How will state pension changes affect you?

The government has announced details of a new flat rate state pension that will start in April 2017.

Older couple sitting by the water using pension money

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The long-awaited pension White Paper, published on January 14, lays out in detail how the universal pension will work, confirming that people will have to make 35 years of National Insurance contributions to qualify, up from a current 30 years.

While all this may seem a long way off for anyone in their twenties or thirties, the changes will have a major impact for everyone, so it’s well worth knowing what’s in store, whatever your age.

Here, we outline what the flat-rate pension is likely to mean for you, as well as explaining who the winners and losers will be….

What is happening to the state pension?

The state pension system is being simplified, so that it is easier to understand, enabling people to plan more effectively for retirement.

Under current rules, the full state pension is £107.45 a week. This can be increased to £142.70 if you are eligible to top up with pension credit and the second state pension (S2P, formerly known as the State Earnings Related Pension Scheme or SERPS). 

However, with effect from April 2017, the current basic state pension and second state pension will replaced by a single scheme. Pensioners will therefore receive a flat-rate state pension, worth £144 a week. According to research from Prudential, a 65-year-old today would need a £130,000 private pension pot to generate the same weekly income (based on the highest single life annuity without a guarantee).

The £144 will also increase in line with inflation between now and 2017. According to experts, this is likely to push the sum up to around between £155 and £162 a week by then.

But the minimum number of years to qualify for the full state pension will also go up from 30 to 35 years, and a minimum qualification period of 10 years will be reintroduced, so anyone who has not paid National Insurance for at least 10 years will not get a state pension. Since 2010, there has been no minimum period to qualify.

The triple-lock inflation guarantee – under which the state pension rises according to the highest of the Consumer Prices Index, the rise in earnings or 2.5% – will continue to apply.

What about people who are already receiving their state pension?

These people won’t be affected by the changes. They will continue to receive their pensions under the current system, as will anyone reaching state pension aged prior to April 6, 2017, when the changes come into effect.

People who currently receive more than £144 a week will have their extra payments protected.  A spokesperson for Saga said: “Some people could be receiving over £200 a week from state pensions (with Basic State Pension, SERPS and S2P) and they will continue to do so.  Over time, however, there will be no additional state pension accruing and future generations will have just the flat-rate state pension.”

What age can I start claiming the state pension?

For men born before December 6, 1953, the current state pension age is 65.

For women born after April 5, 1950 but before 6 December 1953, their state pension age is between 60 and 65.

However, by 2018, for any women born after December 1953, the women’s state pension age will have been increased to 65. Between 2018 and 2020 the state pension age for men and women will be increased to 66, and by 2026, the state pension age will rise to 67.

The White Paper has confirmed that the state pension age will rise in line with increasing life expectancy. It recommends that this age should be reviewed at least once during the life of each parliament and that a minimum of 10 years’ notice should be given if any change is to be made.

Raj Mody, head of pensions advisory at accountants PwC, said:  “If the government wants to link the state pension age with life expectancy, we expect a rise to age 68 may need to be brought forward at some point to around 2035 to keep pace with projections.This means we could see the state pension age easily hit 70 by 2050.  

“A school leaver just entering the workforce may have to start saving an £100 extra a month just to bridge the gap between the current state pension age of 65 and their likely state pension age by the time they reach that stage of their life, assuming they have no other source of income to rely on.”

What is happening to contracting out?

Since 1987, pension savers have been able to contract out of the S2P or SERPS earnings-related element part of the state pension, and have paid lower National Insurance contributions as a result.

Contracting out for private pensions and Defined Contribution schemes stopped in April 2012, and, under changes outlined in the White Paper, final salary scheme member schemes will no longer be able to contract out from April 2017.

Tom McPhail at financial advisor, Hargreaves Lansdown, explained: “Those who contracted out via a personal pension received rebates of part of their national insurance contributions paid directly into a pension plan. Those contracted out via a final salary pension scheme, benefit from reduced employee and employer national insurance contribution rates, since the scheme guarantees to pay an equivalent to the second tier pension.”

An estimated six million workers will face higher National Insurance payments in future once "contracting out" the state second pension to employers is abolished.

The fact that contracting out will no longer happen is also likely to have an impact on final salary pensions. Tom McPhail said: “We will almost certainly see another wave of private sector final salary scheme closures in response to the abolition of contracting out.”

Who are the winners from these changes?

Low earners, women who have taken time out of the workplace to bring up children, and the self-employed will potentially be the biggest winners when the new basic state pension comes into effect, as under existing rules it is almost impossible for them to earn a full state pension.

For example, currently the self-employed can only receive a maximum state pension of £107.45 per week, but from April 2017, they will be entitled to the same flat-rate pension as employees.

Many couples will also benefit from the changes, as they will now each qualify for the full flat-rate pension as individuals, rather than receive the current less generous joint couple’s rate.

Who will lose out?

Anyone retiring before the reforms are implemented in 2017 will miss out on the £144 a week pension, and may receive a lower state pension.

A spokesman for the National Pensioners Convention said; “Existing pensioners will be excluded by the proposals, despite at least 5 million, mainly women, getting less than £144 a week. They will be left to struggle on with a low state pension and a complicated means-tested Pension Credit which 1.8m older people still don’t claim, despite being eligible.”

High earners might also lose out when the changes come into effect. They could potentially have built up a state pension of more than £144 a week up to a maximum of £250 per week, but from 2017 this will be reduced to the flat rate of £144 per week.

Employees who belong to contracted out final salary schemes will also lose out, as they will have to pay higher NI contributions from 2017.

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