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BeeHive  >  Press Articles  >  In depth: Change is coming and it cannot be ignored.

In depth: Change is coming and it cannot be ignored.

John Boyd-Carpenter was minister of pensions and national insurance during the time one of the most important aspects of Britain's post-war pension system was introduced through the National Insurance Act of 1959.

That act, when implemented in 1961, put in place a second state pension to supplement the flat-rate old-age pension. Boyd-Carpenter and his junior minister, Margaret Thatcher, introduced the novel concept of 'contracting out'; the process whereby employers running schemes that provided at least an equivalent pension benefit to the state second pension scheme could, with their employees, pay a lower rate of national insurance contribution (NIC).

Contracting out, effectively diverting NICs into company pension schemes, became the engine that drove the unprecedented growth in private sector pensions in the UK through the 1960s and 1970s.

Thatcher's government in 1988 extended contracting out to defined contribution (DC) pension arrangements, thereby powering the spread of private sector individual pensions and modern group pension schemes with the same engine.

Contracting out has effectively meant that much of the money raised through NICs for the provision of earnings-related state second pensions has found its way into private sector pension schemes of one kind or another.

Our system, I think, has given us the best of both worlds: a compulsory workplace pension scheme provided on a pay-as-you-go basis through the national insurance system, but with the option of contracting out of that in favour of a funded private sector alternative.

But our 49-year experiment with the compulsory provision of earnings-related state second pensions is about to come to an end. From April next year the state second pension will begin the process of being changed to a scheme that will eventually provide a flat-rate pension 'funded' by earnings-related NICs.

Eventually all employees will become eligible for a flat-rate basic pension and a flat-rate second pension, both provided by the state.

This is being done as a redistributive measure in part to curb the spread of means-tested handouts to the elderly in the future, and as a consequence the right to contract out into DC schemes will soon be removed. The engine that has driven our private sector pension schemes for most of the last five decades is gradually being shut down.

These are fundamental changes that are happening to our pension system. I think it's really important that we understand them and what they may mean for us all.

Steve Bee

First published in Pensions Week, 9 November 2009