Twelve million pensioners to lose out when credits are scrapped

Experts warn of a two-tier system that will last for 30 years. Chiara Cavaglieri and Julian Knight report

Anger is growing over the coalition's overhaul of the state pension system.

The plans outlined in a Green Paper last week will see means-tested pension credits scrapped and a new flat rate state pension paying an estimated £155 a week introduced in 2015. However, pensioner groups are furious that the new scheme will not be open to 12 million people who are already retired or are set to collect the state pension before 2015.

"It is breathtaking the way in which the Government has abandoned those who have spent years contributing to our society, by excluding them from plans to raise the state pension," says Dot Gibson, teh general secretary of the National Pensioners Convention (NPC).

This will create a huge divide between today's retirees, who will be stuck with the current system, and everyone else who will, in the main, benefit from a higher pension income based on a far less complicated model. Steven Baxter, longevity consultant at Club Vita, calculated that based on current trends, we will have to wait until 2027 before half of pensioners are receiving the new pension and 2042 before 90 per cent of retired people are. "That means we will have at least 30 years of a two-tier system that could provoke uncomfortable envy among current pensioners," he says.

This disparity will see one tier of existing pensioners on a full basic state pension receiving only £102.15 a week (as of 6 April 2011), and another tier of pensioners earning around £155 under the new system as long as they have 30 years of National Insurance (NI) contributions.

There are some high earners who will be wishing their state pension birthday falls before the new system comes in – in fact the figures from the Department for Work and Pensions (DWP) highlight that 1.5 million pensioners receive a state pension of at least £150 a week, many of whom qualify for earnings-related top-up payments from the state second pension (S2P). However, for those who do not currently qualify for the full basic state pension, many of whom will be women, the gap when both systems are running side by side will be even more apparent.

Women on average get about £40 less state pension than men, according to recent figures from the DWP. Women tend to have lower earnings and are less likely to build up enough qualifying years to get the full basic state pension, not least because many spend long periods out of work caring for children. Reforms are in place to address this inequality, including more generous credits for carers, but the DWP has said it will take until 2020 for the proportion of women qualifying for the full amount to catch up with men.

"The real losers will be the millions of older women who don't have a full state pension record, but would benefit from these changes," Ms Gibson said.

The self-employed are another group who suffer under the current system. At the moment, those who work for themselves are not entitled to the S2P because they pay reduced NI contributions, but under the new proposals, the S2P will be scrapped and everyone is in a position to build up as good a pension as everyone else. The only drawback will be a potential NI hike to bring self-employed rates from 9 per cent up to the 12 per cent most workers pay, although this has yet to be decided.

Another significant problem with the current system is that although almost half of all pensioners (45 per cent) are entitled to the means-tested pension credit, about one-third fail to claim it, equating to up to £2.9bn of unclaimed cash in 2008-09. Many find the system for claiming this welfare too complicated, or are hesitant to go through the process of declaring exactly what they have or haven't got. But if we do see a £140 state pension for all in 2015, this will automatically take it above the £132.60 guaranteed income that pension credit currently offers.

It seems that for anyone worried about missing out on the new state pension, either because they are already retired or will be soon, the message is tough luck – and hope for proposals for changes that existing pensioners might benefit from.

"The issue here is that this will be a really good system for future generations of pensioners – it's what we should already have – but the Government is saying it's only going to do it for future pensioners, otherwise it can't do it at all," says Dr Ros Altmann, director general of Saga. "It's what we're stuck with, but I do hope the Government may find a way to improve things for current pensioners because it's clearly not good enough."

In the meantime, there are other ways to boost a pension; those nearing retirement should think about topping up their pension now to try to get the most out of it. For many it will also be worthwhile putting off claiming the basic state pension and continuing to work instead which increases the weekly allowance by 1 per cent for every five weeks. Another option is to buy back missed years of NI contributions to fill gaps of up to six years in order to be eligible for the full state pension.

"I hesitate to say buying back extra years because you just don't know what you're going to get at the moment, but do look at what tax breaks you could take advantage of and think about sheltering money in an individual savings account (ISA) ahead of retirement," says Tom McPhail, a pensions expert at Hargreaves Lansdown.