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Q&A: state pension reform explained
The government has announced the introduction of a flat-rate state pension, here's what it means for you.
by Michelle McGagh on Jan 15, 2013 at 11:29
The government has announced plans for a new flat-rate state pension that removes means-testing and which it hopes will provide clarity for everyone saving for their retirement.
Since the Beveridge Report set out the plan for the welfare state 70 years ago, Britain’s demographics have changed dramatically. In the 1940s a minority of men could expect to live to 65 whereas 36% of people born in 2013 are expected to live to 100, according to the Office for National Statistics.
Improving life expectancy has put a strain on the UK state pension system that successive governments have tried to ease with reams of legislation, leading to a complex, means-tested pension system.
Now the coalition has published its white paper, 'The single-tier pension: a simple foundation for saving', which it hopes will make the system fairer and easier to understand.
What changes are coming in?
The single-tier pension will be implemented in April 2017 ‘at the earliest’. It will see pensioners who qualify receive a £144-a-week state pension.
This is an increase from the £142.70 basic level of means-tested pension currently available for a single pensioner.
The means-testing element of the state pension will be removed completely, instead national insurance contributions (NICs) will be calculated to determine whether you qualify for the £144 pension.
How do I know if I qualify?
Anyone who has 35 years of qualifying NICs or credits for the full amount will receive the £144-a-week state pension. This means that anyone who works for 35 years will qualify.
There will be a minimum qualifying period of between seven and 10 years to receive anything from the state. Those with fewer than 35 years but more than 10 will receive a smaller single-tier amount.
Will it always be £144-a-week?
No, the state pension keeps increasing as the cost of living keeps increasing. In 2011 the government introduced the ‘triple lock’ guarantee for pensions which ensures the state pension will increase at the highest of either growth in prices, average earnings or 2.5%. The paper has confirmed that the triple lock will stay in place.
Whatever the rate of state pension on offer you will still need to have 35 years qualifying NICs in order to receive the full amount.
When will I get my pension?
The state pension age is on the rise. It is set to increase a year to 66 by October 2020, and to 67 between 2026 and 2028.
The equalisation in state pension age between men and women will also be complete in November 2018 to bring women’s retirement in line with men’s.
However, the state pension age is likely to rise again as the government has said it will link it to longevity. We are all living longer which has led to predictions that future generations won’t receive their state pension until age 70.
In the paper the government said it will carry out a review of the state pension age every five years ‘based around the principle that people should maintain a specific proportion of adult life receiving the state pension’. The first review of the state pension age will take place in the next Parliament.
What if I am contracted out?
Contracting out is a tricky business. The current state pension is made up of several parts; although the main components are the basic state pension and the additional state pension, also known as the second state pension (S2P).
The amount you get from the additional state pension, or S2P, depends on the contributions you make into it through your NICs. Employees were given the option of ‘contracting out’ of S2P and redirecting the money into a private or workplace pension.
By contracting out, employees and the employer paid a reduced NI rate because the employee would not benefit from S2P. Instead they benefited from extra money in their private or workplace pension to replace the money lost from not contributing to S2P; this money is known as protected rights.
Under the new rules S2P will be abolished after the implementation of the single-tier pension as contracting out was already abolished in April 2012.
Around 80% of people have contracted out of the S2P at some point in their careers but they will be brought fully back into the state system and will begin paying full NICs – which is the increase equivalent to 1.4% of relevant earnings.
Although many people who are contracted out will begrudge the government increasing their NI, they will recoup the extra payments they make. The government said ‘the vast majority of those who pay a higher rate of NI as a result of the ending of contracting out will be able to get extra state pension for years worked or credited after the single-tier pension is implemented’.
So there will still be different levels of pension?
Just because there is a flat rate of £144-a-week it doesn’t mean that everyone will get that.
Most people of working age will have made NICs before the implementation of the single-tier pension so the government has had to put a transition process in place.
Everyone who has worked will have a ‘foundation amount’ – basically an amount calculated on what NICs you have paid to date. The entitlement to the state pension will be built up from this foundation amount, adding £4.11 to the pension for every year worked after implementation until it reaches £144.
However, some people who have already accumulated a ‘foundation amount’ of over £144 will be entitled to a higher state pension.
People will fall into four groups when implementation happens:
1. Those with a foundation amount equal to £144, who have paid in for 35 years and not been contracted out.
2. Those with less than the full level of the single-tier pension, such as young people with few qualifying working years or older people who have spent years contracted out. These people are able to amass an extra £4.11 to foundation amount for each year worked until they hit £144.
3. Those with more than £144, likely to be older people with many working years behind them who did not contract out of S2P. They will receive the difference between the foundation amount and £144 as an extra weekly payment.
4. Those with no NI record like those who have not started working yet. They will benefit from going straight into the new system.
What if I am self-employed?
The self-employed benefit from the pension reform. Previously, NICs paid by the self-employed didn’t count towards the state pension, meaning they received a lower state pension in retirement. However, under the new rules all NICs will be treated equally in the calculation of the single-tier pensions.
Are the changes good?
Yes, broadly. The government hopes to encourage people to save for their own retirement by setting out just what they will get from the state. By providing a solid base pension that will not be swayed by means-testing it is hoped that people will be encouraged to plan for their old age.
Pensions minister Steve Webb said: ‘The current state pension system is too complicated and leaves millions of people needing means-tested top-ups. We can do better.
‘Our simple, single tier pension will provide a decent, solid foundation for new pensioners in an otherwise less certain world, ensuring it pays to save.’
It is also good news for women who have tended to miss out on a full state pension because they work less hours or took employment breaks and were not contributing as much.
Secretary of state for work and pensions Iain Duncan Smith said: ‘This reform is good news for women who for too long have been effectively punished by the current system. The single tier will mean that more women can get a full state pension in their own right and stop this shameful situation where they are let down by the system when it comes to retirement because they have taken time out to care for their family.’
Who doesn’t benefit?
Not everyone has welcomed the single-tier state pension. The National Pensioners’ Convention yesterday labelled it a ‘con trick’ for future generations who will be asked to contribute more for longer and receive less.
Under the current rules you can pay 30 years NICs and get the full basic and S2P of around £150 a week but under the new rules you work for 35 years and receive £144 a week.
It has also complained that existing pensioners are not included in the reforms. They are left with the complicated old means-tested pension credit system.
At the moment pensioners can get £107-a-week minus means-testing, which increases to £142.70 with a means-tested pension credit. Unfortunately not all pensioners apply for the pension credit, there are 1.8 million people who are eligible who don’t receive it.
Wealthy people are also disadvantaged by the system. A higher earner at the moment can get a S2P worth up to £150-a-week on top of the state pension but that will be scrapped and they will no longer have the chance to build up this additional amount.
More about this:
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- Cameron is wrong to 'rethink' the £140-a-week state pension
- Thanks Dad! for starting me on my first pension
- State pension ranges from £7 to £230, DWP reveals
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- End of 'contracting out' could put your retirement income at risk
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