House of Commons - Work and Pensions

Select Committee on Work and Pensions Fourth Report

5 THE STATE SECOND PENSION

224. Employees earning more than the lower earnings limit pay into the "Additional Pension" (unless they are "contracted-out" and contributing to an occupational or personal pension instead.) Between April 1978 and April 2002, this was built up under the State Earnings-Related Pension Scheme (SERPS). From April 2002, SERPS was replaced by the State Second Pension (S2P).

225. DWP's 2005 Women and Pensions report described S2P as "one of the key changes to the State Pension system to give women with low earnings or time out of the workplace a better State Pension record."[310]

The Government's proposals for S2P

226. S2P formed an important part of the retirement income package envisaged by the Pensions Commission. The Commission envisaged the state providing a "replacement rate equal to about 30% of median earnings at the point of retirement" - 17% Basic State Pension and 14% State Second Pension (based on 44 years of contributions or credits).[311]

227. As a result of measures in the White Paper S2P entitlement is to be extended:

More generous crediting arrangements are proposed for those with caring responsibilities, which will mean that "up to 1 million more individuals (around 90% of which are women) will be accruing State Second Pension entitlements in retirement."[312]
The contracted-out option for DC schemes is to be abolished in around 2012.[313] At this point around 3 million personal pension policy holders and around 500,000 members of occupational DC schemes will start to accrue S2P rights.[314]

THE MOVE TO A FLAT-RATE S2P

228. S2P is already becoming more flat-rate in nature over time. This is because it is calculated on earnings between two earnings thresholds (with lower earners and certain carers and people with disabilities credited in).[315] Under current indexation arrangements, these thresholds are converging, with accruals expected to become flat-rate in around 2055.[316] From that date, accruals would be unrelated to an individual's earnings.

229. Like the Pensions Commission, the Government considers this move towards a flat-rate second pension to be desirable: the White Paper states that the "introduction of the new personal accounts scheme will mean that for the first time everyone will have access to a genuinely low-cost private savings vehicle. We do not want the State Second Pension to duplicate this, which is why we are able to reinforce and speed up its change in focus to a flat-rate top-up benefit."[317]

230. The Pensions Commission recommended that this process should be accelerated by freezing the Upper Earnings Limit for S2P accruals in nominal terms.[318] In line with this, the White Paper introduces measures to result in accruals becoming flat-rate by around 2030. At this point a year of contributions or credits will be worth around £1.40 a week of S2P (in constant earnings terms).[319] The result should be that, as the White Paper puts it:[320]

"after 40 years of work or credits, a low earner can expect to build up an additional top-up of around £60 a week. Coupled with their Basic State Pension entitlement, this will give a total State Pension at retirement of around £135 a week in today's earnings terms."

231. The Pensions Policy Institute pointed out that "unequal outcomes" in pension provision "favouring the better off, will persist for decades." One of the reasons for this was "because the flattening of S2P is slow."[321]

232. The Department provided information to show illustrative S2P outcomes for low, median and high earners over the period 2005 to 2053. It assumes that a person works or is credited into the system from the age of 25 i.e. 40 years of work/crediting (increasing as State Pension Age rises.)

Table 2: Weekly S2P outcomes for working from age 25 - State Pension Age

Weekly earnings
	Retiring in	2005	2010	2020	2031	2042	2053
Low	£230	£35.86	£37.67	£38.78	£44.24	£54.74	£60.95
Median	£440	£84.97	£79.27	£78.62	£62.66	£64.83	£66.19
High	£630	£129.28	£118.26	£115.79	£76.70	£71.32	£67.31

Source: Department for Work and Pensions

233. The Department explained that:

"People earning higher amounts will still see higher S2P outcomes as earnings-related rights accrued prior to 2030 will be honoured. Eventually, outcomes for all earners will be the same as pre-2030 amounts disappear - the first completely flat rate S2P will be paid to people in around 2080."
"The theoretical maximum overall S2P for someone retiring in 2052 is £86.50. However, to achieve this outcome, a contributor would need to work from age 16 to age 68 and during the period up to 2030 (when earnings relation is still in place) would need to have consistent annual earnings of over £30,000."[322]

234. The result is that the more years of contributions or credits you have, the more S2P you qualify for. In the context of BSP, the White Paper argued that a reduction in the number of qualifying years was needed to help those with interrupted work records get full BSP entitlement.[323] It does not explain why the same rationale should not apply to S2P. The Secretary of State explained that "for the State Second Pension, it literally depends on how many years you have been contributing. That is what you get out. You can contribute for 40 years, but for each of those years you get more when it comes to your retirement."[324] People will be able to accrue more S2P as SPA increases.[325]

S2P: A SOURCE OF COMPLEXITY

235. It is difficult, however, to be sure what proportion of people will reach these levels of S2P entitlement. This is partly because of the complexity of the system, the way it has changed over time and the length of time over which entitlement is accrued. As DWP has commented, it takes many years for the changes to feed through to S2P entitlement. [326]

236. S2P continues, therefore, to remain a source of complexity. Citizens Advice noted that "the erosion of SERPS benefits, and the difficulty of evaluating contracting out options has left many people unclear and wary about second tier state pensions."[327] In oral evidence, Teresa Perchard said:[328]

"As those people come through the system, they will be coming out with different things, so it will make advising people, either what to expect or whether what they have got is right, quite challenging, because it will be a moving level down to flat rate. It is an area that is quite difficult to advise people on now and it will become more difficult because the rate will be changing."

237. The Secretary of State himself acknowledged this, describing the S2P as having "a built-in element of complexity that no amount of reform is ever going to remove, but, I think, moving to a flat rate more quickly is going to speed up the simplification of the State Pension system."[329]

GAPS IN S2P ENTITLEMENT

238. The proposed changes to credits bring S2P and BSP entitlement more into line, for example, in both cases:

Credits for childcare would be available until the youngest child is aged 12 (currently it is up to age 6 for S2P and 16 for BSP);
A new weekly credit would protect the Basic and State Second Pension record of carers who provide 20 hours or more care for someone receiving a disability benefit.[330]

239. There are 19 activities that can credit someone in to the Basic State Pension and, of these, only seven also qualify the individual for the State Second Pension. Those that do not qualify an individual for S2P include periods of unemployment, receiving Maternity Allowance, Statutory Adoption Pay or Statutory Sick Pay.[331] It is clear that more gaps remain in the system of credits and contributions for S2P than the Basic State Pension, particularly for the self-employed and those who are sick and disabled.

The self-employed

240. The Government has decided not to extend S2P to the self-employed. A number of reasons are given for this: complexities with the Commission's suggestion that the self-employed might be included by means of age-related NI contributions; "reluctance to commit taxpayer's money to a speculative scheme where enrolment may be low"; the new opportunities to save in personal accounts; and the fact that the average duration of employment was an average of eight years.[332]

Those who are long-term sick or disabled

241. While the White Paper proposes removing the Labour Market Attachment Test to ensure fair treatment for those who are long-term sick or disabled[333] it also raises the question as to whether credits to S2P should begin after 52 weeks, after the 13 week assessment phase, or be restricted to those on the Support component of the new Employment and Support Allowance (ie. to those with the most severe illnesses and disabilities).[334] Asked what the rationale for restricting entitlement to those on the Support component only would be, the Secretary of State said: [335]

"Off the top of my head, I do not think there probably would be one, but it is one of the things that we are looking at as a possible option, because it is there on the table in front of us if we wanted to go down that road."

242. Teresa Perchard of Citizens Advice took the view that such a measure would simply create "a new group of future disadvantaged poor pensioners with an insufficient NI contributions record."[336]

243. The Committee believes that those on the Employment and Support Allowance should be credited into the State Second Pension after the 13 week assessment phase.

244. As a result of such gaps (or potential gaps) in the contribution and credit arrangements for S2P, inequalities in S2P provision, compared to BSP, will continue. The Pensions Policy Institute's initial analysis was that "many people - more than a third - will receive less than £135 a week"[337] (the amount of state pension - BSP and S2P - the White Paper says a person could expect who has been in employment or caring throughout their working life).[338]

245. The Committee welcomes measures in the White Paper to improve coverage of S2P for carers and the simplification that would arise in the long term from moving to flat rate accrual. However, we note that inequalities in S2P provision are set to continue and the fact that, as the Secretary of State acknowledged, S2P will continue to be a source of complexity. DWP should provide estimates of how many people it expects to receive less than £135 a week in BSP and S2P in 2030 and in 2050.

310 DWP (2005), 'Women and Pensions: the Evidence', p 73, para 26 Back

311 Pensions Commission, Second Report, November 2005, p 19 Back

312 White Paper, para 3.95 Back

313 White Paper Volume 2, para 3.38. This is to happen at the same time as the BSP is linked to earnings Back

314 White Paper Volume 2, para 3.56 Back

315 For a fuller description, see Pensions Commission, First Report, October 2004, Appendix F, Section 5, Back

316 Pensions Commission, First Report, October 2004, Appendix F p 156. Pensions Commission, Second Report, November 2005, p 159. Under current indexation arrangements, the Lower Earnings Threshold is linked to earnings and the Lower and Upper Earnings Limit are expected to be linked to prices Back

317 White Paper, para 3.47 Back

318 Pensions Commission, Second Report, November 2005, p 220 Back

319 The value of the flat-rate element of S2P increases year on year - for instance it will be worth around £1.20 a week in 2010 but around £1.55 a week in 2050 in constant earnings terms. White Paper, para 3.50. White Paper, Volume 2, para 4.25. Back

320 White Paper, para 3.52 Back

321 Ev 406, para 4 Back