The State Pension system has been under scrutiny for some time now, with many arguments put forward that the complexity of the system is a barrier to individuals saving for retirement – The current system is a ‘two-tier’ approach consisting of:
• A basic state pension of up to £107.45 for those with at least ‘30 qualifying years’ of National Insurance contributions and;
• An additional state pension for employed individuals earning (for 2012/13) over £5,564 (in any one job)
Needless to say many people are confused with regards to what state pension they are likely to get at retirement and trying to calculate or estimate this yourself is no easy task.
In the recent Budget, however, the Chancellor finally outlined plans to move to a ‘single-tier’ flat rate pension of £140 with full details due to be revealed later in the year.
So what does this mean for all of us in terms of what we can expect from the new state pension system? We have outlined some common questions that may be asked below:
I am already receiving my State Pension, if this is less than £140 per week will I receive an increase?
The changes outlined will not relate to those already in receipt of their state pension – they will only affect those who are yet to retire.
Currently the pension credit system means that everyone should get a minimum income of £142.70 per week* where their total income would otherwise be less than this.
What happens, if under the current system, my basic state pension plus any additional state pension would have been more than £140?
It is estimated that the first person to retire on a completely flat-rate pension would not be until around 2080.
It is therefore likely that most of us will have a state pension calculated from entitlements built up from a mixture of the existing and new systems.
I have previously contracted-out of the additional (second) state pension, will I be worse off under a flat rate pension?
It is currently unclear exactly how this will work under a flat-rate system. Up until 6 April 2012 it was possible for individuals to ‘opt-out’ of the additional state pension and instead receive a national insurance rebate to a personal pension scheme instead. There will therefore have to be some sort of ‘contracting-out’ offset (as there is now) to reflect the fact that (a) such individuals have paid less into the system in terms of national insurance and (b) they will also receive some of their pension from funds built up from these rebated amounts.
Until the Government details its plans further it is not clear how such an adjustment might be made.
Are there any other potential issues these changes may bring?
From 6 April 2012 the only types of scheme that can ‘contract out’ of the additional state pension are defined benefits pension schemes (e.g. – final salary based arrangements). A move towards a single-tier flat rate state pension could therefore result in the end of ‘contracting out’ altogether as there would by definition be no additional/second state pension element.
Based on the new levels of NI contributions for 2012/13 this would mean an increase of 3.4% for employers and 1.4% for employees. Some employers may simply not be willing to meet this cost and could either seek to reduce the level at which scheme benefits accrue, or in some circumstances close these schemes altogether.
Much of the above commentary is based on information contained in an HM Treasury consultation document and it is important to reaffirm that detailed proposals are yet to be published as to how the transition to a flat-rate pension will work in practice.
Of course, whatever the detail it is worth considering that a flat-rate pension would provide a pension income of just £7,280 per annum. With the Pensions commission concluding that a person on median earnings (£21,528 in 2011** ) should be aiming to retire on at least 45% of their earnings (or £9687.60 if retiring today), state provision alone will still be woefully inadequate and the changes will not detract from the need to make additional provision for retirement.
As always please feel free to contact us for advice or guidance on any aspect of your retirement planning.
• This assumes entitlement to the guarantee component of pension credit and is based on the figures for 2012/13 tax year
• ** figure from the IFS study ‘Poverty and inequality in the uk:2011’
For further information on your retirement and the best way to take your pension please contact us.