One aspect of retirement income which financial advisors are especially reluctant to advise on is, rather annoyingly, the new state pension.
The basic idea is simple enough. If you have made 35 years of National Insurance (NI) contributions you are entitled to receive the full state pension when you reach the state retirement age. This is currently £159.55 a week (2017/2018). Perhaps the most valuable feature is that the value of the state pension is currently protected by the so-called triple lock. What that means is that the state pension will rise by the higher of annual inflation, average wage growth and 2.5% each year. Since annual inflation rose to 3.0% in September 2017, the key month for indexing many state benefits and payments, the state pension will rise by at least £4.78 a week from April 2018.
The current government’s commitment to the triple lock, however, only extends to 2020. Beyond that date it is likely that the triple lock will be downgraded to a double, or even a single lock. Even so, any sort of protection against inflation is a valuable benefit.
What causes confusion and even resentment though is that we are currently transitioning between the old-style pension and the new, much more straight forward, scheme. The problem is that retirement ages have been extended, with some women especially having their retirement ages synced with men’s far more rapidly than they had expected.
The transition also means that most people have accrued entitlements under both schemes. Although the old system was, on the face of it, less generous (£125.97 from next April), many existing pensioners retired earlier than current workers can expect to do. They also only required 30 years of National Insurance contributions to be entitled to the full pension.
The greatest distortion though is caused by the State Earnings Related Pension Scheme (SERPS). Although benefits ceased accruing under SERPS in April 2002, it still can top up the basic state pension to a maximum of £167.26 (2017/2018) and can be partially inherited by a legal partner.
Adding a final twist of confusion was that it was possible to “contract” out of SERPS. What that meant in practical terms was that the additional NI contributions required to be eligible for SERPS were instead paid into a private or company pension scheme.
Fair enough you may think, but unfortunately when it comes to calculating what you are entitled to under the new state pension an allowance is made for the years in which you paid reduced NI contributions because you were contracted out. Put simply, if you were contracted, you will get less state pension because it will be assumed that the contracted out payments will make up the difference. An estimate of the pension which the contracted out payments may entitle you to is shown on your pension statement as the Contracted Out Pension Equivalent or COPE.
So now all that is as clear as mud, let’s try to make this a bit easier with some practical steps you can take today
The first is to go online to the government’s excellent website (and no I’ve not been paid to say that).
Here you can check what your new state pension entitlement is based on your NI contributions to date and also see a forecast of what it might be if you were to work until your state retirement age.
Your statement will look something like this. The big number at the top is what you will receive if you make National Insurance contributions until you reach your State Pension Age.
In this case the lucky pensioner will receive the full state benefit of £158.16 at his state retirement date of 19th September, 2029 (be sure to send me a birthday card!).
The figure of £103.46 below shows how much pension I will receive based on my NI contributions to date, even if I don’t contribute a penny more.
You can check your state retirement age here
The process is simple. If you haven’t already got a Government Gateway account, which you will need to get your pension statement, you can register quickly and they will send you an activation code by post.
Once you’ve got your online statement
If you on track for 35 years of NI contributions by the time you retire and you are entitled to the full £159.55 per week, happy days.
However, if your statement shows less than you were expecting, or is in any way unclear, or you simply don’t understand it, I would strongly encourage you to give them a call. The number for the Future Pension Centre is 0345 3000 168. They don’t bite and virtually everyone I have spoken to has been pleasantly surprised by how helpful and patient they have been.
They will also be able to send you a paper statement of your entitlements, which takes into account all of the wrinkles above (and more). The general idea is that this will be more accurate and usually higher. If the government determines that you would have been better off under the old scheme, it will adjust your entitlement (upwards) to reflect that (yay!).
- A minimum of 10 complete NI contribution years is required to get anything at all from the new state pension. So if, for whatever reason, you will only have nine years by the time you reach the state retirement age, it is worth seriously considering making a voluntary contribution to bring yourself up to at least ten years. For a single payment of around £741 you will receive will receive 10/35ths of the £159.55 weekly pension or £2,370 a year for life. That’s not a bad return for a one-off payment.
- Even if you’re on track to be above 10 years, but below 35, paying the £741 would increase your annual pension by £237 for the rest of your life, which again is a pretty decent return.
- It is also worth noting that the more recent missed years tend to be more expensive to top up, so consider topping up the earliest missed years first. For example, according to the HMRC website it would only cost me £626.60 to top up 2010/2011, but £733.20 to top up 2016/2017.
- One thing to be aware of though is that if you had already made 30 years of full NI contributions before April 2016, and the government decides you would be better off under the old system, there is no point in making extra contributions. Some people have inadvertently done this and it is not always possible to claim a refund.
- If you’re the main carer of a child under the age of twelve, make sure you are getting the National Insurance Credits that you are entitled to. That would give you twelve years of contributions credits even if you never actually make a single contribution.
- If you have any incomplete contribution years over the past six years, you can pay the missing months. In theory this means that if you have 11 months one year, a single payments of less than £62 you could increase your annual pension by the £237 for the rest of your life.
- And finally most voluntary National Insurance Contributions are classified as Class 3. However, there is a cheaper category, Class 2, for self-employed people earning less than £6,025 per year. NI contributions aren’t mandatory below that income threshold, but it might be worth considering making voluntary Class 2 contributions, if this applies to you, as they are far cheaper at £2.85 a week rather than the standard £14.25 Class 3 rate. This was going to be phased out, but has been given a reprieve until at least 2019. This could save the very smallest businesses almost £600 a year to keep their NI contributions up to date.
And one last point to highlight the value of the new state pension. The FT Advisor magazine has calculated that it would cost £276,900 to replicate the state pension, and its inflation-linked annual increases, with a private pension.
Basically this is too good to missl!
Take care out there