The current two-tiered State Pension is one of the most complex parts of our tax and benefits system and has been crying out for reform. The government announced significant changes yesterday.
From 2017, the current basic State Pension and earnings-related State Pension systems will be replaced with a single-tier State Pension. This will be £144 per week (£7,488 a year) in today's terms, likely to be around £162 a week in 2017.
The complex interaction of State Pension, savings credit and minimum income guarantee will be abolished.
Change in the eligibility criteria
A minimum qualification period of between 7 and 10 years will be introduced. Anyone with less than 10 years' of National Insurance contributions will not receive a State Pension - carers will receive National Insurance credits to build State Pension entitlement. The minimum number of years to qualify for the full State Pension will increase from 30 to 35 years.
State Pension age increase
There will be a review of the State Pension age in the next Parliament. Future increases to State Pension age will be longevity-based, however, there are already increases due to come into force.
By 2018, women's State Pension age will have been increased to 65; between 2018 and 2020 the State Pension age for both men and women will be increased to 66; and by 2028 to 67.
A further rise to 68 is scheduled to start in 2044 but is likely to happen sooner.
Contracting out ends
There will no longer be an earnings-related element to the State Pension and the ability to contract out of the second-tier earnings related pension will be abolished. Final salary pension schemes will end contracting out from April 2017.
Members will therefore pay a higher rate of employee National Insurance contributions from April 2017. Their employers will pay a higher rate of employer National Insurance. An employee earning £40,000 a year in a final salary pension scheme will pay approximately £480 a year more.
How will you be affected?
Those who will have reached State Pension age by 2017 will not be affected and will retain their pension entitlements based on the current system.
Those reaching State Pension age after 2017 will be affected; whether they're a winner or loser will depend upon their circumstances. There will be a one-off recalculation of everyone's State Pension entitlement, a monumental and expensive task to ensure existing entitlements are protected.
Those who contracted out of the second-tier pension - winners and losers
Anyone who has contracted out of S2P or SERPS will have a deduction applied to their £144 per week entitlement when the new rules become effective. The details are not yet available, however the deduction is likely to reflect the time spent contracted out and is unlikely to result in an income less than the current basic State Pension rate of £107.45 a week.
From 2017 until you reach your State Pension age, you can build additional entitlement, up to a maximum of £144 a week.
Those who are contracted into the second-tier pension - winners
Anyone with a combined entitlement of State and second-tier pension worth less than £144 per week (under today's system) will receive £144 per week if they have paid 35 years' National Insurance contributions.
Anyone below State Pension age in 2017, with a combined entitlement of State and second-tier pension of more than £144 will keep that level of pension income.
Those who have had both contracted in and contracted out periods - winners and losers
Anyone who has been both contracted in and contracted out of S2P or SERPS between 1987 and 2017 will have a one-off deduction made to their entitlement based on the amount of time they were contracted out. They will be able to increase this amount up to £144 based on qualifying years between 2017 and their state pension age.
The self-employed - winners
The self-employed currently only receive a maximum State Pension of £107.45 per week. This will increase from 2017 to £144 per week for those who have 35 or more qualifying years.
Low earners - winners
Those who have combined basic and second tier pensions of less than £144 will win as they will benefit from an increase to £144 per week.
Those with less than 10 years' service at retirement - losers
Currently State Pension is accrued on a year-by-year basis. However, 10 years will now be the minimum qualifying period. Someone with nine years' service under the current system would receive £32.24 per week or £1,676 per year. This will be lost under the new system.
High earners - losers
Under the present system a high earner might have accrued a State Pension in excess of £144 a week, in theory up to a maximum of £250 per week.
This will now be reduced to £144 per week (although benefits accrued to 2017 are retained).
State Pension age rises - losers
Everyone will lose out by receiving their State Pension later and may have to defer retirement or live on other resources. This will be particularly relevant to people in their 20s and 30s.
Final salary scheme members - winners and losers
Following the abolition of contracting out, both employee and employer National Insurance contributions will rise. In the private sector this may precipitate a further wave of scheme closures.
In the public sector, members may well be angered by their increased National Insurance bill, however given that they will be building up a more generous State Pension and retaining their defined benefit public sector pension, they will benefit from these reforms.
State pension reform: the verdict
The new simpler system will be far easier for people to understand. The changes are expected to be cost-neutral in the short term, but save money in the longer term as the State Pension age rises with longevity.
The one-off assessment of some 26 million people's entitlements will be a monumental and expensive task. However once complete, taxpayers should make savings from a simpler system, which requires less administration.
What could you do next?
The reform makes it easier to understand the level of income you could receive from the State when you retire. Add to that any income you will receive from any work pension you have. Will that be enough? Our clients who are building an additional provision for their retirement paid an average of £7,000 into their SIPPs (Self Invested Personal Pensions) last year.
You can start or top up a SIPP online in less than five minutes. If you prefer, you can do so by phone or post.
The value of investments can go down in value as well as up, so you could get back less than you invest. It is therefore important that you understand the risks and commitments. This website is not personal advice based on your circumstances. So you can make informed decisions for yourself we aim to provide you with the best information, best service and best prices. If you are unsure about the suitability of an investment please contact us for advice.