(FSA).
Recent developments
201. The Government’s proposals for the reform of the pensions system in Britain were set out in the Green Paper A new contract for welfare: PARTNERSHIP IN PENSIONS (Cm 4179), published in December 1998.
202. Key principles set out in the Green Paper were that the new pensions system should:
- improve pensions for low earners and carers by reforming SERPS with a more generous State Second Pension;
- introduce new stakeholder pensions for moderate and higher earners; and
- continue to support and strengthen the framework for occupational pension provision.
203. Some of the measures to achieve the above aims were introduced in the *Welfare Reform and Pensions Act 1999. These include the legislative framework for the introduction of stakeholder pensions. It is intended to implement stakeholder pensions from April 2001. These schemes will offer money purchase benefits to members, providing benefits related to the contributions paid by the members, together with the investment returns on those contributions (less charges). The charges will be subject to an upper limit.
204. Stakeholder pension schemes will be targeted at those with moderate earnings (around £9,500 to £21,600 a year) who want to save more for retirement but who do not have access to an occupational scheme and for whom many existing personal pensions can be unsuitable or expensive. They will be set up within an approved governance structure (the arrangements for the management and oversight of a pension scheme) and meet minimum standards intended to encourage more moderate earners to save for their retirement. However, everyone will be able to pay into such a pension scheme, regardless of whether they are in work or not.
205. The Welfare Reform and Pensions Act 1999 also included legislation on several detailed proposals on occupational and personal pension schemes which were contained in the consultation document Strengthening the Pensions Framework that accompanied the 1998 Green Paper.
The measures in the Bill
State Second Pension
206. The State Second Pension will reform SERPS by boosting the Additional (second tier) Pension of low earners and providing Additional Pension for the first time for carers and some long-term disabled people with broken work records.
207. State Second Pension will be calculated by reference to the surplus in an individual’s earnings factor. An individual’s earnings factor corresponds to the whole of his earnings up to the Upper Earnings Limit and the surplus to the amount of those earnings between the Lower Earnings Limit and the Upper Earnings Limit.
208. The State Second Pension regime will provide for a new Low Earnings Threshold, which will be uprated in line with increases in national average earnings. In 1999/00 terms this Low Earnings Threshold will be £9,500. Anyone earning less than £9,500 but at or above the annual Lower Earnings Limit (£3,432 in 1999/00) will be treated for State Second Pension purposes as if they had an earnings factor of £9,500.
209. Carers, who have no earnings or earnings below the annual LEL, will be treated for State Second Pension purposes as if they had earnings of £9,500 for any year throughout which:
210. Those entitled to long-term *Incapacity Benefit or *Severe Disablement Allowance throughout a tax year will also be treated for State Second Pension purposes as if they had an earnings factor of £9,500 in that year, provided they meet a simple labour market attachment condition when they reach state pension age. This condition requires that they have worked and paid Class 1 National Insurance contributions for at least one tenth of their working life since 1978, when Additional Pension was introduced.
211. There will be two stages to the State Second Pension. The first will be earnings-related. On the surplus in an earnings factor (actual or treated) of £9,500 (that is £9,500 less the prevailing annual Lower Earnings Limit), everyone will earn at least twice as much entitlement to Additional Pension as they did under SERPS. Where there is a surplus in the earnings factor corresponding to the amount of a person’s earnings above £9,500 but not exceeding £21,600, the accrual rate on that surplus will be half what it would have been under SERPS. This will have the effect of recouping some of the increased accrual that everyone will receive on the surplus in the earnings factor of £9,500. However, everyone earning under £21,600 will receive more than they would have done under SERPS, with the largest proportionate gains going to those with the lowest earnings. No-one will receive less than they would have done under SERPS, with those earning £21,600 and above receiving the same as under SERPS.
212. In the second stage, to be introduced when stakeholder pension schemes have become established, State Second Pension will become a flat-rate scheme for those with a significant part of their working life ahead of them (for example, those aged under 45 at the point of change). Everyone in the second stage of State Second Pension will be treated as if they had earnings of £9,500 (or corresponding to the prevailing Low Earnings Threshold at that time), regardless of the level of their actual earnings. Qualifying carers and long-term disabled people with broken work records will continue to be treated as if they had such an earnings factor. State Second Pension will continue to be calculated by reference to the surplus in that earnings factor. National Insurance rebates to those in contracted-out pension schemes will continue to be earnings-related.
Contracting-out arrangements
213. The contracting-out regime is central to the success of private pension provision and the Government is keen to ensure that any changes made to the arrangements for contracting-out to reflect the introduction of the new State Second Pension, continue to support and encourage private pension provision. In recognition of the level of importance the Pensions Industry attaches to the contracting-out regime, it has been decided to consult on two approaches for revising the arrangements.
214. When individuals contract-out they do so on the basis that their pension arrangements will give them, broadly speaking, what they would have received from the state had they not contracted-out. As there is a reduced liability on the State, individuals and employers running occupational schemes receive a contracted-out rebate, which is calculated by reference to the cost of State benefit given up. As the new State Second Pension is designed to boost the pension of low and moderate earners, the contracting-out arrangements will need to be changed to ensure that members of contracted-out pension schemes are not better off contracting back in. The consultation document explores two options for achieving this.
215. The first approach suggests that all rebates be increased to reflect the three-part accrual rate within the new State Second Pension. This will go some way to ensuring that individuals are not worse off remaining contracted-out. However, a problem remains because the State Second Pension will treat those earning under £9,500 as if they were earning that amount. For a variety of reasons, schemes could not be asked to replicate this provision so the first approach proposes that individuals earning below £9,500 receive a top up via the State Second Pension to that amount to make sure membership of their scheme remains viable.
216. One further problem remains, and that is how to ensure that for increased rebates salary-related schemes provide extra pension benefits. The first approach therefore puts forward a number of proposals for increasing benefit for low paid individuals who leave their scheme before pension age. This is because they are at risk of being better off in the state scheme rather than remaining in their scheme due to the difference in the way contracted-out scheme benefits and State Second Pension benefits are revalued. All proposals focus on revaluing low paid early leaver benefits in line with earnings rather than prices as is the case now.
217. The second approach proposes a somewhat different route. It suggests that rebates for occupational schemes remain as they are now, so they would be based on a universal SERPS-style accrual. But to overcome the difficulties associated with individuals being better off in the state scheme, a State Second Pension top-up to £21,600 is proposed. This avoids schemes having to change their benefit provision. However, contracted-out personal pension schemes would have rebates based on the three-part accrual within the State Second Pension and a state top-up limited to £9,500.
218. The consultation document Structure of Rebates for the State Second Pension was issued on 29 November. The consultation period will run to 14 January 2000. The Government hopes to bring forward legislation to implement the preferred way forward during the Bill's committee stage.
Improving the framework for occupational and personal pensions
219. Besides the reform of the National Insurance rebate, there are four main parts to the reform of occupational pensions in the Bill:
- increased member involvement in schemes by requiring that all schemes must have one-third Member Nominated Trustees (MNTs) by a process laid out in regulations or under procedures devised by the employer and approved by scheme members. The purpose is to increase confidence in the schemes, thereby encouraging more employees to join;
- further protection of members’ pension rights by:
- allowing the Occupational Pensions Regulatory Authority9 (Opra) to make their register of disqualified trustees more accessible to the public; and
- giving powers to Opra to monitor schemes which are in the process of winding up to ensure that winding up is undertaken as quickly as possible;
- changes to the existing regulation-making powers to enable future regulations to require money purchase schemes to provide members with an illustration of the likely future value of their pension, thereby improving members’ appreciation of the value of their pension rights; and
- measures to provide further clarification, simplification and flexibility for those operating schemes. These will:
- increase the options for discharging contracted-out pension rights;
- increase the options available to scheme members when they transfer their pension rights; and
- allow a greater range of persons to make representations to the Pensions Ombudsman.
COMMENTARY ON CLAUSES
CHAPTER I: STATE PENSIONS
State second pension
Clause 28: Earnings from which pension is derived
220. Subsection (1) inserts section 2A into section 22 of the *Social Security Contributions and Benefits Act 1992 (the "Contributions and Benefits Act")which sets out the earnings on which Additional Pension (in the State Earnings-Related Pension Scheme or SERPS) is calculated. Under State Second Pension, Additional Pension is to be calculated on those earnings on which Class 1 employee National Insurance contributions have been paid or treated as paid.
221. From April 2000 employees earning below a new Primary Threshold will no longer pay National Insurance contributions. Those employees with earnings between the prevailing Lower Earnings Limit (LEL) (£66 a week in 1999/00) and the new Primary Threshold10 will be treated as if they had paid National Insurance contributions on those earnings. Provided their annual earnings are at least 52 times the weekly LEL (£3,432 in 1999/00), the year will qualify for contributory benefits such as basic Retirement Pension. If their earnings exceed this amount, employees will accrue entitlement to Additional Pension on the amount by which their earnings exceed 52 times the LEL.
222. The self-employed do not accrue entitlement to Additional Pension. Their flat-rate Class 2 National Insurance contributions entitle them to flat-rate contributory benefits, such as basic Retirement Pension. However, someone may be both an employed earner and a self-employed earner in the course of a year. In such a case, and if they are a member of SERPS, their Class 2 contributions are currently taken into account when calculating the amount of surplus Class 1 contributions on which their entitlement to Additional Pension is based. If they are contracted-out of SERPS into an occupational pension or personal pension scheme, they receive a rebate of National Insurance contributions which is based solely on their Class 1 employee contributions. This section has the effect of treating members of State Second Pension in the same way as those contracted-out by taking account only of their Class 1 earnings when calculating the amount of their State Second Pension entitlement or the amount of their rebate.
223. Subsection (2)(a) inserts new paragraph (za) into section 44(6) which sets out how earnings factors are to be determined for State Second Pension purposes. For State Second Pension the earnings factor will be the total of the earnings on which Class 1 employee National Insurance contributions have been paid or treated as paid, unless the person concerned is regarded as having an earnings factor for one of the reasons set out in subsection (3) below.
224. Subsection 2(b) amends section 44(6)(a) to limit the current method of determining earnings factors for Additional Pension under SERPS to the period before “the first appointed year”, which is the year from which State Second Pension will take effect.
225. Subsection (3) inserts new section 44A into the Contributions and Benefits Act.
New section 44A: Deemed earnings factors
New section 44A(1) provides for a person to be deemed to have an earnings factor equal to the Low Earnings Threshold when calculating entitlement to Additional Pension under the State Second Pension if they qualify in any of the ways set out in section 44A(2). In 1999/00 terms the Low Earnings Threshold will be £9,500 (see new section 44A(5) below).
New section 44A(2)(a) provides for a person to be treated as if they had an earnings factor of £9,500 in a qualifying year when they had earnings at or above the level needed to make the year a qualifying one for basic pension (earnings at or above the annual LEL of £3,432 in 1999/00, which is 52 times the weekly LEL of £66 a week in 1999/00) but less than the Low Earnings Threshold (£9,500).
New section 44A(2)(b) provides for a person to be treated as if they had an earnings factor of £9,500 in a qualifying year if Invalid Care Allowance was paid to them throughout the year. A person can also qualify if they would have been entitled to receive Invalid Care Allowance were it not for the fact that they received another (higher) benefit, such as *Widow’s Benefits or Incapacity Benefit.
New section 44A(2)(c) provides for a person with no earnings, or earnings below the LEL, to be treated as if they had an earnings factor of £9,500 in a qualifying year when they were paid Child Benefit for a child under 6, or if they satisfied certain other conditions to be specified in regulations. It is intended that these other conditions will be the same as those specified in paragraphs 2 (a) or 3 and 4 of the Social Security Pensions (Home Responsibilities) Regulations 1994 (S.I. 1994/704). These regulations provide for a person to be treated as being precluded from regular employment by responsibilities at home if:
(i) they receive *Income Support without needing to be available for work, because they are caring for a sick or disabled person; or
(ii) they spend at least 35 hours a week caring for a person who receives *Attendance Allowance or the care component in *Disability Living Allowance at the middle or highest rate.
New section 44A(2)(d) provides for a person to be treated as if they had an earnings factor of £9,500 in a qualifying year if long-term Incapacity Benefit was paid to them throughout the tax year. A person can also qualify if they would have been entitled to receive long-term Incapacity Benefit but failed to satisfy the necessary contribution conditions for that benefit, or received another (higher) benefit, such as *Widows' Benefits, or received an occupational or personal pension which reduced the amount of Incapacity Benefit to nil. Such a person would also need to satisfy the labour market attachment test set out in new sections 44A(3) and (4) below.
New section 44A(3) and (4) detail the labour market attachment conditions for those who could qualify for State Second Pension on grounds of entitlement to long-term Incapacity Benefit. Such a person must have paid, or be treated as having paid, Class 1 employee National Insurance contributions for at least one tenth of their working life 11 since 1978, when Additional Pension was introduced. For instance, someone reaching state pension age in 2005/06 would have a working life of 27 years and would need to have worked and to have paid National Insurance contributions for 3 years (1/10th of 27 years rounded to the nearest whole year) in order to receive entitlement to State Second Pension on grounds of incapacity for work. Anyone reaching state pension age after April 2024 would need 5 years (working life of 46 years, up to a maximum working life of 49 years, 1/10th rounded to the nearest whole year being 5 years). National Insurance credits 12 will not satisfy this condition. However, any year in which the person has worked but not actually paid Class 1 National Insurance contributions because their earnings, although above the annual LEL, were below the new Primary Threshold on which such contributions are paid, will be treated as if they had paid contributions on those earnings.
Any year where the disabled person has been a carer and qualifies for State Second Pension by virtue of subsections (2) (b) or (c) above will be excluded from the number of years in the working life when calculating whether they have met the labour market attachment condition. For instance, someone retiring on 6 April 2024 would have a working life of 46 years and would need 5 years (1/10th of 46 years rounded to nearest whole number) in which they had worked and paid Class 1 National Insurance contributions. But if they had received Child Benefit for a child under 6, and were treated as precluded from regular employment by responsibilities at home for those 5 years whilst the child was under that age, or if they were entitled to Invalid Care Allowance for 5 years, their working life would be reduced to 41 years and they will only need 4 years (1/10th of 41 years rounded to nearest whole number).
New section 44A(5) sets the Low Earnings Threshold in State Second Pension at £9,500. This is subject to new section 148A of the *Social Security Administration Act 1992 (the "Administration Act") which provides for the Low Threshold to be increased in line with rises in national average earnings (see the note to subsection (1) of clause 29 below).
New section 44A(6) defines “occupational pension scheme” and “personal pension scheme” as used in the inserted new section 44A(2)(d)(ii).
226. Subsection (4) provides for someone to be treated as if they had an earnings factor of £9,500 in a qualifying year if they are paid Severe Disablement Allowance (SDA) throughout the year and they meet the labour market attachment test set out in new section 44A(3) and (4). SDA is being withdrawn for new claimants from April 2001 but those already receiving the benefit will continue to do so.
Clause 29: Calculation
227. Subsection (1) amends subsection (2) of section 45 of the Contributions and Benefits Act, which sets out the way Additional Pension is calculated. It provides for Additional Pension to be the sum of entitlement accrued under SERPS and entitlement accrued under State Second Pension.
228. Subsection (2) inserts new section 45ZA after section 45 of the Contributions and Benefits Act. It sets out the way in which State Second Pension is to be calculated.
New section 45ZA: The additional pension in a Category A retirement pension
New section 45ZA(1) provides for the amount of State Second Pension entitlement in each year to be based on the surplus in a person’s earnings factor – the amount by which the (actual or deemed) earnings factor exceeds the amount needed to qualify for basic retirement pension (the Qualifying Earnings Factor, which is 52 times the prevailing weekly LEL). See the note to subsection (1) of clause 22 above.
New section 45ZA(2) to (5) sets out the calculation for State Second Pension. First, the surplus earnings factors in each year are to be divided into the bands shown in the tables in subsections (4) or (5). Secondly, the surpluses in each of the bands are to be revalued for each year to ensure that they maintain their value in earnings terms. This is done in line with the increase in national average earnings up to the year before the year in which state pension age is reached (under section 148 of the Administration Act). Thirdly, the revalued surpluses in each band are to be multiplied by the relevant percentage in the tables in subsections (4) or (5). Finally, the totals for each year are added together and divided by the number of years in the working life since 1978, when Additional Pension was introduced, to give the annual amount of Additional Pension from State Second Pension payable. The annual amount will be divided by 52 to give the weekly amount payable. This will be in addition to any entitlement to Additional Pension accrued under SERPS between 1978 and the introduction of State Second Pension.
This calculation differs from that used for SERPS by the application of different accrual rates to the surplus in the earnings factor falling within different bands of surplus earnings factors. Under SERPS anyone retiring from 6 April 2009 onwards (Table 2) would have had one accrual rate of 20% on their surplus earnings factor. Under State Second Pension the same person will have an accrual rate of 40% on the surplus in their earnings factor falling within Band 1. Band 1 covers surpluses in the earnings factor which correspond to the amount of earnings between the Qualifying Earnings Factor and the Low Earnings Threshold of £9,500. This band will include those low earners, carers and disabled people with broken work records who are treated as if they had an earnings factor of £9,500 in a qualifying year under section 44A(2) of the Contributions and Benefits Act as inserted by subsection 3 of clause 28 above.
Surpluses in a person’s earnings factor falling within Band 2 will have an accrual rate of 10%. Band 2 covers twice the amount of surplus falling within Band 1, rounded to the nearest £100. So, if the Qualifying Earnings Factor is £3432 (52 times the 1999/00 weekly LEL) and the Low Earnings Threshold is £9,500, the amount of surplus falling within Band 1 will be £6,068. This means that the amount of surplus falling within Band 2 will be £12,136 and the upper limit of Band 2 will be £9,500 + £12,136, rounded to the nearest £100, which is £21,600. Someone earning £21,600 will receive the same amount from State Second Pension as they would have done under SERPS, because the higher accrual rate on the surplus in their earnings factor falling within Band 1 will be entirely offset by the lower accrual rate on the surplus in their earnings factor falling within Band 2. Anyone earning less than £21,600 will receive more from State Second Pension than they would have done under SERPS.
Surpluses in a person’s earnings factor falling within Band 3 will have an accrual rate of 20%, that is the same as under SERPS. Band 3 covers surpluses in the earnings factor which correspond to earnings which are above the surplus falling within Band 2 but not exceeding the Upper Earnings Limit.
Someone reaching state pension age before 5 April 2009 would have had an accrual rate higher than 20% under SERPS. This is because of the changes made in the Social Security Act 1986 which reduced the accrual rate in SERPS in stages from 25% to 20% for those retiring between 2000/01 and 2009/10 (in respect of accruals from 1988/89). There will be similar transitional arrangements in State Second Pension and Table 1 shows the accrual rate for those retiring before 6 April 2009. Someone reaching state pension age before then will have accrual rates which give an extra 1% on the surplus in their earnings factor falling within Band 1, 0.25% on the surplus in their earnings factor falling within Band 2, and 0.5% on the surplus in their earnings factor falling within Band 3 for each year by which the year in which they reach state pension age is earlier than 2009/10. For instance, someone reaching state pension age in the year beginning 6 April 2008 would have accrual rates of: 41% on the surplus in their earnings factor falling within Band 1 (twice what it would have been under SERPS); 10.25% on any surplus falling within Band 2 (half what it would have been under SERPS); and 20.5% on any surplus falling within Band 3 (the same as it would have been under SERPS).
New section 45ZA(6) enables regulations to be made to bring in Stage 2 of the State Second Pension for people who attain pensionable age after a date set out in the regulations. The intention is that the regulations will apply to persons with a significant part of their working life ahead of them. All those coming within the scope of Stage 2 will earn entitlement to State Second Pension as if they had an earnings factor of £9,500, regardless of their actual earnings. This means that low earners, carers and long-term disabled people with broken work records will continue to be deemed to have an earnings factor of £9,500. However, those earning more than £9,500 will only earn entitlement to State Second Pension on the surplus in their earnings factor falling within Band 1, that is the amount between the prevailing annual LEL (the Qualifying Earnings Factor) and the Low Earnings Threshold (the deemed earnings factor under new section 44A, which is £9,500 or the prevailing level at the time Stage 2 is introduced). This will only apply to entitlement accrued after the “second appointed year, which will be the year in which Stage 2 is introduced. Any entitlement accrued under Stage 1 will be preserved. It is intended that Stage 2 will not be brought in until stakeholder pension schemes have established themselves. Contracted-out National Insurance rebates will continue to be earnings-related.
New section 45ZA(7) and (8) set the method of calculating the number of years in the working life to be used in the calculation of any Additional Pension payable under State Second Pension to widows and widowers, based on their late spouse’s contributions. This method is the same as that used under SERPS for those widowed from 6 April 1999 onwards.
New section 45ZA(9) and (10) define “the value of N”, “LET”, “QEF”, “2QEF” and “relevant year” as used in the tables in the inserted new section 45ZA.
(7) The FSA is a statutory authority established by the Financial Services and Markets Bill to regulate the UK financial services industry. It has powers to authorise financial service providers, to regulate their actions and impose disciplinary sanctions. Part of their role is to investigate complaints from individuals who believe they have been given wrong or bad advice by the company that sold them their personal pension. Back
(8)
Home Responsibilities Protection protects the basic retirement pension position of someone caring for a child under 16 or a sick or disabled person. It is not a National Insurance credit or benefit in its own right, but works by reducing the number of qualifying years needed for a full basic retirement pension.
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(9)
Opra is a statutory body created by the Pensions Act 1995, which is responsible for ensuring that occupational pension schemes comply with the requirements of the relevant legislation. It has the power to investigate and can impose a range of penalties for non-compliance, including prohibition from acting as a trustee and imposition of fines. It may also pursue criminal proceedings.
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(10) The Primary Threshold is the point at which employees begin to pay National Insurance contributions. It will be increased over the 2 years beginning April 2000 to the level of the Income Tax Personal Allowance. The Primary Threshold for 2000/01 will be £76.00 per week.
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(11) A full working life for state pension purposes is counted from the start of the tax year in which a person reaches 16 to the end of the tax year before the one in which they reach state pension age.
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(12) A Class 1 National Insurance credit is a credit of earnings for the sole purpose of assisting a person towards satisfying the contribution conditions for basic Retirement Pension, Widows’ Benefits, Incapacity Benefit or Jobseeker's Allowance. A credit is available for weeks where a person is unable to work due to one of a number of specified contingencies, the most common of which is that he is incapable of work through illness or disability or he is unemployed, available for and actively seeking work. Alternatively, a credit may accompany receipt of a particular benefit such as Invalid Care Allowance or Statutory Maternity Pay, or be awarded automatically to a man within five years of state pension age who has no liability to pay contributions. Earnings cannot be credited beyond the extent needed to give a person a Qualifying Earnings Factor for that year.
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