The new pension credit proposals

The November 2001 pre-Budget report finalised the Government's plans for the "Pension Credit". A new IFS report, released today, analyses the proposals.

The Pension Credit will be introduced in October 2003. It aims to:

• Increase the incomes of poorer pensioners.
• Ensure saving is better rewarded by reforming the system so that poorer pensioners can keep more of an private income.

Overall, the package means the Government will pay about £2 billion extra annually to pensioners.

Poor pensioners will gain most — the bottom 10% will gain most, an average of £11 a week. The proportional effect on incomes falls off steadily as income rises, as the figure shows. On average pensioner couples will gain £6.60 a week, while singles will gain £5.30.

Figure: Effect of Pension Credit reform across the Pensioner income distribution

Pensioner poverty could be substantially reduced. We estimate the reform could cut the proportion of pensioners below one widely-used poverty line by five percentage points. And this is in addition to the poverty reduction achieved by the large increase in the Minimum Income Guarantee for the poorest pensioners, which is currently being phased in. But the decline in poverty will only materialise if pensioners can be persuaded to claim the benefit that they are entitled to, and at present around 30% of pensioners entitled to means-tested benefits do not claim them.

Report author Tom Clark said: "Whether the Pension Credit succeeds in alleviating pensioner poverty will depend on whether pensioners can be encouraged to apply for the extra money they are entitled to. Achieving a simpler and more pensioner-friendly benefit claims procedure is therefore crucial."

The Autumn 2001 Pension Credit proposals modified the original plans. In particular, the Government has:

• Decided against plans to abolish entirely the rules which reduce benefit entitlement when pensioners hold capital. Outright abolition could have undermined the incentive to save in stakeholder pensions.
• Increased the generosity of housing and council tax benefit for pensioners. These changes ensure that reductions in these benefits do not eat into gains from the Pension Credit. These changes have approximately doubled the cost of the reform.

The changes to housing benefit and council tax benefit ensure that the effect of the Pension Credit reform on the incentive to save for retirement is more positive than it was when we analysed the original proposals. The number of pensioners for whom building up extra private pension entitlement would not be worthwhile — because reduced benefit entitlement would completely or almost completely offset it — will be sharply reduced. But the overall effect on saving incentives remains mixed, because the retirement incomes that the reform brings about could lead some individuals to decide that they need to save less than they otherwise would have done to achieve a comfortable retirement.

The policy represents a further move towards a means-tested pension system. It will increase the number of adults aged 65 or over in families entitled to one or more means-tested benefit by almost 700,000, and this number is likely to grow over time. Indeed, the main outstanding questions hanging over the policy concern the longer term — not only the large number of individuals who will eventually be entitled, but also how much it will cost and whether or not it will fit in coherently with the rest of the pension system. The answers to all these will depend entirely on how the new benefit is indexed.

Ends

Notes to Editors

1. All cash amounts are in 2001 prices.
2. Results estimated using TAXBEN, the IFS tax and benefit model, run on 1998/99 Family Resources Survey.
3. Modelled reform is only planned structural changes to benefit system. The increase in the rate of the Minimum Income Guarantee due over the next few years is excluded.
4. 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 theory.
5. Constant levels of real non-benefit income have been assumed.