UK pensions: when is a flat-rate pension not a flat-rate pension?
Written by Carl Turner on November 26, 2014.
Promises, promises! When Pensions Minister, Steve Webb, announced a simpler, fairer and easier to understand flat rate state pension system for the UK, the news was largely welcomed. The prospect of a single-tier system with everybody paying the same rate of National Insurance and everybody receiving the same pension is a great idea in theory, but as ever, in practice the announced changes are not as simple or as clear-cut as they first seem.
From April 2016, any individual who has worked and made National Insurance contributions for at least 35 years will supposedly be entitled to a full state pension, widely expected to be £155 per week. This compares to the current full state pension of £113.10 payable to workers who have contributed for 30 years. However under the current system, many retirees receive extra top ups through second tier pension benefits, namely the State Second Pension and the Pension Credit. The new regulations will do away with these second tier benefits seemingly simplifying the system but in reality, complicating things for many. Drilling down into the detail, 58% of retirees will not get the full single-tier amount in 2016 according to one analysis – and many are likely to be worse off under the new regulations.
From April 2016, the government proposes the calculation of a ‘foundation’ amount for everybody reaching retirement. This will be worked out by taking the number of years that person has paid National Insurance contributions and the amount of additional state benefit they receive. If this amount comes out at less than £155, the government will top up to the flat rate for anyone who has contributed for a minimum of 35 years. However, the devil is in the detail and there are exceptions.
These include those close to retirement who have at some time during their working lives benefitted from an employer final-salary scheme and contracted out of the State Second Pension (also known as State Earnings Related Pension or SERPS). It is estimated that up to 80% of older workers fall into this category, mainly middle to high earners. The trade-off for contracting out was that paid National Insurance contributions at 10.6% rather than the full 12%. Now the government is saying that those lower NI contributions will mean an as-yet-unquantified reduction on the £155 a week state pension. The government claims that the vast majority of retirees will be getting a bigger pension under the new regulations than they would currently be entitled to but has yet to provide the figures to back this up, and many people about to retire are still in the dark as to their entitlement.
The situation is worse still for those who contributed to a private pension scheme and contracted out between 1978 and 1998. At the time, the government pledged to fund any increase in inflation on the guaranteed minimum pension paid out by their final-salary schemes to match the benefits offered by SERPS. Now the government has said that they will no longer pay these inflation increases which leaves many with a black hole of thousands of pounds of pension income over the course of a 30 or 40 year retirement. Effectively, inflation will mean that their pensions will be falling in real terms year on year.
Some employers will be adversely affected by the new leglisation too. Those who offered employee final-salary schemes previously enjoyed a rebate of 3.4% on their National Insurance contributions but this benefit will now be slashed. To compensate, these companies are permitted to either cut the benefits of their employees or ask them to increase contributions. Employees affected will be worse off to the tune of £23 per week on average.
The constant changing of the pensions goalposts is a source of worry for many people who are nearing retirement. The question marks which remain over whether or not they will receive the full £155 per week state pension means that they cannot make accurate financial plans for the future, which can be very stressful.
Those retiring imminently don’t have time on their side to remedy this situation but the rest of us can take a valuable lesson from their experience; and that is not to rely on a state pension. Aside from the difficulty in working out exactly what your entitlement will be, however much the state decides to give you, it won’t afford you the kind of retirement that I’m sure you are hoping for. That is why a private, personalised pension is a must-have for each and every one of us and why I am passionate about helping individuals put a plan in place to fund the retirement that they desire.