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STATE PENSIONS – ALL CHANGE PLEASE!
  
Successive governments have wrestled, with varying degrees of courage, with the challenge of how to deal with an ageing population and a growing social security bill to address the issue before it gets out of hand.

The main quandary with the state pension is that pensions being paid to today’s pensioners are funded from National Insurance contributions (NICs) paid by today’s working age population. As longevity increases, the imbalance between the number of people of working age and the number of pensioners is steadily increasing. This is not an issue exclusive to the UK, as governments around the world face the same challenge.

If no adjustments are made, it has been forecast that expenditure on state pensions will rise from 6.9% of GDP in 2012/13 to 8.5% of GDP by 2060/61 (figures based on Department for Work & Pensions projections).

An independent commission was established in 2012 to identify the long-term challenges and to propose solutions. The commission determined that:
  • People are not saving enough to provide them with the retirement income that they wish to have available to spend.
  • The current system is too complex, which discourages people from saving.
  • Some groups – particularly women – have less opportunity to save, owing to career breaks, etc.
  • The state pension age (SPA) has to rise to take into account the increasing longevity of the UK population.
Enter the single-tier state pension

From 6th April 2016, the existing state pension system will change, with the introduction of a single-tier pension and the phasing-out of additional pensions calculated with reference to an individual’s NI record and earnings throughout their working lives (the latest incarnation of which is the second state pension, S2P, which previously included state earnings-related pension scheme, or SERPS, and state graduated pensions).

Who will be affected?

Anyone already at SPA on or before 6th April 2016 (i.e. any male born before 6th April 1951 and any female born before 6th April 1953) will receive a pension based on the current rules. They will receive:
  • X/30ths × full rate pension (£155.65 per week from 6th April 2016), where ‘X’=the number of qualifying years (which are accrued by paying Class 1, Class 2 or Class 3 NICs, or by receiving NI credits).
There is no minimum qualifying period and it is possible to use a spouse or civil partner’s NI record after divorce or their death to increase one’s own entitlement to the current basic state pension.

From 6th April 2016, the following rules will apply:
  • Individuals will need an NIC record (through contributions or credits) of at least 10 qualifying years to obtain any entitlement to a state pension.
  • To obtain the maximum single-tier pension, an individual will need 35 qualifying years.
  • The maximum single-tier pension will be paid at a flat rate of £155.65 per week (as announced in the Chancellor’s Autumn Statement).
  • For individuals who reach SPA after 6th April 2016, they may still receive a higher amount because of additional pension entitlement built up prior to that date via the graduated pension, SERPS and/or S2P.
  • Class 1, 2 and 3 NICs will all accrue entitlement to the single-tier pension at the same rate (at the moment Class 2 contributions do not accrue any additional state pension).
  • It will no longer be possible to use a spouse’s or civil partner’s NI record to increase the amount of state pension received.
  • It will no longer be possible to receive a lump sum if receipt of state pension is deferred.
Transitional rules

As with many fiscal changes introduced by governments, there is no single cut-off date after which everyone switches to the new system. This is largely because the Government wished to ensure that the reforms did not cost the Treasury anything. Transitional rules will therefore apply.

From 6th April 2016, everyone who has not reached SPA will be given a starting amount of pension to be known as the ‘foundation amount’. In broad terms, this will be the higher of the amount that would have been received under the old system (i.e. basic pension plus any additional pensions, less any benefits accrued from contracting out) and the amount which would be payable under the new rules.

If the foundation amount is greater than the equivalent single-tier pension, then at SPA the full single-tier pension rate will be received and any amount over this to which they would currently be entitled will be treated as a ‘protected amount’ and increased each year in line with the change in the consumer prices index. No further qualifying years will be taken into account, as the full rate pension will already be paid.

If the amount is lower, any NICs or credits after April 2016 will increase the pension received, up to a maximum of the flat rate.

For those who will reach their SPA before 6th April 2016 , additional benefits can also be obtained for a very short period by purchasing a new class of NI contributions – Class 3A, available since 12th October 2015 and until 5th April 2017, which will enable individuals to purchase top-up pension income as opposed to additional qualifying years. The costs will vary depending on the individual’s age at the time of purchase.

For an individual aged 65 to purchase the maximum additional income of £25 per week (£1,300 per annum) the cost will be £22,250. This purchases a Government-backed guaranteed index-linked income with a 50% spouse’s/civil partner’s pension. Whether that represents a good return on your ‘investment’ will depend on a number of factors, including how long you (and your spouse/partner) live, how high (or low) inflation is and general annuity rates available at the time.
  
Action required

To determine the extent to which you may be affected by the changes and if you are within ten years of your SPA, it is now possible to obtain a personalised statement based on the new rules at www.gov.uk/state-pension-statement.

To determine whether topping up your pension may be worthwhile, an online calculator is available at www.gov.uk/state-pension-topup