Memorandum submitted by Age Concern
Personal Accounts and means testing: making sure it pays to save
Proposals for auto-enrolment into a personal account or another type of pension have received widespread support as a way of improving the retirement prospects for many people. However there have been concerns that contributing to a personal account may be unsuitable for some people because of the interaction with means-tested benefits. It is important to look at this issue while not deterring the many people who could benefit from saving and receiving an additional boost from an employer's contribution and tax relief. This paper looks at who is at risk from saving inappropriately and what can be done to address this.
The paper has been prepared by Age Concern in consultation with the Equality and Human Rights Commission, Help the Aged, Trades Union Congress and Which? We work together as the People's Pensions Coalition - a group of consumer and advocacy groups committed to a progressive pensions settlement.
1. What is the problem?
There is a concern that some people may not benefit from saving because of the interaction with means-tested benefits. However a message that it does not pay to save could deter the many who will be better off.
Means-tested benefits (also called income-related benefits) such as Pension Credit are targeted at the least well off through an assessment of income and savings. Inevitably this means that the more income and savings people have, the less help they receive from the benefit system. Those who can only make limited savings may find that they are little or no better off from paying into a private pension because of the interaction with means-tested benefits. However there is a danger that if people hear a message that it may not pay to save, this could deter some of the many who will be much better off in retirement from contributing to private pensions.
2. Is this a new issue?
No - there has always been an interaction between private savings and state benefits and concern that some people gain little or nothing from saving - this a key reason why the Government introduced the savings credit within Pension Credit.
The difference is that from 2012 people will be automatically enrolled into a personal account or another type of pension and this will include many people in low-paid or short-term jobs who previously may not have considered making pension provision. Many people will not opt out due to inertia. This will generally be a positive thing as it will help people who might otherwise not get round to saving. However it could result in some people building up limited pension provision which will make little difference to their retirement income.
3. How important are means-tested benefits?
Although the proportion of people entitled to Pension Credit may fall over time means-testing will continue to play a significant role.
Means-tested benefits play a significant role in supporting retirement income in the UK. Currently around 2.7 million pensioner households receive Pension Credit although an estimated 4.1 million are entitled to the benefit. This represents 46% of the pensioner population. In addition there will be people entitled to other means-tested benefits. Although most of the debate has been around Pension Credit, entitlement to Housing Benefit and Council Tax Benefit also needs to be taken into account. Low income tenants are particularly likely to be reliant on Housing Benefit to meet their rent. (See the appendix for more information about the main means-tested benefits for older people and how these interact with private pensions).
The Government estimates that the proportion entitled to Pension Credit will reduce over time to 37% in 2030 and 29% in 2050. The Pensions Policy Institute (PPI) using somewhat different assumptions suggest this figure could be higher. Even on the Government's figures a considerable minority will be entitled to Pension Credit in the future although the Department for Work and Pensions (DWP) estimates that by 2050 just 6 percent will be entitled to guarantee credit alone (the part of Pension Credit which ensures a minimum income) and therefore at risk of losing benefit on a £1 for £1 basis. The DWP also notes that people entitled to Pension Credit will increasingly be those who are have severe disability or caring responsibilities in later life who are entitled to higher amounts of Pension Credit. These people may not necessarily retire onto Pension Credit but may have become entitled later and in this case will have still benefited from saving during the earlier years of their retirement.
4. Who may not benefit from saving?
The majority of people will be better off from saving in a personal account or other type of pension but there are some groups of people for whom there is a risk that they will not benefit from saving.
DWP and PPI modelling work suggests that most people will benefit from saving in a personal account or occupational pension. The DWP states that 'a payback of £2 or more plus inflation for every £1 an individual saves could be expected by many' and that even the minority who could face high withdrawals of benefits for some part of their retirement could see a higher return from saving by taking part of their pension as a lump sum payment. The PPI has also looked at returns from saving and classified people as low, medium or high risk of personal accounts being unsuitable. For example people in the medium risk group include people in their 20s who will have low earnings and broken work records, and those with low earnings and full work records but do not start to save until they are in their 40s or 50s. The high risk group includes people who are likely to rent in retirement and have no additional savings. Self-employed people will be at greater risk than employees in similar situations because they will not benefit from an employer contribution. They will not be auto-enrolled but will need to decide whether to save in a personal accounts.
5. How does an individual know the risks of saving or not saving?
It is often difficult or impossible for people to predict whether they will end up not benefiting from having saved for their retirement.
While it is possible to say, in general, the kinds of circumstances that lead to people being at risk of not getting a good return from pension saving it is very difficult for any individual (or their adviser) to predict if they will be in this position. This is because there are a range of risks and unknowns. For example:
· Working life: people do not necessarily know if their earnings will go up or down in the future or if they will have breaks due to caring or illness. They could also spend time in the future working for an employer who pays more generous pension contributions.
· Personal circumstances: the return from pensions depends on factors such as the number of years someone lives and draws their pension and whether they have a partner in retirement (which reduces the likelihood of being entitled to means-tested benefits).
· Economic circumstances: returns from pension investments and inflation during retirement will affect the value of pensions.
· Policy changes: future governments may make changes to the tax regime, pensions or means-tested benefits.
All these factors could affect the return that someone receives. For example any calculations have to be based on current benefit rules yet going by past experience it is likely that there will be changes in the future. If means-tested benefits become more generous then many more people may be little better off from having paid into a personal account. On the other hand if the opposite happens and means-tested benefits become far meaner then many will find themselves in great poverty in retirement and regret not having made private provision. Even if the current system of means-tested benefits maintains its value the levels are by no means generous and few would choose to have this standard of living in retirement. A further point is that regardless of someone's overall monetary position there are many people who would prefer not to rely on means-tested benefits or would not claim their full entitlements.
6. How could the system work better?
A much higher state pension which would substantially reduce the risk of inappropriate saving. In the context of the current system there are other measures that could also reduce this risk.
There are two major changes that could reduce the interaction between means-tested benefits and private pensions:
· A substantial increase in the state pension: If everyone received a basic pension paid at the level of current standard amount of Pension Credit guarantee for a single person (£119.05) means-testing would be substantially reduced. However this would cost £11.7 billion.
· A substantial reduction in the rates of means-tested benefits: This would make saving more likely to pay but would result in a major rise in pensioner poverty.
An increase in poverty would be unacceptable and although we want to see state pensions improved the financial costs make this unlikely at present. However even in the context of the current system there are 2 approaches that could help ensure that people do not save inappropriately:
· Information and advice to make sure people who are likely to see no or little benefit from saving consider opting out of pensions.
· Measures to reduce the impact of small pensions on means-tested benefits through changes to benefit rules and/or an increase in the trivial commutation limits.
If these issues are not taken forward there is a danger that negative publicity about saving not being worthwhile could encourage many to opt out.
7. What is the role of information and advice?
Access to good personalised information and guidance is essential to help people plan for their retirement and make decisions about saving
We see an important role for a nationally available generic advice service which we hope will be established after the Thoresen Review. The Personal Accounts Board and other occupational pension providers should give clear information about their pension schemes but cannot and should not be advising people whether to opt out. Instead people should be encouraged to seek further information and advice. However the general information provided by personal accounts and other providers could indicate the types of people who would particularly benefit from seeking advice such as those approaching retirement who have little previous savings.
Some people will decide that saving is not the best option for them at a particular time - for example because they have other priorities such as paying off debts or saving to buy a home. In terms of those who will be at risk because of the interaction with benefits, as stated above, this will be very difficult to predict and people also have their own preferences. Some want to use their money today regardless of the advantages of saving for future income. Others may choose to build up their own private pension preferring to rely on this rather than means-tested support even if this may not increase their financial situation overall.
Generic advice would not recommend particular actions nor could it recommend that people opt out or stay in a pension scheme. However it could help people look at their financial situation broadly and consider the risks of saving and not saving. Where the risks of not benefiting from saving are high this can be pointed out, but it is still the individual's decision. For example a personal account is unlikely to be suitable for a single person who is a tenant, is approaching 65, and has never paid into a private pension.
The delivery of good generic advice could be made easier if other improvements suggested in this paper were implemented, as fewer people would be at any risk of not doing well from saving.
8. How could changing trivial commutation levels help?
Increasing the amount of pension that could be taken as a lump sum would leave less people trapped in the position of having a small pension which reduces their benefits.
People whose total pension fund(s) come to less that the trivial commutation limit (currently £16,000) can take their money as a lump sum rather than converting the pension fund into an income for life. This is a relatively low level of fund - someone with just over £16,000 could take 25% of this as a lump sum but would need to convert the remaining amount into a pension. A fund of this size would provide a man of 65 with a flat rate pension of only around £70 a month. A woman would receive around £65 a month. 
The PPI estimates that increasing the limit from £15,000 (the 2006-07 limit) to £30,000 would increase the proportion of people who can trivially commute from 13% to 22%. If alongside this the amount of savings ignored when assessing means-tested benefits was increased from £6,000 to £10,000 some people who might otherwise be at medium risk of personal accounts being unsuitable (eg because of interrupted working lives) would be at low risk and others who previously would be at high risk would be at medium risk.
9. How could means-tested benefits be reformed to make saving pay?
Increasing the amount of capital not taken into account for means-tested benefits and/or introducing a modest pension disregard could help ensure people benefit from saving.
Increasing the amount of capital not taken into account is mentioned above. Another approach would be to disregard a modest amount of private pension. Further work by the PPI, commissioned by B & CE Benefit Schemes looked at introducing a pension income disregard of £12 a week. Simply put, this means ignoring the first £12 a week of private pension income in the calculation of benefits. This would ensure that everyone benefited from private pension saving and would increase the saving returns for groups at risk of lower returns such as those who have been self-employed and people who rent in retirement and are reliant on Housing Benefit. The policy also promotes personal choice as those with lower pension pots would have a genuine choice between taking a lump sum, or opting for a regular, albeit small, weekly pension income.
For those living close to the poverty line, such small regular sums could make a substantial difference to their quality of life. The other benefit of this approach is that it means that promotion of auto-enrolment into personal accounts as the right option for the majority can be done with much more confidence as people would be better protected from any risks of saving.
10. So are there any disadvantages in making such changes?
There are always trade-offs that need to be considered in pension reform. While changes to trivial commutation and means-tested benefits would increase the value of saving there would be implications:
Costs: The PPI estimates the increase in trivial commutation level and savings disregards set out above would cost around £500 million a year in 2012 while introducing a £12 pension disregard would increase the cost of means-tested benefits in 2012 by 4% - around £600 million. This needs to be balanced against the advantages of reducing the numbers who may be saving inappropriately.
Capital rather than income: Increasing the amount of money that people can take as a lump sum could be seen as moving away from the aim of pensions in providing an income that lasts throughout retirement. However it could provide a valuable retirement nest egg for people with limited resources which will include the benefits of an employer contribution and tax relief. It would also mean that people with small pension pots are not forced to take an annuity at one of the poorer rates available for smaller amounts.
Levels of means-testing: Changes to make means-tested benefits more generous to those with modest savings (for example by introducing a pensions disregard or increasing savings limits) would increase the return on savings for disadvantaged groups. However they would also increase the proportion of people eligible for means-tested support in retirement and consequently the numbers who could be in the position where saving reduces benefit.
A pension disregard: This would add to the complexity of the benefit system and the PPI paper sets out a range of decisions that would need to be taken such as how it interacts with savings credit and contracting out. On the other hand an advantage over increasing the amount of capital that people can receive is that it maintains income in retirement. It also has the advantage that it would apply to people whose income fell in retirement eg after bereavement, whereas a decision around trivially commutation cannot be changed.
Another option that has been suggested is that people for whom personal accounts turn out not to be suitable should be able to claim back money contributed. This is not something we have considered in detail although our initial reaction is that this could prove more complicated than changes to benefits rules and trivial commutation. For example it would raise questions such as: how would contributions made many years ago be valued, would it apply just to people who were no better off in retirement or include those who gained something from having saved but not the full amount of the pension built up, and how would those who came on to means-tested benefits years after retirement be treated?
11. What next?
The interaction with means-tested benefits is not a reason to delay or reconsider the policy of auto-enrolment. However the Government should set up a review to look at the options and trade offs.
There are no easy answers - there never are with pension reform. However we do not believe that the interaction with means-tested benefits is a reason to delay or reconsider the introduction of auto-enrolment into personal accounts or other occupational pensions. Instead we need to consider the changes that could be introduced alongside auto-enrolment to help ensure that people with limited lifetime savings opportunities can increase their retirement incomes and benefit from the employer contributions and tax relief that better off savers receive. The work already carried out and referred to in this paper provides a good basis for further consideration. We hope that the Government will take forward a review in this area which would include modelling of the numbers likely to be at risk, an analysis of the range of options, and consultation with interested stakeholders.
All rights reserved. Third parties may only reproduce this paper or parts of it for academic, educational or research purposes or where the prior consent of Age Concern England has been obtained for influencing or developing policy and practice.
Policy Unit, Age Concern England, Astral House, 1268 London Road, London SW16 4ER. Registered charity no. 261794.
Appendix: Summary of means-tested benefits and how they interact with private savings (based on April 2007-08 rates)
Pension Credit guarantee tops income up to a set amount - currently this is a minimum figure of £119.05 a week for a single person and £181.70 for a couple. These amounts are higher for some severely disabled people, some carers and people with certain housing costs.
Pension Credit savings credit ensures that people with modest savings or pensions over and above a set level end up with a higher income than those who have not saved. The maximum savings credit is £19.05 for a single personal and £25.26 for a couple. For example someone whose only income is an occupational pension of £10 a week and a full basic state pension would be entitled to Pension Credit guarantee and savings credit and would be £6 better off than someone who just receives the basic state pension and Pension Credit guarantee.
Housing and Council Tax Benefit are based on someone's income, savings, and other circumstances including the level of rent and council tax they have to pay. These benefits provide full or partial help with housing costs.
How are income and savings treated for these benefits?
State and private pensions are fully taken into account when benefit entitlement is worked out - although as stated above people with modest levels of private pensions could benefit from the savings credit. For all 3 benefits the first £6,000 of savings does not affect benefit. Every £500 over the £6,000 threshold will be counted as an additional £1 a week income. There is no upper savings threshold for Pension Credit but there is a £16,000 upper threshold for Housing and Council Tax Benefit (except if someone is in receipt of Pension Credit guarantee).
How does receipt of pension affect means-tested benefits?
The higher someone's income the less benefit they receive. The calculations for the benefits above work in different ways. Some examples of outcomes are:
· Someone receiving the guarantee credit alone would lose £1 of benefit for an additional £1 income from a personal account (or other pension)
· Someone receiving savings credit, Housing Benefit and Council Tax Benefit would lose 91 pence for an additional £1 income from a personal account
· Someone receiving savings credit alone would lose 40 pence for an additional £1 income from a personal account
· Someone receiving Council Tax Benefit alone would lose 20 pence for an additional £1 from a personal account
Note: The figures above assume that people are not liable for income tax. Those who are would lose slightly more benefit for each additional £1 of gross income.
 House of Commons Hansard written answers 1 October 2007
 PPI Briefing note number 30, 2006. http://www.pensionspolicyinstitute.org.uk/news.asp?p=222&s=6&a=0
 Projections of Pension Credit Entitlement, DWP (http://www.dwp.gov.uk/pensionsreform/forum/docs/fs-pc-projection.pdf)
 Pensioner poverty over the next decade: what role for tax and benefit reform? IFS, 2007.
 Thoresen acknowledges that the term generic advice in not always easily understood and is better described as 'providing information and guidance to people better equipping them with the tools to make informed decisions'. His final report aims to recommend a term to be used to describe the service appropriately.
 FSA comparative tables - mid range figure for level, single life, non-smoker. www.FSA.gov.uk
 Increasing the value of saving in personal accounts PPI, 2007.
 Increasing the value of savings in personal accounts: rewarding modest amounts of pension savings PPI, 2007.