The UK State Pension | Features Explained
The new UK state pension system, effective from April 2016, means big changes for workers upon retirement. In this guide, we will discuss the features of the new state pension as well as briefly touching on the rules that applied to those who retire before the 2016 deadline. Suffice to say that the restructuring of the system has brought about some of the most significant pension changes many of us have seen in our lifetimes.
For purposes of clarity, it must be understood that the new state pension only applies to those who retire on or after 6 April 2016. All those retiring prior to that date are subject to the old system and its associated rules. Furthermore, how the rules apply to you depend on when you reach the state retirement age, regardless of when it is you actually cease working.
Features Under the Old Rules
Under the old system, there were two state pensions a worker might be eligible for. The basic state pension and the second state pension, also known as the State Earnings Related Pension Scheme (SERP) or second state pension (S2P). Below are the details for both:
- Basic State Pension – Every worker who puts in a combined 30 years of National Insurance payments is eligible to receive the full basic state pension upon reaching retirement age. For reference purposes, this would mean weekly payments of £115.95 for a single recipient during the 2015/2016 tax year. These payments can be enhanced through a number of different credits and the additional second state pension.
- SERPS – The second state pension is a way to receive additional payments based on earnings. The maximum a recipient could receive for the 2014/2015 tax year was £163 per week. However, most workers opted out of the second state pension in order to increase take-home pay or invest the money elsewhere.
There are a small number of UK workers who have been caught in a veritable 'no man's land' between the old system and the new, based on when they reach a state retirement age. Most of these people are females in their early 60s. The government now offers a way of topping up state pension payments by making additional Class 3A voluntary National Insurance contributions until retirement. Those additional contributions will ensure such workers are not harmed by the new flat rate scheme.
Features Under the New Rules
Given that the new state pension system will be effective from 2016, it is important that we spend a lot of time on explaining the features under the new rules. The remainder of this guide will be devoted to the flat rate system all UK workers will eventually be subject to.
As previously stated, the new system is effective from April 2016. Both the basic state pension and the second state pension existing under the old rules are done away with. Everyone reaching retirement age on or after the deadline will be subject to a new flat rate scheme ostensibly designed to be more fair to consumers and more affordable for the government.
The initial amount pensioners will be paid under the flat rate scheme was established by the government in autumn 2015. It will be reviewed on a regular basis to account for cost-of-living increases, inflation, and so on. What a pensioner begins receiving in the first year of retirement will likely go up as time goes by.
Here are the most important things you need to know about the new UK state pension system:
- Minimum Payment – The new system has been established with a minimum payment that is greater than the established pension credit limit, according to the Age UK charity. In practical terms, that means about £148 per week for the 2016/17 tax year. Pensioners may get more or less depending on their circumstances.
- NI Contributions – In order to qualify for the full state pension payment, a worker must now contribute to the National Insurance programme for at least 35 years. Those years do not have to be consecutive, by the way. Any combination will suffice. Lower state payments are possible for those who work at least 10 combined years but not the maximum of 35.
- Individual Contract – The new state pension is an individual contract between a worker and the government plan. There will be no special rules in place for spouses, civil partners, etc.
- Pension Credits – Some of the pension credits under the old system will remain intact under the new flat rate scheme; others will be eliminated. Individuals will have to look at the free government guidance for details or consult an experienced financial advisor.
Where this gets really confusing is for the millions of workers who will be contributing National Insurance payments under both the old and new systems. How their payments are calculated will depend on a number of factors including the total years of contribution, when contributions began, and at what point they reach retirement age.
Past Contributions under the New System
The new UK state pension does consider past National Insurance contributions when determining eventual payments. The easiest way to understand it is to simply know that every worker who contributed under the old system will have a level of accrued contributions that will act as the starting point for calculating payments. Pensioners will receive the higher of the following two amounts:
- the amount that would have been received under the old basic state pension and second state pension were they still intact; or
- the amount that would have been received had the new state pension been in place at the time the individual began working.
The combination of this principle and the availability of some existing pension credits means you could receive more or less than the £148 starting payment. It has been estimated by some experts that the majority of pensioners retiring in the first few years of the new system will receive less.
Additional Benefits of the New System
One of the aims of the government in reforming the UK state pension system was to create a system that was cost-neutral from one year to the next. In other words, the government does not want to pay out more in pension payments than it receives by way of National Insurance contributions, inflation notwithstanding. Yet at the same time, good form and basic human compassion requires that some of the means-tested benefits in place under the old system remain intact under the new.
With that said, three of the primary benefits that will remain intact are as follows:
- Pension Credit – The two-part pension credit is a way to top off your state pension payments if you are eligible to receive one or both parts. Estimates suggest there are about 4 million current pensioners eligible to receive the pension credit, yet nearly a third still do not claim it.
- Housing Benefit – The housing benefit helps low-income individuals and families pay their rent. It will still be available under the new state pension system although it will be combined with the Pension Credit rather than being applied as a standalone benefit.
- Council Tax Support – This benefit reduces the local council tax burden of low-income pensioners. It was implemented in 2013 to replace the former Council Tax Benefit. It remains intact under the new flat rate pension system.
The new UK state pension is quite different from the older system it replaced. If it lives up to claims, it should eventually result in a system that is more equitable for all UK workers. In the meantime, those who have worked and retired under the old system will continue to receive the benefits they were promised when they began working.
As a reminder in closing, we urge you not to rely on the state pension as your primary source of retirement income. Be sure to have other means in place. Those other means can include everything from personal pensions to workplace pensions to savings and investments. You will need other sources of income to supplement what the UK state pension provides.
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