Will Labour start means testing the state pension? How would it work?

I decided to take early retirement in 2020, just before the pandemic. 

I’m 66 in August and will get my state pension from early September.

I have 46 years of NI contributions and am looking forward to getting my full state pension, which I feel I have more than contributed to over the years.

I have read that the new government is considering means testing the state pension.

I would be interested in your view on this, and what they would possibly consider means testing and how that would affect the state pension.

Tanya Jefferies, of This is Money, replies: You are not the only reader who has written to us about this since the election.

Labour has said nothing to justify your suspicion, but it will be carrying out a major pension review, and a change of government is bound to prompt concern about disruption to financial matters that seemed settled.

Since a big overhaul in 2016, the way to qualify for the state pension is to build a National Insurance record over 35 years, either by paying contributions via employment or earning annual credits because of extenuating circumstances like caring duties, ill health or unemployment.

Legacy rules due to the now abolished system of ‘contracting out’ of the second state pension (also called SERPS) mean some people with more than 35 qualifying years might still get less than the full new state pension, now worth £11,500 a year.

Some people who contracted out and reached retirement age before April 2016 also receive less than that, while those who contracted in can get more.

You do not say whether you are affected by contracting out, but you or anyone who wants to can check their state pension forecast and their National Insurance record on gov.uk.

People who can afford to can buy voluntary state pension top-ups if they are short of qualifying years, or defer their state pensions to improve their payments.

So, will Labour have a different view of this system as it stands, and take the frankly radical step of cutting the state pension for those who are better off?

We asked a finance industry boss who has expertise in both our own state pension and the version in Australia, where it is means tested, to answer your question.

Mike Ambery: Australia’s means test is based on income received from all sources for an individual and their partner

Mike Ambery, retirement savings director at Standard Life, replies: Unlike most government benefits, the state pension is not means tested.

Instead, people’s eligibility is determined by their National Insurance record and it’s the payments or credits they’ve made which determine whether people receive the full sum or not.

This approach is so much a part of our retirement system that it’s rarely questioned but a number of factors have come together that mean there is an element of pressure for reform, or at least a conversation about the current approach.

The main drivers for change are our ageing society and the triple lock guarantee.

The triple lock in particular is in the spotlight.

It has been one of the most significant pieces of pension policy since it was introduced in 2010 as it ensures the state pension keeps pace with living costs and it’s been incredibly beneficial to pensioners in recent years when inflation has been high.

While it’s been valuable it’s also been expensive to maintain and a focus of much speculation about its long-term affordability.

The new Government will have to contend with these challenges but we know from the campaign trail that Labour is committed to the triple lock so the prospect of change there is slim.

It’s possible it could however look at other aspects of the state pension as part of a promised pension review to shore up its affordability however.

Means testing is used in other countries to determine eligibility.

In Australia for example in the level of state pension (Age Pension in Australia) is means tested. The test is based on income received from all sources for an individual and their partner. Subject to certain limits state pension is reduced based upon income.

The reduction by means testing could effectively mean on some levels of income no state pension would be paid or the level of state pension paid would be reduced gradually (tapered) based on income.

Income would need to be defined and could be classed simply as money received from other pensions, income from rental homes, savings, shares, equity release from home ownership schemes and even winnings from skill or luck.

It is unlikely that income would be viewed as other state related income benefits.

For any means testing to be put into place, there would need to be a system of recording income (in a similar way to a current tax return with HMRC) and the ability to challenge the assessment where people’s income varies.

That said the operational ease for the state to put means-testing in place would be possible, but it would likely be unpopular and the ability of individuals to complete and engage with it could be very challenging as people’s physical and mental capability becomes poorer later in life. 

A further complication is whilst the income test may be relevant, there would also need to be consideration of expenditure.

In particular home ownership, rental costs and care/medical costs can dramatically impact an individual’s cost of living. We do already see care costs subject to means-testing.

While some people have, or are on course to have, sufficient private pension savings to allow for a comfortable retirement, there are millions who are or will be heavily dependent on the state pension.

This might suggest that means testing is a possible route but this is likely to be unpopular.

Looking abroad again, proposals for means testing in New Zealand were quashed as people argued it is a right for all having made appropriate contributions.

An alternative to means testing, which has already been used by government to control costs, is increasing the age of eligibility.

State pension age has been gradually increasing, and is already set to increase to 67 by 2028 and 68 by 2046.

There is a chance that this could increase either further or faster based on affordability.

However, there are challenges with this approach too as it penalises those who are unable to keep working and those in poor health who may not expect to live much beyond state pension age.

What this highlights is that there are no easy answers for policy makers and the Government will be hoping it can deliver on its growth agenda to shore up public finances.

For those people at the point of state pension eligibility, the prospect of any imminent changes are lower.

The Government will want to ensure people have time to plan ahead and typically changes to state pension are implemented over many years.