now on disability benefits and who lives alone, Andy (not his real name) knows what it is like to live on a tight budget. The mention of pensions makes his stomach turn even though he can count himself lucky on the particular issue of the inflation increases and the additional pension. “There’s a slight touch of the toad beneath the harrow,” he said. “I’ve got a terrifying feeling that I’m not going to get a good pension at all.”

He has a friend – a single professional who is still working – who will retire two years after the change. Is Andy worried about him? “Wages have been dropping and it’s a cliché to say that people never make adequate provision. But I don’t think he understands; he believes that you can live very well. His rather nice car is going to be the first thing that goes. Holidays go.

“We’re single men so replacing the audio/visual is a big priority. And then there are the white goods. A computer is absolutely vital. Generosity with your friends – giving retired friends your old computer – is going to become de rigueur.”

Not wanting to fall into despondency, he said: “OK, I’ve got to look on the bright side: I’m not living in Syria.”