1st April 2016 at 10:29am
In an effort to simplify the pension system a host of changes will come into effect on 6 April. There’s no denying that the current system is very complicated, but as the details surface it’s becoming clear that the New State Pension (NSP) is perhaps not as simple as it first seemed.
The government promoted the New State Pension as a fairer, flat-rate system which will replace the need for additions and top-ups. However Pensions Minister Baroness Altmann conceded in an interview that the whole idea of the flat-rate has been misrepresented as it’s “not something everyone will get at the beginning”.
So amid all the confusion, what is actually going to happen?
To help cut through the complexity, we’ve highlighted the main changes below:
How do I qualify for the New State Pension?
This is one of the biggest changes to the State Pension. Under the current rules you only need to have paid one year’s worth of National Insurance (NI) to qualify for your pension, but come 6 April that’s increasing to a minimum of ten years.
The number of years you need to have paid NI to be entitled to the full State Pension amount is also increasing by five years – from 30 to 35.
In the long term, the New State Pension will be based on your own NI record. This is a change as under the old rules it was sometimes possible to get some State Pension based on the NI record of your current or former spouse. However this change won’t come into effect straight away so some people could continue to benefit from this under transitional rules.
How much can I expect from the State Pension?
The key date here is 6 April 2016. If you reach State Pension age before this date then you won’t be affected by the New State Pension.
The standard maximum amount for the New State Pension will be £155.65, but it’s important to understand that it doesn’t mean everyone will get that amount – it could be more or it could be less.
Determining how much you can expect to receive is actually very complicated, and a survey for the Open University found that 70% of people don’t understand how reductions will be calculated.
How can I calculate the New State Pension?
The reality is that when the new flat rate comes in from April 2016 you could get more or less. This will depend on your National Insurance contributions, whether you’d built up any additional State Pension before 6 April 2016 and whether you had any periods of being contracted out of the additional State Pension.
You can clarify your individual situation by getting a State Pension statement from the government. This tells you how much State Pension you’ve earned so far and provides a forecast of how much you could receive when you reach State Pension age.
What if I’ve been contracted-out?
Many people approaching the State Pension age in the next couple of decades will also have contracted-out at some point, which affects their State Pension entitlement.
Contracting out is where you build a private pension in place of some or all of your entitlement to additional State Pension, for particular tax years. As some State Pension was given up, lower employer and employee NI contributions were paid during periods of contracted out service.
So, when working out your foundation amount for New State Pension purposes, a deduction has to be made to reflect that lower NI contributions have been paid during those periods. The deduction is intended to be broadly equivalent in value to the private pension funded by NI rebates.
The problem is 60% of those surveyed by the Open University didn’t appreciate that contracting out would affect the amount they’re entitled to as part of the New State Pension. Even more worryingly, 24% of employees didn’t know whether or not they had ever been contracted out.
If your foundation amount is less than £155.65 a week, perhaps due to the contracted out deduction, you can still top up your New State Pension through ongoing National Insurance contributions.
New State Pension – the winners and the losers
According to official figures from the Department for Work and Pensions, over six million people will have benefited from a notionally higher State Pension by 2030.
However, as time goes on the number of ‘winners’ starts to diminish, with statistics estimating that 70% of retirees will be worse off by 2050.
So if you’re more than 15 years away from the State Pension age then it’s worth factoring in any shortfall to your financial plan.
Laws and tax rules may change in the future. The information here is based on our understanding in March 2016. Personal circumstances also have an impact on tax treatment. The information in this blog or any response to comments should not be regarded as financial advice.