The state pension should be mean-tested for retirees on incomes over either £45,000 or £30,000 to make the system fairer and more affordable, according to an academic study.
Cuts in payouts to wealthy pensioners should be introduced gradually from 2019, because otherwise the state pension age will have to rise for everyone, it argues.
Limiting the extent to which the better-off receive the benefit would allow the Government to delay state pension age increases and curb costs for the working population who must fund payouts, believes Paul Sweeting, Professor of Actuarial Sciences at the University of Kent.
State pension payouts: Means test could cut in at the current income threshold for 40 per cent higher rate taxpayers, which is £45,000 a year
Proposals that the state pension age should rise to 68 by 2039 are currently under consideration by the Government, with a decision due soon. The state pension age is already due to rise to 67 for both men and women by 2028.
Meanwhile the ‘triple lock’, which sees the state pension go up by at least 2.5 per cent a year, is set to continue for now under the Tory deal with the DUP following the election.
The basic state pension is currently £122.30 a week, plus additional top-ups if you paid for them, for those who reached official retirement age before April 2016. It is £155.65 a week if you qualify for the full new flat-rate payout and retired since April last year.
At present, everyone builds up rights to a future state pension according to their National Insurance payments record. You can claim it no matter how wealthy you are because it is based on contributions made over your working life.
In response to the University of Kent proposal, a Government spokesperson said: ‘The new state pension is not means tested and it is right that people who have paid into the National Insurance system are provided for in later life. There are no plans to change this.’
How would means testing the state pension work?
Two ways to means test the state pension for better off retirees, in order to control costs and delay increases in the official retirement age, are proposed by Professor Sweeting.
The test could cut in at the income threshold for 40 per cent higher rate taxpayers, which is currently £45,000 a year.
Means test: How state pension could be reduced for wealthier pensions from 2019 onwards (Source: University of Kent)
Alternatively, it could be set half-way up the income band for 20 per cent basic rate taxpayers – currently between £11,500 and £45,000 – which would put it at about £30,000.
Introducing cuts to the state pension could happen at different rates, depending on which threshold was used. Both are illustrated in the table on the right.
1) ‘High and fast’: If it was £45,000, then in 2019 anyone earning enough to pay higher rate tax would give up £1 of their basic state pension or new state pension for every £10 income received in the higher tax band.
In 2020, the rate of means-testing would be stepped up to £1 of pension lost for every £9 of income in the higher tax band, then £8 in 2021, £7 in 2022 and so on.
Full means testing at a rate of £1 lost for £1 earned would be reached in 2028.
2) ‘Low and slow’: If the means test was set at £30,000, £1 of basic state pension or new state pension would be sacrificed for every £20 earned above the means-testing limit in 2019, then for every £15 in 2020, £12 in 2021 and so on.
Full means testing at a rate of £1 lost for £1 earned would be reached in 2040.
Safeguards would be needed to prevent wealthy people transforming income into capital gains to avoid the means test, says the study. Also, as the rate of means-testing increased, people would have less of an incentive to save for retirement, meaning they might have to be compelled to do so, it adds.
What about increasing the state pension age?
Some form of means-testing of the state pension is necessary to make it affordable for future generations and fairer for those with lower life expectancy, according to Professor Sweeting.
The Government’s current plan is to extend the state pension age, which benefits the wealthiest in society who tend to live longer, he argues.
Meanwhile, costs are mounting for the working population who pay for the system.
He says the burden of paying for the state pension rose from £2,000 a year per worker in 2009 to £2,500 a year per worker in 2015. It is projected to reach £2,900 a year per worker by 2040 when current plans to increase the state pension age are taken into account.
Professor Sweeting believes the state pension age would need to rise a lot faster to keep costs under £2,500 per worker. The state pension age would need to rise to 68 by 3030, 69 by 2042 and 70 by 2056, he says.
This rate of increase would see an increasing proportion of the state pension end up in the hands of the wealthy, who have a higher life expectancy, according to his study.
For example, if the state pension age was 69, the wealthiest would expect to receive their pension for more than 40 per cent longer than the least well off, it says.
However, means-testing would allow the Government to postpone state pension increases.
Under the ‘high and fast’ scenario, the study says costs could be controlled and the state pension age could rise gradually to 67 between 2025 and 2035, to 68 between 2035 and 2045, and to 69 between 2054 and 2063.
Professor Sweeting works at the University of Kent’s School of Mathematics, Statistics and Actuarial Science. He was previously head of research at Legal & General Investment Management, and before that a European head of strategy and a managing director at JP Morgan Asset Management.
Looking ahead: Some form of means-testing is necessary to make the state pension affordable and fairer for , according to Professor Paul Sweeting.
How should we pay for the state pension in future?
The argument over whether to keep the state pension triple lock and how to pay for it became a big issue in the recent election.
The popular policy means annual rises in the state pension are decided by whatever is the highest of price inflation, average earnings growth or 2.5 per cent.
The Conservatives proposed a switch to double lock, which means it would only go up by whichever is the highest of inflation or earnings growth, a change pension experts say would lead to lower increases for pensioners in future.
But this plan was dropped under the party’s deal with the DUP to maintain a majority in the new hung parliament.
The OECD, an organisation of 35 economically powerful nations including the UK, said scrapping the state pension for the richest to increase payouts for poor retirees should be considered.
Axe the state pension for the richest 5-10 per cent, get workers to pay in more, and make people wait longer before they claim are the main options to deal with funding pressures, OECD official Mark Pearson told the Financial Times.
Paying the state pension only to those who really need it would ‘ease the tyranny of the maths’ as the elderly population grows while the number of workers declines, suggests the Paris-based group’s deputy director of employment, labour and social affairs.
But Chris Noon, partner at pensions consultancy Hymans Robertson, argues people are not saving enough for retirement so the state pension will still need to increase faster than inflation or earnings whatever we do about the triple lock.
He contends that the triple lock has cost the government £1.8-2billion over seven years, while the launch of the new flat rate state pension in April 2016 will ultimately save the Government £8billion a year.