The flat-rate state pension: what it means for you
From April 2016, the current state pension arrangements will be replaced by a single state scheme, which the government has touted at a 'flat rate' of £144 a week.
The idea is that the new system does away with earning-related top up payments, which are horribly complicated, and means-testing, which effectively penalises those who save for their retirement.
However, because the new system has to reflect promises made in the past, it will in fact be anything but simple. Each individual's national insurance (NI) record, career history and childcare responsibilities will be taken into account, so there will still be a wide range of benefit outcomes.
The flat-rate figure of £144, in today's money, will actually be the maximum figure when the new regime is fully implemented. But that's decades away and there are rafts of transitional arrangements.
The central tenet of the new scheme is that to obtain the maximum benefit both men and women must accrue a maximum 35-year NI record. One welcome piece of news is that the self-employed can, for the first time, use their NI records to qualify.
If your NI record is insufficient, it can be bolstered by credits for activities such as caring for a child under 12 or looking after a disabled or sick relative for at least 20 hours a week.
You can also receive NI credits if you are unemployed and signing on, are over 18 and on an approved vocational training scheme that lasts less than one year (university courses do not normally count), or are married to a member of the armed forces and accompanying them abroad.
The 35-year rule applies even if you are one of the thousands of women who received a letter from the Department for Work and Pensions (DWP) stating, quite wrongly, that a 30-year record would provide a full entitlement.
Advantages and disadvantages
The new system will not be phased in but will start – cliff-face style – for anyone who reaches state pension age on or after 6 April 2016.
This will be an advantage to some people and a disadvantage to others – those who had less well paid jobs but have already retired are most likely to miss out as the less well paid stand to gain most under the new system, while those who have accrued a large state second pension under the old system but are too young to retire before the new rules come into force will also be worse off.
The new top payment worth £144 a week, upgraded for inflation, is considerably less than the £200-plus some higher earners receive under the existing earnings-related state second pension (S2P) or its predecessor, the state earnings-related pension scheme (Serps).
Unfortunately, if you reach your state pension age before April 2016 but would be better off under the new regime, you cannot simply delay taking your pension.
Critically, your entitlement to the S2P or Serps you have built up will not vanish completely.
Instead, when the new regime takes effect, your entitlement will be worked out under both the current system and the new system. If your entitlement under the current regime is the higher of the two (because of Serps/S2P benefits) this will provide a 'foundation amount', which you will be entitled to, but from that date onwards you will not be able to build up any further entitlement under the old Serps/S2P rules.
If your 'foundation amount' is above the £144 flat rate, the 'foundation amount' is the state pension you will receive. If your 'foundation amount' is below £144, you will be able to continue to build entitlement under the new system towards £144, but no more than that amount.
This will make the administration of the scheme even more complicated. "The government seems to be indifferent to some serious problems they will experience running two systems side by side for 40 years, and the transition rules are very complex, which goes against the central idea to simplify the system,' says Malcolm McLean, a consultant at Barnett Waddingham. "It is as complex as anything I've seen – an absolute maze."
Impact on women
The government likes to claim that the new deal will be good for women – but this is bunkum. Women have long been able to claim NI credits for looking after children, and now they have to work to accrue an additional five years' NI record. Furthermore, as this is such a complicated area, and so few understand it, the government has been able to introduce some swingeing cuts without anyone raising an eyebrow.
The most damaging change for women is that, as state pensions in future will depend on the individual's own contribution record, women won't be allowed to 'inherit' benefits earned by their husbands after 2016.
Currently, married women with an incomplete record of NI contributions (NICs) are entitled to a basic pension of 60% of their husband's entitlement, and divorcees can use their former husband's NI record, for the duration of the marriage, if it is better than their own.
Furthermore, a widow can inherit her husband's basic pension, plus half of his entitlement to top-ups such as S2P and Serps, if her own NICs would provide less. Annex 3 to the government's White Paper does promise transitional arrangements but even the experts are having difficulty deciphering them.
We think that most benefits that are accumulated, or inherited, before 2016 are protected but no such benefits will be allowed after the new regime's start date.
This is particularly important for a small number of women who paid lower NI rates in the 1960s and 1970s, known as the 'married woman's stamp'. The reduced stamp was abolished in 1977, so this now affects only a small number of women, and the government is making provision for this group and will pay them a pension equivalent to what they would be entitled to under the current system.
The other big change is that some people with an insufficient NI record will not be entitled to any state pension whatsoever, but the government hasn't yet decided whether the cut-off period will be less than seven or less than 10 years.
How much will you receive?
To work out how much you will receive, you first need to establish your state pension age, and those goalposts are constantly moving. For women, particularly sharp rises are required to bring the state pension age into line with men, initially in steps to 65 by 2018.
Then, for both sexes, the state pension age is rising in stages to 66 by 2020 and 68 by 2046. You can check your own date using the government's website at www.gov.uk/calculate-state-pension.
In future the pension age will be linked to longevity, and reviewed every five years, which, actuaries predict, will mean today's 33-year-olds will have a state pension age of 73, and for 18-year-olds, it could be as high as 77. Nearer term, however, the first review will be in 2016 and, as longevity is rising so rapidly, don't rule out a further hike in five or 10 years.
National insurance records are calculated on a 6 April to 5 April basis and if you haven't earned enough in a year to get a state pension credit then you will not qualify in that year – however, the threshold is quite modest at £5,564 a year.
If you have left full-time work, perhaps assuming your 30-year NI record would be enough to secure a full state pension, or you have a gap in your employment history, you can improve the situation by buying additional NICs to 'buy back' lost years. At current rates, it costs around £700 to make up a year's worth of NICs, which would give you an extra £186 a year in pension payments for life.
However, you only have up to six years to effectively make up any shortfall. Additionally, the government has promised to extend this window of opportunity, so those retiring after April 2016 will have until 2023 to buy back the contributions they could have paid between 2006 and 2016.
Whether to act now or later is a moot point. If the rules are changed later you might not need to take any action, but as the cost of an ageing population mounts, the thrust will be for additional years to be required for the maximum pension, and the longer you leave it, the more NI buy- back is likely to cost.
"My best guess is the cost of NI contributions could be raised from £655 for a year to around the £750 mark for anyone hitting state pension age after the single tier is introduced," says Laith Khalaf, pensions investment manager at Hargreaves Lansdown. "This is a pretty generous arrangement and may be targeted for review by the government.
"You might think this is a reason to buy now while stocks last but I think there is so much uncertainty about the state pension that you have to be careful about buying extra years at the present time – it's possible you could end up paying out for no benefit."
If you are not currently in the workplace, a cost-effective way to improve your NI record is to set yourself up as self-employed and opt to pay self-employed NICs, even if your earnings are so small that paying them is not compulsory. This class of NI costs just £2.65 a week, or £137 a year, but they can only be paid in the relevant tax year.
Those who stayed at home to care for children under 12 or a sick parent should have built up credit that would count towards their pension entitlement.
You will not need to apply for your NI credits if you receive child benefit for children under the 12, but you may have decided not to receive child benefit if you or your spouse earn more than the controversial £60,000 threshold introduced in January, so you will need to actively claim this credit. Credits are now calculated on a weekly basis not annually.
People other than parents – such as grandmothers looking after grandchildren also need to actively claim these credits from HMRC (www.hmrc.gov.uk/ni/intro/credits.htm).
You can obtain your own record of NICs, which will detail the NI paid, any credits awarded and how many qualifying years have been attained from the DWP's pensions service at secure.thepensionserv-ice.gov.uk/statepensionforecast/default.aspx.
Note too, that most people will be entitled to three years of extra credits, which were automatically given to people aged 16 to 18, though this practice was stopped in 2010 for today's young people.
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This feature was written for our sister magazine Money Observer
A scheme originally established in 1944 to provide protection against sickness and unemployment as well as helping fund the National Health Service (NHS) and state benefits. NI contributions are compulsory and based on a person’s earnings above a certain threshold. There are several classes of NI, but which one an individual pays depends on whether they are employed, self-employed, unemployed or an employer. Payment of Class 1 contributions by employees gives them entitlement to the basic state pension, the additional state pension, jobseeker’s allowance, employment and support allowance, maternity allowance and bereavement benefits. From April 2016, to qualify for the full state pension, individuals will need 35 years’ of NI contributions.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.