The government has now put forward proposals in a Green Paper for a single-tier, flat-rate pension of around £140 per week. Experts believe the changes would benefit seven million pensioners while another five million would lose out. Find out who the winners and losers are.
The flat-rate pension would replace the current two-tier system of basic state pension and second state pension (S2P). Those who currently rely on a basic state pension would see their pension go up, but those who would enjoy additional state pension based on higher earnings stand to lose out as this extra state pension will cease under the new system.
A Pensions Policy Institute (PPI) report on the Green Paper has suggested that the overall impact of introducing a flat-rate state pension in 2016 will be 'cost neutral', and benefit seven million pensioners, but could leave five million less well off than they would be under the present system.
PPI director Niki Cleal said: "Some seven million pensioners could see their household pension income increase under the single-tier reform by 2034, but five million pensioners could see their household's pension income reduce.
"A single-tier pension is likely to be beneficial for some women, carers and some low earners who tend not to qualify for a high amount of state pension in the current system. The self-employed may also benefit, although they may have to pay higher national insurance contributions in the future."
Higher earners may lose out
Cleal also stated that 'those individuals who would have qualified for large amounts of state pension in the current system could lose out the most under a single-tier pension - often moderate to higher earners with an expected full career and National Insurance contribution record.
"A single-tier pension could also significantly reduce the percentage of pensioner households eligible for pension credit from 35% under the current system, to around 5% of pensioner households by 2055."
An end to pension means testing?
One big benefit of a flat-rate system is the end of pension means-testing, whereby many pensioners currently receive a basic state pension and an additional top-up of pension credit to take their retirement income to the a minimum level.
As well as being costly to administer, the current means-tested system leaves a large number less well-off than they should be as a result of failing to claim. The Department for Work and Pensions estimates that between 27% and 38% of pensions currently fall into this category.
Although it is proposed to bring in the new system by 2016, the changes only affect future pensioners. Those who are already claiming state pension will not switch to the new system but continue to receive basic state pension and pension credit if they qualify for it.
As well as indicating that current pensioners will continue with the old system, the government has promised that accumulated entitlement to S2P will not be lost. This means that a group of pre-retirement savers will still enjoy an augmented state pension. They will no longer be able to carry on building up S2P however, so the two-tier system will eventually die out. Anyone 'contracted-out' of S2P will have to start paying higher national insurance contributions.