Retirement Planning The State Pension System

Transcription

1 Retirement Planning The State Pension System This section will cover the State pension system a notoriously weak area for many candidates. In terms of the exam there are only a limited number of questions on the subject and candidates sometimes don t pay as much attention to it as other parts of the syllabus. This may be a big mistake. The milestones are to understand: The differences between the pre and post April 2006 regime To understand how post April 2016 benefits are calculated When it can be useful to make voluntary NIC A brief history of the State Pension Whilst there has been some form of state pension for over 100 years, the basis of the current system started in Its designers did not want it to be a hand out so it has always a contributory element. This is done by building up an entitlement through paying National Insurance Contributions or NIC which are paid by employers, employees and the self-employed. A quirk of the system is that you can be employed and not pay NIC but still get credit for the state pension. In the 18/19 tax year if you earn between 6,032, the Lower Earnings Level and 8,424, the Primary Contribution Threshold, you do not pay NIC but will get a full credit for that year. Benefits could also be built up by receiving NIC credits which are usually given when someone is receiving welfare benefits such as Job Seekers Allowance. Although individuals make contributions the system is unfunded. NIC do not go into a fund but are simply used to pay the pensions of those who have retired. This is known as the Pay as You Go system. It enabled pensions to be paid from its inception in 1948 and can work if the ratio between those in work and those receiving pensions stays constant. However, the UK population is ageing and the proportion of pensioners to workers is increasing. This makes it untenable unless significant changes are made. The Government s initial response was to increase the state pension age. For over 50 years this was 65 for men and 60 for women. It s worth remembering that back in 1948 when there was a high proportion of men doing physical work many men might only expect to live for another five years after reaching 65. This difference in ages between men and women was not too significant at a time when most women ceased work on marriage or when they had children. Indeed, until 1978 a married woman could opt to pay a lower rate of NIC and rely on her husband s contribution record so that when he reached 65 they received a married couple s pension. 1

2 The equalisation of the State Pension Age is currently on-going. The last women to receive a state pension at 60 were born on April so they would have got this on April It was planned that the pension age would go up by one month for every month you were born after April so the SPA for someone born on April was 60 years and 1 month. If things had gone to plan women born on April would have got their pension at 65 in However, the increase in State Pension Age has been accelerated and by 2020 it will be 66 for both men and women. Further plans are to increase it to 68 by mid-century. Back in 1948 the then called, Old Age Pension, was paid as a flat rate. It was set at a level that was insufficient to cover the essentials of life so there was a system of additional means tested help. It was realised over time that there should be some form of additional pension that was linked to the individual s earnings. Over time three separate systems were used: Graduated Pension Scheme (GPS) up until April1975 State Earnings Related Pension Scheme (SERPS) April 1978 to April 2002 State Second Pension (S2P) April 2002 to April 2016 Someone who reached state pension age before April could be getting a pension made up of the flat rate basic pension, GPS, SERPS and S2P. In addition, anyone over the state pension age for women can get their income topped up to 153 a week or for couples under Guarantee Credit. This though is means tested. There is a further Savings Credit that can only be paid to those who reached State Pension Age before April This mitigates the effects of means testing for those who have made some savings. It is probably unlikely that you will get a question on the details of the different additional state pensions but since everyone who reached State Pension Age on or before 5 April 2016, will continue on the old basis for the rest of their lives, it s important to know the key details if only to compare them to the post April 16 system. A summary of the pre April 2016 system. This was made up of the flat rate Basic State Pension ( a week for 18/19) and earnings related additional state pension. The Basic State Pension (BSP) was paid to anyone, employed or self-employed, who had 30 years Class 1 or Class 2 National Insurance Contributions or credits. Only employees were entitled to the Additional State Pension. The self-employed were excluded so someone who had always been self-employed all their working life would only get the BSP. It was possible for defined benefit schemes to contract all their members from both SERPS and S2P. Both the employer and employee paid a lower rate of NIC but did not build up any credit for Additional State Pension. Between April 1988 and April 2012 it was possible for money purchase schemes and individuals to contract out of the additional state pension. 2

3 There are normally no survivor benefits with BSP. The exception is where a married couple s pension is being paid. If the man dies his wife would then receive a BSP based on her late husband s contributions. SERPS and S2P will pay at least 50% of the pension to a surviving spouse. All parts of the state pension can be deferred, either at SPA or later although only one deferment can be made. The minimum deferment is 5 weeks and the pension will increase by 1% for every 5 weeks it is deferred. This is 10.4% for a 12 month deferment. Alternatively, if it is deferred for 12 months it can be taken as a lump sum with interest at 2% above base rate. This is taxable but the rate will be based on the first 1 of income. In other words, if the payment is 8,000 and before this is added to other non-savings income, the individual is paying basic rate tax, the whole sum will be taxed at 20% even if some of it is in the higher rate band Pensions are paid gross but are taxable The BSP will increase each year by the greater of, CPI, National Average Earnings or 2.5%. Additional State Pension will only increase by CPI. The Single Tier State Pension On April the whole state pension system changed. Before looking in detail at how this will be calculated it is useful to take an overview of the changes. The new system will only apply for men born on or after April and for women born on or after April Everyone born before those dates will carry on under the old system. April marked the start of a long process that could take 30 to 40 years to complete. The eventual aim is that there will be a flat rate pension. For 2018/19 this is a week. Contracting out was abolished so members of formerly contracted out schemes now pay higher NIC. The number of years NIC contributions to qualify for the full pension is now 35 years and there is a minimum requirement to have 10 years otherwise nothing will be paid. Savings credit has been abolished for those in the new regime although Guarantee Credit remains to top up income to 163 for a single person or for couples. Pension deferment is still possible but deferment must be for 9 weeks to get a 1% increase. The lumps sum option has been abolished. 3

4 Transitional Arrangements The easiest way to understand how the system works is to take the example of someone who starts work for the first time after April Simon started work on May Every year he has a full NIC record he will build up 1/35 th of the current flat rate pension. For 18/19 that would be 4.70 a week. After 35 years he would be entitled to the full pension at his state pension age. That is likely to be well before SPA but he will continue to pay NIC until then but will not get any further increase in his pension entitlement. It doesn t matter if he earns just the minimum wage all his whole working life or he is a high flying executive, he will get the same pension. There is no earnings related element. For at least the next 30 years most people who reach state pension age will have pre April 2016 benefits and these will be taken into account in calculating their pension rights. Everyone who comes under the new system will get a starting or foundation amount. This will calculate the individual s pension based on both the old and the new basis and the starting amount will be the highest of these two. Individuals who have been contracted out will have a deduction from the starting amount. This will apply whether the individual was a member of a contracted out scheme or contracted out using a Personal Pension between 1988 and The rationale behind this is that having been contracted out you will have an additional pension from another source. The starting amount will either be more or less than the original single tier pension of a week. If it is higher the excess amount is called a protected payment. Antonia is 50 and has a starting amount of a week because she has substantial additional state pension rights. Her protected amount is 45 a week. This will be increased each year in line with CPI and paid on top of the flat rate pension. However, whilst she will continue to pay NIC for the rest of her working life she will not build up any further increases to her pension. If the starting amount is below a week then each year s NIC will build up another 4.70 a week until they have built up entitlement to the flat rate pension. Tristan is five years off his state pension age and his starting amount is 120 a week. For the next five years (assuming the level does not increase) he builds up 4.70 a week so at state pension age his pension will be

5 Voluntary NIC Contributions Anyone reaching state pension age after April needs 35 years qualifying years If an individual has fewer than 35 years their pension will be reduced. Anyone with less than 10 qualifying years will not get a state pension. Making voluntary contributions enable individuals to ensure the current tax year becomes qualifying or to buy back earlier years that aren t qualifying to increase their state pension. Whilst the principle is simple the details are more complicated. The main restrictions on voluntary contributions are: Anyone who reached State Pension Age (SPA) before 6 April 2016 cannot increase their pension above the current level of the Basic State Pension. Anyone who reached SPA on or after 6 April 2016 cannot increase their pension above the level of the Single Tier Pension ( a week in 18/19). The number of missing years that can be made up is limited. Voluntary contributions cannot be made in the tax year the individual reaches State Pension Age. Women who elected to pay the lower rate of contribution cannot buy back those years they were paying the lower rate. Should voluntary NIC be made? With a state pension age of 66 from 2020 individuals could be working for 46 years. Since only 35 years contributions or credits are needed it is unlikely anyone younger than 40 need be concerned about paying voluntary NIC even if for whatever reason they have not built up a credit in that year. Individuals approaching state pension age may realise that they are short of the 35 years or the 10 years to get any pension at all. Before making any decision, a state pension forecast should be obtained. The way in which individuals make the contributions will depend on whether, for the tax year they are making voluntary contributions they are: Self-employed with profits below that year s threshold Living and working overseas. Living but not working overseas. Employed in the UK 5

6 Self-employed If an individual s profits are below the small profits ( 6,025) they can make Class 2 voluntary contributions. This is very good value as the rate is 2.95 a week rather than for class 3. However, class 2 will be abolished from April Living and working abroad These individuals can make class 2 contributions provided they previously lived in the UK for three years or paid three years NIC. Living abroad but not working They can pay class 3 but only if at some time you have lived in the UK for at least three years in a row or paid NIC contributions for three years. Employed Here there is a further level of complication since the rules are different depending on whether SPA is before or after 6 April Individuals who reached state pension age before 6 April If these individuals have 30 qualifying years they will receive the Basic State Pension of a week. If they have less than 30 years they will not be entitled to the full BSP but they can make up the missing years by paying class 3 NIC even though they are over state pension age. This is normally restricted to the six years after you reach State Pension Age. Tom reached SPA on July so has until 30 June 2020 to pay additional contributions This group covers: Men born between 6 April 1945 and 5 April 1950 Women born between 6 April 1950 and 5 October 1952 This rule also covers anyone who has at least 20 qualifying years. 6

7 Individuals whose SPA is after 6 April 2016 These will have a starting amount based on the greater of the pension accrued on the old basis or on the new basis. In both cases a deduction will be made for periods when contracted out. Starting amount more than a week It is not possible to top up your state pension Starting amount less than a week Many individuals will be in this position but it does not mean that they should start paying Class 3 contributions. Every qualifying year from 2016/17 will build up 1/35 th of the STP. Jo is 50 and has a foundation amount of 120 a week. She plans on working another 10 years so will reach the Single Tier Pension and should not make Class 3 NIC (The STP will be higher than week by the time she reaches SPA but so will the credit she will get for each qualifying year.) If you are unlikely to reach the STP class 3 contributions can be made either by making up missing years or making contributions in future years. David has a foundation amount less than the STP. If he has any missing years between 2006/07 and 2015/16 he can pay voluntary NIC. These must be made by 5 April 2023 Helen is a teacher who retired in 2016 aged 60. She had 35 years service but her starting amount is equivalent to the Basic State Pension as she has been contracted out throughout her working life. Her state pension age is 66 but as she doesn t intend to work until then her starting amount will not increase. She can however pay class 3 NIC as each year s contribution will increase her state pension by 4.55 a week based on 2017/18 rates. This is excellent value since for a total cost of (52 x 14.25) she will get an additional pension of around 245 a year. This means if she survives beyond 69 she will have received more in pension than the initial cost. That concludes this chapter so you should now understand: The differences between the pre and post April 2006 regime To understand how post April 2016 benefits are calculated. How voluntary NIC can be made. 7