Choosing the shape of pensions to come

One disappointment for existing pensioners is that they are excluded. Anyone who retires before these measures are implemented will receive their state pension under existing arrangements.

A second disappointment is that there is no clear timetable by which change will be implemented, leading to continued uncertainty for those retiring over the next couple of decades.

Finally, although millions will be better off in retirement, many will end up paying dearly for an inferior pension.

Nevertheless, the proposals have been warmly welcomed. National Association of Pension Funds chief executive Joanne Segars said: "We've endured one of the meanest state pensions in Europe for far too long. The current system is not only unfair, it's a complex mess. Even pension experts struggle to calculate their own state pension from a jigsaw of payments and credits."

Katja Hall, Confederation of British Industry policy director, agreed: "Simplifying the state pension is good news, as people will get their pension without the bureaucracy of a two-tier system and means-testing."

However, some were disappointed by the lack of detail or timetable. Chris Curry of the Pensions Policy Institute said: "They have started to raise the issues but only with a loose description of where they would like to get to. There isn't much detail and it is very thin on numbers."

We look at the proposals and try to answer your questions.

Q Are we finally getting a universal pension?

A No. Not everyone will get one, only those who contribute. The paper makes two alternative proposals. The first envisages our existing arrangements continuing, with some amendments. The second option, which is clearly favourite, looks like a flat pension.

Q Why do I find all this so hard to follow?

A To understand what is going on, you have to first understand how the existing system works. Firstly, we have a flat basic pension of currently 97.65, available to anyone who has worked and paid full national insurance contributions for 30 years, or who has childcare or caring credits worth the same amount.

On top of that, many employees who are contracted into the state second pension receive an earnings-linked top-up known as S2P, or its predecessor Serps (state earnings-linked pension).Those who are contracted out into an employer or personal pension look to their employer or themselves to provide this top-up.

Finally, the self-employed receive no earnings-linked top-up to their basic pension, and therefore pay lower national insurance contributions.

Q What was wrong with this system?

A Many, particularly women, were excluded from the basic pension and did not work, so could not build up a decent earnings-linked top-up.

Furthermore, the better-paid could do quite well from the old Serps system, accruing around 175 pension a week on top of their basic 97.

The last government decided to make it fairer, so that everyone got the same out of both the basic pension and the top-up. This meant some would get more for paying in less, while others who paid in more would see their benefit cut.

To do this, it was decided to gradually reduce the worth of the top-up, so that rather than being linked to earnings, everyone got the same amount.

For example, currently you can build up an earnings-related top-up pension on a salary between 14,000 and 40,000. By the mid-2030s, only earnings of 14,000 will be taken into consideration, with everyone accruing the same. For every year in work, or with caring credits, you will be credited with 1.60 of pension in retirement.

Q How would the first option work?

A The first proposal is that we simply speed up the rate at which we get rid of the earnings-related top-up, so a completely flat accrual rate is reached by, say, 2020.

You would still have to contribute for 30 years for your state pension, but you could earn 1.60 worth of top-ups for up to 50 years. Contracting-out arrangements continue separately, and the self-employed continue to do their own thing.

However, the problem with this is that by 2050 only around half of retirees would be receiving the equivalent of 140 weekly. The basic pension would rise in line with earnings, while the state top-up is linked to the much lower Consumer Prices Index.

More radically, the self-employed could be brought into the system and both elements of the pension linked to earnings.

However, this would cost more money than is available to the Department for Work and Pensions, and would require the initial pension to be lower.

Q What is option two?

A This has become known as a universal pension, but is actually a single payout of probably 140 in today's money, which includes both the basic pension and the earnings-linked top-up.

You would have to have made at least seven years of contributions to qualify for any of it, and require 30 years' contributions to receive the full amount. It would all be uprated each year.

The second state pension would disappear, so would the ability to contract out. Savings credit would also be abolished.

The self-employed would be brought into the system, but would have to pay higher national insurance contributions.

Q When might this pension begin to be paid?

A There is no indication of this in the paper. Commentators are convinced it could not be achieved in the current parliament. There is some possibility it could begin in 2015/16, but many are doubtful.

On the one hand, it is vital it is introduced as soon as possible, to make sense of the new quasi-compulsory workplace pensions, known as auto-enrolment, which are being introduced in 2012.

From then, everyone not in a company scheme must automatically be enrolled in one, or in alternative arrangements such as Nest (the government-sponsored National Employment Savings Trust).

But they can opt out. Without reform of the state pension, the benefits of saving under these arrangements is very unclear.

Q Will everyone be better off?

A No. Those on higher than average earnings will continue to pay high rates of national insurance as a percentage of their earnings, but only receive the small flat top-up pension in return.

Furthermore, those who work for more than 30 years could end up paying up to 20 years worth of national insurance for no further benefit.

Q I have contributed to Serps and S2P for 30 years and expect my state pension to be topped up. Will I lose this money when the new flat pension is introduced?

A No. The entitlement you have built up already will be calculated. Where this is more than 140 (in today's terms) you will receive the extra.

Q I contracted out of Serps. Will I keep this money and get my 140?

A No. Some people contracted out of Serps into a personal pension and then contracted back in again. Most company pension money purchase schemes are also now contracted back in. Some final salary schemes and all the public sector pensions are contracted out.

At retirement, the Department for Work and Pensions calculates how big your total state and top-up pension should be and then subtracts an amount corresponding to the years for which you were contracted out of the state scheme. This should therefore be paid by your company or personal pension.

Similar calculations would have to be made if the new single-tier pension was introduced. The green paper envisages that individuals would see their state pension entitlement made up from state and private sources up until 2050, until the legacy of contracting out had worked its way completely through the system.

Q I am an engineer and belong to a contracted-out final salary company scheme. If contracting out is to end, what does this mean for me and my pension?

A The first impact you will notice is that your national insurance contributions will rise by 1.4 per cent. But your employer would see their contribution on your behalf rise by 3.4 per cent of your salary. The expectation is that this would lead to many more scheme closures.

Q I am a teacher in a contracted-out public sector scheme. What will ending contracting out mean for me?

A As with private sector employees, your NI contributions will rise by 1.4 per cent. Otherwise, the difference is an accounting exercise, with money moving from one part of the government's balance sheet to another.

However, the green paper says the change in employer contributions could mean a review of schemes so benefits are reduced to reflect the state pension payout.

Public sector pensions are already under review, but a new formula for valuing pensions announced in the Budget could add up to 12 billion a year to the existing 25bn annual bill.

Q I am self-employed. Will I get a pension of 140?

A You will be able to contribute towards one in the future, but you will have to pay higher NI contributions. The paper does not explore how the NI system for the self-employed will be reformed.