A Summary of the main changes to your State…
The single statefrom April 2016 will be set at £144 a week (£7,500 a year) in 2012/13 terms, just above the minimum income currently guaranteed under the Pension Credit. The intention is that it will increase annually in line with the ‘triple lock’ (the highest of price inflation, earnings inflation and 2.5%) though only increases in line with earnings are guaranteed.
The full pension will be paid to those with at least 35 ‘qualifying years’ of National Insurance contributions or credits, up from the current 30 years for the basic state pension. There will also be a minimum contribution requirement, indicatively set at 10 qualifying years. This reflects the situation before the last significant changes in 2010, when the minimum was removed.
In the future, qualification will be on an individual basis, and individuals will not qualify for pension based on their spouse or civil partner’s record. The state second pension (S2P) will be scrapped, which will also end contracting-out under defined benefit schemes.
The savings credit will also be abolished, meaning that those who remain on means-tested benefits will lose them pound-for-pound where they have personal income. However, there will be a five-year transitional period for those who would previously have been entitled to housing or council tax benefit but will lose it under the new system.
There are no immediate proposals to accelerate the increases to state pension age already announced, but it’s proposed that the age will be reviewed every five years with a view towards keeping the average period for which people receive stateas a constant percentage of adult life.
Entitlements to state pensions already built up will be honored, but for those who have already accrued over £144 a week they will not increase. This could particularly affect those with substantial S2P /SERPS who still have some time to go until. Those who have been contracted out of S2P and/or SERPS will have the £144 a week reduced to reflect this.
The Government is aiming for a simple approach to the transition rather than great precision, which will mean there are likely to be some anomalies.
Transition Arrangements – Contracted In:
The basic principle is that the different components of state pension are added together, and if they total more than £144 a week the excess is preserved. Dealing with each part in turn:
Basic state pension – For those with 30 or more qualifying years by 5 April 2016, the full basic state pension (£107.45 a week in 2012/13) will be used. For those with fewer qualifying years, the amount will be scaled down.
Graduated pension – This was built up by employees between 1961 and 1975. Individuals bought units in the scheme with their contributions, and these are converted into pensions using a unit value set for each tax year. The unit value in 2016 will be used to establish the contribution to the protected state pension. Graduated pensions are modest – the maximum payable in 2012/13 is £10.76 a week (86 units at 12.51p each) – and by 2016 there will be relatively few non-retired people who will have worked long enough and with high enough earnings between 1961 and 1975 to be anywhere near the maximum.
Additional state pension – Benefits from SERPS and S2P will be valued as though the individual reached state pension age in 2016, including revaluing benefits in line with earnings growth up to 2014. If total state pension accrued by 2016 is less than £144 a week (in 2012/13 terms), there is no protected amount but the individual can continue to accrue benefits from future qualifying years. If the accrual is above £144 a week, the excess is protected.
However, while the single pension is guaranteed to grow with average earnings and is expected to benefit from the ‘triple lock’, the excess will only increase with price inflation (CPI) until state pension age. This contrasts with the current position where SERPS and S2P benefits are linked to average earnings before state pension age. It‘s likely to mean that the excess will reduce over time as a proportion of the total.
Transition Arrangements – Contracted Out
Contracting-out has changed so much over the years that accurate transition arrangements would inevitably be complex, and even the simplified approach proposed may well be very difficult to understand when the full details are available.
The basic approach is to make two calculations:
1. Calculate potential protected entitlement:
Accrued basic state pension (£107.45) plus additional state pension (SERPS / Graduated Pension) as though contracted-in until 5 April 1997 minus a contracting-out deduction (COD) plus additional state pension (SERPS/S2P) actually built up since 6 April 1997.
2. Calculate entitlement on the standard post-2016 basis:
£144 minus COD minus a ‘rebate derived amount’ for contracting out from 6 April 1997.
The significance of 6 April 1997 is that before then everyone’s state pension was calculated as though they were contracted in. Then the COD was made for those who were actually contracted out.
For those who are still active members in their original defined benefits scheme, the COD in April 2016 will exactly match the contracted-out pension (GMP) provided by the scheme, though they would have received some of the inflation-linked increases from the Government once the pension came into payment. For deferred members and those in S32 arrangements where fixed rate revaluation was selected, the COD may well be significantly higher than the additional pension credited.
This is because the fixed rates, particularly for earlier years, have turned out to be much higher than the rate of inflation. For those who were contracted-out through a defined contribution scheme, including a personal pension, whether the pre-1997 benefit payable at retirement is higher or lower than the COD depends onreturns and annuity rates at retirement. The assumptions made by the Government Actuary in the early years of contracting-out were considerably more optimistic than those now, so it’s likely that the outcome won’t match the COD.
For post-1997 benefits, the position of those who were contracted-out will depend on how the rebate derived amount is calculated. The name suggests that the starting-point is the rebates paid, which might mean the amount could be based on what the actual outcome has been rather than what the Government Actuary assumed at the time. However, the DWP technical paper says the amount “would be broadly equivalent to the value of additional state pension a person would have been entitled to”, which suggests the calculation may be similar to the one for pre-1997 benefits.
The net effect may be that those with at least 30 qualifying years who have been contracted out will generally end up with benefits equivalent to the current basic state pension on top of their contracted-out benefits. However, depending on the calculation of the rebate-derived amount, it’s possible that those who’ve built up significantly less than 30 years may end up with less than £144 a week in total. There is a twist in the tail, though.
The Government has indicated that those who have been contracted out and have an entitlement under £144 a week will be able to keep building a state pension up to the £144 maximum. There has been comment about how this will unfairly advantage them compared to those who are contracted-in and have no opportunity to build up further pension if they already have £144 or more. In the extreme case, someone could build up the full £144 a week state pension and have substantial contracted-out pension on top.
We’ll have to wait and see whether this difference persists, but if it does it may iron out some of the disadvantage potentially faced by those who were contracted out. Whatever the final details, it’s almost inevitable that some will feel they’ve lost out through the changes. The Government appears to have accepted this as a price worth paying.
Clearly some clients will undoubtedly be worse off after the changes than before. Among the worst affected could be higher earners in mid to late career, who have built up the full £144 state pension already and so will gain no extra state pension from future employment.
If you would like to have a chat about this topic or, indeed, review all your pension provision to see how well off (or not) you will be in retirement please contact the team here atLimited
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