53. Our Report on the Contributory Principle contained
a detailed account of the history and workings of the National
Insurance system, much of it as it relates to state pension provision.
We do not repeat that detail here. However, in considering the
appropriate policy response to tackling pensioner poverty we have
reviewed the pension system as it relates to today's pensioners
and how that will change for future pensioners, taking account
of the new state second pension which is to replace the State
Earnings Related Pension Scheme (SERPS), and the introduction
of stakeholder pensions. In this section we give a brief factual
account of the different types of pension provision in order to
help clarify the arguments we go on to make later in the Report.
The first tier: the basic state pension
54. The basic state pension is the first tier of
pension provision. It is paid at a flat rate (i.e. unrelated to
past earnings) according to the extent to which contributions
have been paid or credited. A full basic state pension is currently
worth £67.50 a week. A married woman without a full contribution
record can claim a basic state pension on her husband's contributions.
In that case the maximum she will receive while he is alive is
£40.40 (the 'married woman's' rate). Since 1980, the basic
state pension has been uprated each year in line with prices while
earnings have risen faster than prices. The National Pensioners
Convention told us that "Between 1975 and 1982, the basic
state pension was consistently around 22-23% of the average earnings
of adult full-time workers, and the statutory requirement to increase
it annually at least in line with average earnings would have
ensured that it remained at that level or higher. Instead, the
breaking of the earnings link in 1980 has had the effect of reducing
the relative value of the basic pension to about 16% of average
55. Although in popular mythology the basic state
pension was uprated in line with earnings for many years, the
Minister of State pointed out that the link between the level
of the basic state pension and earnings lasted a relatively short
period - between 1975 and 1979.
Prior to 1973, there was no legal duty to ensure that benefits
kept pace with inflation. In 1973, the then Government introduced
a general requirement to review the value of benefits annually,
due to come into effect by 1975.
However, by 1975, this general duty to review benefits had been
amended, to give a duty to uprate long-term benefits such as pensions
by relation to earnings or prices, whichever was most advantageous.
Earnings were used as the basis for upratings up to and including
November 1979, with the exception of November 1976 when prices
rose faster than earnings.
The 1980 Social Security Act, which limited the uprating of pensions
to prices only, took effect from November 1980.
56. To receive a full basic state pension, men must
usually have 44 qualifying years of NI contributions out of a
working life of 49 years (aged 16-64). Women usually need 39 years
out of 44 (16-59) although this will rise gradually to be the
same as for men by 2020. All employees with earnings above the
lower earnings limit, and the self-employed earn rights to the
basic state pension. The extension of contribution credits for
periods of unemployment, sickness, maternity and caring, the introduction
of home responsibilities protection and the abolition of a married
woman's option to rely on her husband's NI contribution record
means that it is becoming easier to qualify for a full basic state
pension without working every year. This is particularly true
for women. Currently only a quarter (26.5%) of women over 60 receive
a basic pension independent of a husband's records. Of these,
only half get 100% of the full rate.
The Government Actuary assumes that by 2025 married women retiring
in that year will be entitled to state pensions worth on average
84% of the full basic rate, compared with 57% now.
However, it will be many years after that before all women pensioners
will be in this situation and by then, if the state pension is
linked only to prices, a full basic state pension will be worth
less in relation to average earnings.
Second tier pensions
57. Since 1978, all employees earning above the lower
earnings limit have had to pay towards a second-tier pension,
either through SERPS or through a private pension. SERPS was originally
designed to give a maximum addition to the basic state pension
of 25% of a person's earnings between the lower and upper earnings
limit. But the 1986 Social Security Act reduced significantly
the value of SERPS for people retiring after 1999. SERPS being
paid to new pensioners has therefore reached a maximum. For people
reaching pension age in 2010, their SERPS pension will be at most
20% of their relevant earnings. Widows currently inherit 100%
of their husbands' SERPS pensions, but for widows of people who
die after October 2002, this is reduced to 50%.
58. If employees contract out of SERPS into a private
second tier pension, they pay a reduced National Insurance Contribution
or get a rebate of their NI contributions paid into their private
pensions. SERPS and the contracting out arrangements provide a
degree of compulsory second tier pension for employees. There
is no equivalent compulsion for self-employed people to contribute
towards a second-tier pension.
59. From 2002, SERPS is to be replaced with a new
state second pension. From that date, no new SERPS rights will
be accumulated, and rights to the state second pension will begin
to accrue. By 2050, the state second pension will have completely
replaced SERPS. People retiring between 2002 and 2050 who have
contributed to both types of pension will have a pension based
on a mixture of the two schemes. Like SERPS, the state second
pension will apply to employees and they will be able to contract
out of it into a private pension.
60. SERPS provides employees with a supplement to
their basic state pension which is purely proportional to past
earnings between the lower and upper earnings limit. Someone whose
weekly earnings were £100 above the lower earnings limit
would receive a pension of half that of someone with earnings
of £200 more than the lower earnings limit. In the first
phase of the state second pension it will depend on past earnings
but it will provide a pension which is a higher proportion of
the earnings of those on low earnings compared with those on higher
earnings. In the second phase, the state second pension will become
a flat-rate top-up to the basic state pension. Entitlement will
depend on having earned at or above the lower earnings limit but
will be unrelated to earnings in any other way.
61. In calculating a person's entitlement to SERPS,
the past earnings on which it is based are revalued to the year
of retirement according to increases in average earnings. However,
during retirement, SERPS entitlements are increased each year
only in line with prices, like the basic state pension. A similar
arrangement will apply to the state second pension so that the
value of a full second state pension for newly retired people
will rise in line with earnings. However, once retired, pensioners
will see their state second pension increase each year in line
with prices only.
The third tier: voluntary private provision
62. Many people make additional voluntary private
provision beyond the compulsory element of second tier pensions,
through occupational pensions and personal pensions. From 2001,
stakeholder pensions will offer a new means of contracting out
of state second tier pension provision. The Department's memorandum
states that "the new Stakeholder Pension gives a safe, flexible,
low-cost way to save for a pension to around 5 million workers
for whom a private pension is not a cost-effective option."
Once in payment, private pensions tend to be increased each year
by at most the rise in prices.
The safety net: the Minimum Income Guarantee
63. Pensioners with income and savings below specified
levels are also entitled to a top-up from the Minimum Income Guarantee
(MIG) (formerly Income Support for Pensions). Those with savings
below £8,000 (£12,000 from April 2001)
are entitled to an amount which brings their income up to specified
These levels depend on age and whether the pensioner is part of
a couple or is single. The levels for single people aged 60-74,
75-79 and 80+ are £78.45, £80.45 and £86.05 respectively.
For couples the corresponding levels are £121.95, £125.35
and £131. So the MIG is above the single person's basic state
pension level and above a couple's combined basic state pensions
where the woman is receiving the married woman's rate of pension.
The present Government has given a commitment to link the MIG
to increases in average earnings for the remainder of this Parliament.
However, there are concerns that the MIG is too low: as we have
already noted, the Minister admitted that it was not enough and
that he would not be able to live on that amount.
88 Social Security Committee Fifth Report, Session
1999-2000, The Contributory Principle, HC 56-1. Back
Ev., p. 34, para. 3.4. Back
Q 262. Back
Social Security Act 1973. Back
National Insurance Act 1974, consolidated into the Social Security
Act 1975. Back
The Abstract of Statistics for Social Security Benefits and Contributions
and Indices of Prices and Earnings, 1999 edition, DSS Analytical
Services Division, 2000, table 2. Back
Appendix 19. Back
Government Actuary's Department, National Insurance Long Term
Financial Estimates, Cm 4573. Back
Q 164. Back
Ev., p. 77, para. 4. Back
Ev., p. 83, para 43. Back
Savings over £3000 (£6000 from April 2001) are assumed
to produce income of £1 for every £250 or part thereof.
Ev., p. 81, para 33. Back
Q 2541 Back