The sense that government pension policy has been made up on the back of a fag packet is irresistible

Steve Webb Liberal Democrat

The policy is meant to encourage those on low and middle incomes to save for their retirement.

But Labour former welfare minister Frank Field said it would lead to more means testing and a huge increase in tax, if fully taken up.

The plan - contained in the State Pensions Credit Bill - was also opposed by the Conservatives and Liberal Democrats.

At the moment, people without a substantial private pension are entitled to the Minimum Income Guarantee (MIG), to top-up the basic state pension.

This is meant to be a safety net to prevent pensioners sliding into poverty.

But those with savings of �10,000 or less are not entitled to a top-up - making their savings effectively worthless.

'Long-standing grievance'

From 2003, the MIG will be replaced by the pension credit.

This is designed to remove the disincentive to save by allowing pensioners with modest amounts invested in a pension scheme access to more benefit cash.

Work and Pensions Minister Alistair Darling said five million pensioners stood to gain an extra �400 a year under the plan.

He told MPs the policy "puts right a long-standing grievance. It is fair and it promotes saving".

But it can only work if pensioners are prepared to be "means-tested", to find out the size of their savings.

State second pension

And critics, including Mr Field, say that flies in the face of Labour's 1997 election pledge to reduce means testing.

Mr Darling wants more incentives for saving

He also predicted that the scheme "would not last" and, if fully taken up, would lead be the equivalent of 8p on the standard rate of tax.

He called on the government to scrap the pension credit in favour of a properly-funded state second pension.

Shadow work and pensions secretary David Willetts also cast doubt on the claim that the move would reward thrifty pensioners.

'Complex issue'

In a debate on the second reading of the Pensions Credit Bill, Mr Willetts said findings by the Institute of Fiscal Studies and the Financial Services Authority suggested the issue was not as straightforward as had been made out.

He told Mr Darling: "What you are announcing is the end of the basic state pension as a determinant of the income of pensioners.

"In future the amount you receive as a pensioner will be determined by the minimum income guarantee and the formula for determining the savings credit above that.

"So after decades, throughout most of the 20th century, when there was a belief on all sides of the House that the basic state pension would be an important part of provision for people in their retirement - the secretary of state's measures tonight say farewell to that."

'Thatcherite' approach

Liberal Democrat work and pensions spokesman Steve Webb said the measures were too complicated and it was "a nonsense " to suggest they would encourage saving.

"The theory is lovely, the bar charts look great, the practice falls short," he told MPs.

Mr Webb said there had been no logic in the government's approach to pensions.

"The sense that government pension policy has been made up on the back of a fag packet is irresistible."

He added: "They make it up as they go along, they spot the blunders one year, they try to amend it the next year.

"The pension credit, the savings credit, is a lottery for those who won't get it, it penalises women and it gives people money who haven't saved in just the same way as those who have. In what sense is that an incentive to save?"

Mr Webb accepted that there was a role for means-testing but said it should be for the few rather than the many.

He accused the government of adopting a "mass means-testing, Thatcherite approach".