Today the government released its White Paper on state pension reform. Announcements included ending contracting out in 2017, increasing state pension qualifying age by five years and introducing a single tier state pension.
Flat-rate state pension
Starting in April 2017, the state pension for a single person will be set at £144 a week, or £7,488 a year, in today’s money. By 2017, this is likely to equate to about £162 a week.
- This is no small sum – to build up a state pension of that amount, a 65 year-old would need a pension pot of £206,250. This is why the new state pension will benefit lower earners who currently have basic state pensions of less than £144 a week.
- It is also good news for the self-employed – currently they can only receive maximum state pension of £107.45 per week.
- Taxpayers in general will also benefit from a flat-rate pension. The system will be much simpler, especially combined with the abolition of complex arrangements like second state pension (S2P) and contracting out, which were also proposed in this White Paper. There will be cost savings with a system that is simpler to administer.
- The government has increased the minimum National Insurance (NI) contribution period from 30 years to 35 years, meaning that fewer people will qualify.
- The coalition has also reintroduced a minimum qualification period of ten years – so anyone with fewer than ten years of NI contributions, such as people with less than ten years’ service at retirement, will not get state pension.
- Higher earners will also lose out. At the moment, taxpayers can receive a state pension of up to £250 per week, depending on their NI contributions. But after April 2017, this will be capped at £144 per week, although they’ll be able to keep benefits accrued up to that point. People retiring before 2017 will also miss out on the £144 a week.
The triple lock guarantee (linking state pension to the highest of CPI, earnings and 2.5%) will continue to apply on the new single-tier pension.
Abolishment of savings credit
Currently, if you are 65 or over and your state pension falls below a certain threshold, you can apply for pensions credit. It’s split into two types – guarantee credit and savings credit. The savings credit element is to be abolished under the new reforms. To find out if you can claim pension credit, visit our guide, Do I qualify for pension credit?
Single pensioners whose weekly income is between £111.80 and £189.05 get an extra £18.54 a week, and married pensioners whose weekly income is between £178.35 and £277.23 receive £23.73 a week.
The government says that lower earners who put money aside to top up their retirement income often see it unfairly clawed back through this means-tested system, which is why they have decided to get rid of it.
Also, many pensioners are either unaware of or don’t bother to apply for pension credit, so miss out on it. The flat-rate pension is worth more than savings credit, so in theory lower earners will be better off.
End of contracting-out
Contracting out for private pensions and defined contribution schemes ended in 2012, but people in final salary schemes are still allowed to contract out.
Currently, if you’re contracted out, you and your employer will be paying lower NI contributions, which will be rebated into your employer’s scheme. For more on this see our guide to Contracting out of state second pension (S2P).
For people who are currently contracted out, a one-off deduction will be made to their £144 per week basic pension to make up for the benefits from their second pension. This is not expected to reduce their pensions below the basic rate of £107.45.
People who are contracted in and whose state and second pensions are worth less than £144 a week will receive the flat-rate pension as of 2017. Anyone whose current basic and second pensions are worth more than £144 will be allowed to keep that level of pension.
If you’ve been both contracted in and contracted out, you will have a one-off deduction based on the amount of time you were contracted out and a one-off addition based on the times you were contracted in.
For those in final salary schemes, NI contributions will increase. Industry calculations suggest that this could cost someone earning £25,000 an extra £270 a year and someone earning £40,000 an extra £481 a year.
Public sector workers are set to lose out from this. They are contracted out, so will see their NI contributions increase – but won’t see a concurrent increase in pension benefits.
Young people who have already accrued some contracted out benefits but who still have time to build up 35 qualifying NIC years will potentially benefit from the new £144 a week plus their contracted out savings.
State pension aged linked to longevity
Proposed in last year’s Budget, more details on linking the state pension age to longevity have been pushed back to the next Parliament. However, the state pension reforms state that ten years’ notice will have to be given to consumers before changing the state pension age.