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Falling flat

28 April 2016

People can be forgiven for expecting that the new flat-rate State Pension of £155.65 will apply to them.

The origins of the modern State Pension can be traced back over a hundred years. In recent decades, however, what had been a basic welfare provision has fallen victim to the whims of politicians, and ended up as a complicated patchwork of measures.

Until 5 April this year, the State Pension comprised a basic payment with an additional earnings-related element. This will continue to be the case for men born before 6 April 1951 and women born before 6 April 1953. However, for everyone younger, reaching state pension age will instead trigger a ‘flat-rate’ pension.

The government claims that the new State Pension is simpler to understand because it is calculated on your National Insurance (NI) record alone. To receive what the government calls the ‘full’ weekly State Pension of £155.65, you will require 35 years of NI contributions or credits. Those who have between 10 and 34 years of contributions will receive a proportion of the pension.

Overblown

Ian Price, Divisional Director at St. James’s Place, says that while the new system sounds clear-cut, he thinks “its simplicity has been somewhat inflated”.

There are some complicated changeover arrangements that will affect people who have contributed under the old system. It means that even if you have 35 years of NI contributions, you could end up receiving less than £155.65 a week, while others could get more.

Whether you are in line for the full amount will depend in part on whether you opted in or out of any earnings-related element under the old system. This was known as the State Second Pension, or more commonly as the ‘Additional State Pension’, and replaced the State Earnings-Related Pension Scheme (SERPS) in 2002 – in all cases it promised to pay a benefit on top of the basic State Pension.

In return for being contracted out, you would have paid lower NI contributions and received extra pension from a workplace scheme, or had a rebate paid into a private pension.

If you were contracted out for many years, you are likely to receive much less than £155.65 a week in recognition of the lower NI contributions you paid.

“Some people might be surprised when they find out their State Pension is less than the flat-rate figure touted by government,” says Price.

By being contracted out, benefits would have been accrued in a private or workplace pension. The expectation is that this is likely to be equivalent to the amount forgone under the new system.

Those receiving more than £155.65 are likely to include people with at least 35 years of NI contributions who remained ‘contracted in’ and who built up a significant amount of  extra earnings-related pension over their working lives. Under the changeover rules, they will have this entitlement protected.

Deflated

According to the Institute for Fiscal Studies (IFS), only 17% of those reaching State Pension age over the next four years will receive £155.65 per week, while 23% will enjoy a higher income and 61% will receive a smaller sum.1

While many will gain in the short term, it seems that younger workers will be less fortunate. Unlike their predecessors, there will be no opportunity for them to build up an earnings-related state bonus pension.

Separate findings from the Pensions Policy Institute suggest that three quarters of people currently in their 20s will miss out, to the tune of £19,000 per person on average – and two thirds of people in their 30s are set to lose out, on average by £17,000 – over the course of their retirement.2

“Increasingly, we’re seeing the onus for retirement provision shifted from the state onto the individual,” says Price. “The changes to the State Pension can be regarded as another step in that direction.”

The value of an investment with St. James’s Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.

The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief depends on individual circumstances.

1 Institute for Fiscal Studies, 5 April 2016, http://www.ifs.org.uk/publications/8224

2 Pensions Policy Institute, 5 April 2016, http://www.pensionspolicyinstitute.org.uk/press/press-releases/analysis-of-the-impact-of-the-new-state-pension-press-release

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