The November 2000 pre-Budget report announced a major package for pensioners. Its main elements were:

• above-inflation basic pension increases in 2001 and 2002;
• substantially above-inflation increases in the means-tested Minimum Income Guarantee (MIG) in each of the next three years;
• and, from April 2003, the introduction of a new element into the means-tested benefit system known as "Pension Credit".

Overall, the package means the Government will pay over £4 billion extra annually to pensioners by 2003/04. This is revealed in new analysis by the Institute for Fiscal Studies, published today.

The effect on pensioner incomes will be substantial. By 2003 the average single pensioner will gain £9.68 per week, while the average pensioner couple should pocket £11.05. And the impact will be greatest for those on lower incomes. In the chart, all families with someone of over sixty have been ranked by net income (adjusted for family size) and then divided into ten equally-sized 'deciles'. The poorest 10% of pensioners should see average incomes increase over 20%, and each of the bottom five deciles should see an average gain above 5%.

Report author Tom Clark said: "There can be no doubt that the Government is diverting significant extra resources to pensioners. But its basic strategy is still to extend means testing, a policy which raises a number of issues." Once the full package is implemented 60% of the entitlement created will be income based. More generous targeted benefits will see more pensioners being means-tested. By 2003, increases in the MIG alone mean that the number of adults in entitled families will rise by 600,000 from 2.6 million to 3.2 million. As the current system of means testing has widely-perceived flaws, the Government has chosen to couple its extension with the introduction of the Pension Credit.

The current system 'tops-up' the incomes of all poorer pensioners to the same level. So a low-income pensioner, who has saved to provide an extra weekly £1 of income, simply receives ñ less top-up: net income is unchanged by private income, a situation widely seen as unfair. Pension Credit addresses this by reducing entitlement by just 40p for each £1 of private income, which should mean pensioners are always better-off from saving, as 60p of each ñ provided for themselves can be kept. But in practice, the reform's effectiveness might be reduced by interaction with other benefits. Unless housing and council tax benefits are also reformed, then someone who received these as well as Pension Credit would actually gain only 9p for each pound of private income.

A related concern is that the current system might mean that people planning for retirement are put off bothering to save, increasing welfare bills in the long term. Whether Pension Credit helps here is unclear. Certainly, saving becomes 'better value' for those who would in any case have been on benefit, and this should encourage more saving. But the more generous rules of Pension Credit mean 2.3 million adults in families who were ineligible for MIG will be entitled to the Credit, and so exposed to the means test on an income top-up for the first time, making saving 'worse value' for them. Finally, by boosting the incomes of all poorer pensioners, the reforms will cut the amount of saving required to attain any particular 'target retirement income', which might also discourage saving. Theoretical analysis of the reform leaves its impact on overall saving an open question.

The current benefit system reduces benefit entitlement in respect of capital, but Pension Credit will consider only the income capital generates, a change aimed at encouraging saving. The reform will introduce a market distortion, which makes it more attractive for pensioners to hold assets that produce high capital gains rather than income-generating assets, like annuities. In other aspects of policy, notably the plans for stakeholder pensions, Government policy has worked in the opposite direction, encouraging purchase of annuities.

Ends

Notes to editors

1. All cash amounts are in 2000 prices.
2. Results estimated using TAXBEN, the IFS tax and benefit model, run on 1998/99 Family Resources Survey.
3. TAXBEN assumes full take-up of all benefits. If the proportion of pensioners failing to claim means-tested benefit entitlement remains unchanged, the effect on pensioner incomes will be significantly smaller in practice than in theory.
4. Constant levels of real non-benefit income have been assumed.
5. For more details, see IFS Briefing Note No. 17 Recent Pensions Policy and the Pension Credit, by Tom Clark.