State pension: Could it be means tested and would this affect existing pensioners?

I’ve read plenty in the media lately regarding means testing of state pension for people who have private pensions and/or own their property.

I personally feel concerned about this and I am sure I am not the only one.

Questions that come to mind (I am sure there are more) are:

1. Is this likely to be introduced?

2. At what level would this likely to be triggered, for example would it be the level of private pension and or the value of the home someone owns?

3. Would the Government have to give 10 years’ notice for the introduction of this as they do with increases in qualifying age?

4. Would it affect those already claiming the state pension?

Your comments would be welcome and hopefully bring some peace of mind to those already claiming and those due to claim in the coming years.

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Steve Webb replies: When an ‘Old Age Pension’ was first introduced in the UK in 1909 it was paid only to those with annual means (income) below a set level.

But since 1948 the National Insurance retirement pension has been paid largely regardless of people’s income or wealth. 

The main exception to this was a period when those still in work could see their pension reduced based on earnings limits, but these rules were abolished in 1989.

Today, the state pension is payable even to those on the highest incomes, but it is – of course – subject to income tax, meaning that up to 45 per cent of the pension is already clawed back from the wealthiest.

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In my view it would be a huge backward step to introduce any other element of means-testing into the state pension system. I also think that it is highly unlikely that this could happen in the foreseeable future, for reasons I will explain.

The stories that you may have read about financial pressures on the state pension system focus on two things.

First of all, the growing number of pensioners, not least because the ‘baby boom’ generation of the late 1950s and early 1960s is now reaching pension age.

Second, the relative decline in the number of workers to fund those pensions, in part due to a falling birth rate.

How does the Government keep state pension costs down? 

There are several things which the government could do – and has done – to reduce this pressure, all of which have been chosen in preference to going down the means-testing route.

The first is to increase the state pension age. Once male and female state pension ages had been equalised at 65 in 2018, the pension age was raised to 66 in 2020, and will rise again shortly from 66 to 67 between April 2026 and April 2028.

Beyond this, the timing of future changes to state pension ages is less clear. Pension age is currently due to rise from 67 to 68 between 2044 and 2046. But two separate government reviews in recent years have proposed that this age be brought forward, typically to the late 2030s.

Whatever decision is eventually taken on moving to age 68, it does seem highly likely that pension ages will continue to rise, and ages of 69 and even 70 have been floated in government reviews.

Another option to contain costs would be to increase the state pension more slowly. For example, between 1979 and 2010, the annual increase in the state pension was pegged purely to price inflation, resulting in the notorious 75p increase in 2000. 

Since 2010 we have seen a relatively generous uprating process under the ‘triple lock’ rules. But if the government wanted to reduce the future cost of the state pension it could make annual uprating less generous.

A third alternative to means-testing would be to make other changes to the rules to make the state pension less expensive to provide. 

For example, the new state pension is (loosely) based around a 35 year requirement for a full pension, whereas between 2010 and 2016 you could get a full basic pension for just 30 years of contributions. 

If the government wanted to save money, it could tweak rules like this, perhaps raising the target for a full pension from 35 to 40 years for example.

I have gone into all these examples in some detail to show that governments can (and often do) save money on state pensions without resorting to means-testing, which most politicians would regard as a ‘nuclear option’.

Will the Government start means-testing the state pension? 

There are several reasons why I think introducing means-testing is highly unlikely.

Pensioners are a large and growing proportion of the population. They are also much more likely than younger people to vote.

Even if means-testing only started with the very wealthiest of today’s pensioners, voters would no doubt suspect that the principle would be extended to them. It is hard to see any political party being willing to take such a risk.

Assuming that it would be political suicide to introduce means-testing for today’s pensioners, how about doing it for those yet to retire?

In this case you get what the politician most dreads – all of the political flak and none of the money.

As your question suggests, if such a change were to be made for future pensioners, people would need to be given decent notice so that they could plan accordingly. 

If, as you suggest, ten years’ notice was given, then today’s politicians would be announcing a deeply unpopular change which didn’t give them any extra money to spend in the next two Parliaments. It is hard to see how this works politically.

From the perspective of pension policy, means-testing older people sits very badly with the current policy of automatically enrolling millions of people into a voluntary workplace pension. 

If people in work knew they would get less state pension if they saved in a private pension, they might well be tempted to opt out of their workplace pension. This would ultimately leave people more dependent on the state in retirement, not less.

If you look around the world it is relatively rare for state pension systems to be means-tested, though Australia is a notable exception. 

But in Australia workplace pension saving is compulsory, which means people have no choice but to build up a private pension even if this reduces their state pension.

In short, I think for political reasons there is no chance of means-testing today’s state pensions, and very little political upside in announcing plans to do so in decades to come. 

There are other levers which governments can pull to control state pension spending and I strongly suspect that those are the levers they will continue to pull.