Plagued by confusion and policy U-turns - UK State Pensions
Written by Lynda Calver on June 21, 2015.
Most working lives encompass three or four decades. That’s a long period and over such a wide span of time there are many factors that can affect a pension plan. Although the details below specifically concern the UK state pension they are illustrative of just how important it is to regularly review your retirement plans.
In March 2013, the UK government announced a new flat rate state pension, to be introduced in 2016, billed by Pensions Minister, Steve Webb, as simple, fairer and easier to understand. The new system will be a single-tier system with everyone paying the same rate of National Insurance Contributions and receiving the same state pension, expected to be £155 per week.
However, the small print, which is full of complicated and technical clauses, reveals that in fact many of those close to retirement could miss out on the full pension as well as losing thousands of pounds as inflation-linked increases on company pensions are withdrawn. Those affected are individuals who have contributed at some point during their working lives to employer final-salary schemes. Under these schemes, employees could opt to pay a reduced rate of National Insurance (10.6% instead of 12%) in turn for opting out of extra benefits such as the State Second Pension. However under the new rules, because they paid lower contributions, they could lose some of the new £155 a week state pension although how much is yet to be confirmed. Middle to higher earners risk being worse off as a result of this legislation.
Under current pension legislations, everyone who has made National Insurance contributions for at least 30 years receives the state pension of £113.10. The State Second Pension (former known as State Earnings Related Pension or SERPS) was an additional pension payout available to those who didn’t opt out because they benefited from a company final-salary scheme. 80% of older workers have at some point of their working life taken this option, known as ‘contracting out’.
From next year, entitlement to a full state pension will be available to anyone who has made NI contributions for at least 35 years, an increase of 5 years on current rules. In order to simplify the system, the second tier benefits – State Second Pension and Pension Credit – will be abolished.
It sounds a lot simpler but, for many, working out exactly what they will receive will not be that easy. When the new system is introduced in April 2016, the government will make a calculation based on the number of years an individual has contributed and the amount of additional state pension earned. This will be known as the ‘Foundation’ amount. If it totals less than £155, anyone with 35+ years of pension contributions will have their payouts boosted. However those who have contracted out, will be subject to a reduction for each year they were contracted out, based on the fact that they made lower NI contributions during this period. The amount of the reduction is yet to be announced. For those nearing retirement, this leaves them guessing as to how much state pension they will receive. Some may in fact receive no more than the existing state pension of £113.10 per week, which means that they are down to the tune of over £2000 per annum.
There are also changes for those contributing to a private pension scheme and who contracted out of SERPS between 1978 and 1998. They were promised that the government would fund, in part or in total, the inflation increases on the guaranteed minimum pension of their final-salary schemes to ensure that their benefits were equal to SERPS. However a change of policy means that after April 2016, inflation increases will no longer be paid by the government. This retrospective change may mean losses of thousands over a lengthy retirement, especially for those who contracted out in the decade from 1978 to 1988 who won’t see any inflation increases at all.
The Government has also announced plans which will affect employers who offered employees final-salary schemes. The 3.4% National Insurance rebate is to be abolished. Employers can pass these cuts on to their employees by cutting benefits or increasing contributions with the result that employees benefitting from these schemes will be asked to contribute an average of £23 extra per work as of 2016, when they start to pay the full 12% rate of NI contributions.
The news of these changes, revealed in a Money Mail investigation, may require you to review your pension planes particularly if you are approaching retirement in the next couple of years.
If you wish to see if any of these changes will affect you or wish to review your pension arrangements in general please do get in touch.