Stealth tax' on pensions

Millions of people may receive only minimal benefits from their private pensions because of the government's state pension regime, according to experts.

On the eve of the Labour conference, calculations provided to The Observer have convinced pensions experts and charities for the elderly that the government's means-tested pension system, designed by Gordon Brown, is eroding the value of saving for retirement.

Christine Farnish, chief executive of the National Association of Pension Funds, said company pension schemes were already starting to question the value of signing up lower income workers to their schemes. The scheme managers feared workers might be wasting their money.

'It is [also] impacting on insurance companies. They don't touch businesses where there are people on low incomes. It is partly economics and partly because of the risk that someone will say in 20 years' time that they were mis-selling.'

The problem arises from the way small incomes are treated under the state system. Means testing will top up the basic state pension, which is just £79.60 a week for a single person. Last year, the government introduced a new form of pension means-testing offering extra state assistance, beyond that paid to people with no private savings to those with modest savings. But experts believe the policy is backfiring. This is because the extra income may be minimal and the state's top-up benefit is withdrawn on a sliding scale of between 40 and 100 per cent. This is equivalent to taxing pensioners' savings at those rates.

To achieve a private pension income that is free of all means testing, savers today would have to retire with a pension fund of at least £75,000. The average fund is worth only £24,000.

According to projections for The Observer by actuaries Mercer, someone in their early 20s would need to start saving at a rate of £280 a month to build a fund big enough to escape means-testing. Alison O'Connell, director of the pensions think tank the Pensions Policy Institute, said: 'It is a real barrier to saving.'

Mervyn Kohler, of charity Help the Aged, said: 'If you are not in the top 40 per cent of earnings, you are probably wasting your time putting your money into pensions savings if present policies continue.'

Means-testing has been expanded dramatically under Gordon Brown, who sees it as the best way to target state resources at the most needy. But a succession of organisations, from the Confederation of British Industry to the two main opposition parties believe that means-testing is threatening to undermine the entire pension system by discouraging private saving and increasing the cost of state assistance for the elderly.

The Institute for Fiscal Studies has already calculated that more than 80 per cent of pensioners will be receiving means-tested pension payments by 2025.

O'Connell said that it was virtually impossible for financial advisers to categorically recommend private pension saving.

'They can't unambiguously say "save in a pension, it will be good for you",' he said.