C1.01: STATE PENSIONS - BASICS

Transcription

1 C1.01: STATE PENSIONS - BASICS SYLLABUS Eligibility for benefits Form of benefits State Pension Age S2P basis Tax treatment Basis of funding NI contributions Pension Credit Eligibility for benefits State pension benefits are not automatic on grounds of age Instead they are contributory (ie dependent on the individual s National Insurance (NI) contribution record) Spouses and registered civil partners can, in some circumstances receive benefits based on the contribution record of their spouse or registered civil partner Earners build up entitlement to State basic pension benefits through payment of Class 1 NI contributions (employees) or Class 2 NI contributions (self-employed) For those reaching State Pension Age on or before 5 April 2010, to receive full benefits, NI contributions must have been paid or credited for around 90% of a full working career A full working career was 49 years for a man, 44 years for a woman However, the requirement has reduced to 30 years for both men and women, for those reaching State Pension Age on or after 6 April 2010 Contributions are credited as paid for those earning between the Lower Earnings Limit (LEL) and the slightly higher NI threshold They are also credited for various other groups including carers and those in receipt of certain State benefits such as Maternity Allowance Class 3 voluntary contributions can be paid by those who need to make up an incomplete record in some cases If the contribution requirement is not met, the basic pension is scaled down The State Additional Pension or State Second Pension (S2P) is available to employees and some others, including some carers, but not the self-employed The benefits are currently earnings related (see below) with earnings between the Lower Earnings Limit and Upper Accrual Point (UAP) being the basis of benefits Employees are only eligible for S2P if they are earning over the LEL therefore This is similar to the basis of the State Earnings Related Pension Scheme (SERPS) which was replaced by S2P in 2002 The UAP was introduced from 6 April 2009 and is fixed in monetary terms Previously, the maximum level of earnings taken into account was the Upper Earnings Limit (UEL) which increased each year

2 The UEL remains in existence and is the level of earnings up to which employees pay full NI contributions The UEL increases each year so the band of earnings on which full NI contributions are paid, but do not result in extra benefits, will widen over time In 2011/12, the UEL is 817 pw The self-employed are eligible only for the basic pension ( pw for a single person) This increases the need of self-employed individuals to make private provision State pension benefits are not means-tested, though the Pension Credit (see below) is Form of benefits State scheme benefits are generally paid in the form of income The only situation where a lump sum may become available is where State pension benefits are deferred beyond State Pension Age (see below) In recent years, State pensions have been increased in line with prices, measured by the Retail Prices Index (RPI), although larger increases have been announced by government in some years From 2011, the basic pension will be increased in line with the greater of growth in National Average Earnings and prices, now measured by the Consumer Prices Index (CPI) A minimum increase of 2.5% per year is guaranteed and in 2011, it was also guaranteed that the increase would not be less than the increase in the RPI SERPS/S2P benefits will continue to be increased in line with prices only and the measure will be the CPI from 2011 A spouse who is widowed or divorced can sometimes claim a pension based on the other spouse s NI contribution record, with similar rules for registered civil partners This is known as a Category B pension, but the details are beyond this syllabus area SERPS and S2P benefits can be inherited, at least to an extent, by a spouse or registered civil partner of the deceased Generally the amount inherited is 50% of the level available to the deceased However, for those who reach State Pension Age (SPA) before 6 October 2010, the level of inherited SERPS benefit is higher (between 60% and 100%, depending on when SPA is or was reached) State Pension Age Until 5 April 2010, State Pension Age (SPA) was 65 for men and 60 for women However SPA is now in the process of being equalised Originally, it was planned to increase State Pension Age (SPA) for women from 60 to 65 over the period 2010 to 2020 However, the coalition government has accelerated the increase in SPA so that it reaches 66 (rather than 65) for both men and women in 2020 Under the Pensions Act 2007, State Pension Age will increase further for both men and women to 67 over two years starting in 2034 and to 68 over two years starting in 2044 However, this schedule may also be accelerated

3 The increase in SPA is intended to take account of longer life expectancy and its effect on the cost of State Pensions Benefits cannot be taken before SPA in any circumstances They can be deferred indefinitely however Until April 2005, the maximum permitted deferment period was 5 years, but this maximum has now been abolished Benefits which are deferred are increased to take account of their deferment, by 1/5% per week of deferment (ie approximately 10.4% per year) An option to take a lump sum representing the amounts deferred instead of an increase in eventual income benefit was introduced in April 2005 To qualify, benefits must be deferred by at least a year The lump sum is equivalent to the deferred payments, increased with interest currently at 2% above bank base rate The lump sum is taxable at the individual s highest rate, but cannot take the individual into a higher tax band S2P basis S2P is an earnings related benefit available for employees (not the self-employed) Generally, an employee needs to be earning in excess of the Lower Earnings Limit to qualify for benefits It replaced SERPS (State Earnings Related Pension Scheme) in 2002, with the intention of targeting benefits more towards the lower paid SERPS benefits are preserved for periods of employment before April 2002 Assuming a full career in the scheme, SERPS (in its form just before it was replaced) aimed to provide a pension of 20% of earnings between the Lower and Upper Earnings Limits (LEL and UEL) S2P divided earnings further, by creating three bands, from LEL to Low Earnings Threshold (LET), from LET to Upper Earnings Threshold (UET) (also known as the Higher Earnings Threshold or HET) and from UET to UEL From 6 April 2009, the UAP has replaced the UEL as the maximum level of earnings taken into account The target benefit on each band, assuming a full career in S2P was originally: - LEL to LET: 40% - LET to UET: 10% - UET to UAP: 20% From 6 April 2010, future accrual in respect of earnings between the UET and UAP is based on a target career benefit of 10% In calculating benefits, earnings from past years are revalued in line with the increase in national average earnings They are averaged over whole of the individual s working career LET and UET were calculated so that the benefits for someone earning an amount equal to the UET would be approximately the same under S2P as they would have been under SERPS

4 This also applied to those earning above the UET, because the target benefit on earnings above the UET was the same as it was under SERPS Those earning below the UET were better off under the S2P formula The change in 2010 means that those earning over the level of the UET are worse off than would have been the case under SERPS, and the UET is no longer relevant in determining benefit levels Those earning less than the LET (but more than the LEL) are treated for benefit purposes as if they were earning an amount equal to the LET, which can boost benefits considerably In 2011/12, the LEL is 102 per week ( 5,304 per year) and the UAP is 770 per week ( 40,040 per year) The LET is 14,400 per year S2P is in the process of changing so that it gradually becomes a flat rate scheme, which will continue the process of targeting benefits towards low earners Higher earners will be worse off as a result The government has announced that it would like to introduce more radical reform, with the introduction of a higher basic pension to replace S2P, and is consulting on this Alternatively, they have suggested accelerating the moving of S2P to a flat rate basis In the meantime, the originally planned process of moving S2P to a flat rate basis has started with the introduction in April 2009 of an Upper Accrual Point (UAP), which is 770 per week ( 40,040 per year) The LET will continue to increase and will eventually overtake the UAP, which will then be abolished This will leave S2P providing benefits on a flat rate basis (based on 40% of the difference between the LEL and LET for all who complete a full career in S2P) This position should be reached by around 2030 unless accelerated (or overtaken by a new approach) The first tier of S2P is already in effect a flat rate scheme, because over a full career of membership, everyone earning over the LEL builds up a benefit of 40% of the difference between the LEL and LET The reduction in the target benefit on earnings between the UET and UEL from 20% to 10% from April 2010 is a further step towards making S2P a flat rate scheme Tax treatment State pensions are taxable as non-savings income They are always paid gross no tax is deducted at source Generally, for those with other pensions or earnings, there is an adjustment to the tax code used in taxing that income under PAYE, in effect allowing for the fact that the personal allowance will be wholly or partly used by the State pension Where there is tax to pay, the pensioner must account for this direct to HM Revenue & Customs (HMRC) if it has not been collected through the application of PAYE to other income Basis of funding State pensions are provided on what is known as a Pay As You Go (PAYG) basis This means that there is no invested fund

5 Instead, current benefits are paid from current NI contributions This has created pressure on the system because demographic changes mean that the number of people working has remained roughly constant in recent years, but the number of pensioners has increased substantially The result has inevitably been an increase in NI contributions This is also one of the reasons that SPA is being increased NI Contributions As mentioned above, eligibility for State pension benefits (both basic pension and S2P) is based on the individual s NI contribution record Class 1 NI contributions are paid by employees and employers They apply to earnings above the NI primary threshold (for employee contributions) or NI secondary threshold (for employer contributions) Employers pay full rate (13.8%) on all earnings above the threshold Employees pay full rate (12%) only on earnings between the threshold and the UEL They pay 2% on earnings above the UEL Class 1 contributions cease for employees at SPA, but the employer is still liable if the employee works on Class 2 contributions are paid by the self-employed at a flat rate ( 2.50 per week in 2011/12) Class 3 is a voluntary flat rate contribution ( pw) which can be paid in some cases by those who need to make up for a partially incomplete contribution record Class 4 contributions are profit-related contributions paid by the self-employed (though no pension benefits are earned by them) The rate is 9% on profits between 7,225 and 42,475 per year and 1% of profits above 42,475 in 2010/11 The lower limit is in line with the Class 1 primary threshold and the upper limit is in line with the UEL Pension Credit Pension Credit is a means-tested benefit designed to help low income pensioners There are two parts the Guarantee Credit (formerly the Minimum Income Guarantee or MIG) and the Savings Credit The Guarantee Credit ensures that the income of pensioners is at least equal to a minimum level known as the appropriate amount In 2011/12, this is pw ( pw for a couple) If income is below this level, the Guarantee Credit makes it up to this level The Savings Credit is designed to reward savings by providing additional amounts if income exceeds a minimum level (equal to the State basic pension) The maximum available in 2011/12 is pw ( pw for a couple) This is reduced by income above a certain level (equal to the appropriate amount for Guarantee Credit purposes at the rate of 40% of the excess It falls away once income reaches around 189 pw ( 278 pw for a couple)

6 Guarantee Credit was originally available to those over 60, but this minimum age is increasing in line with SPA for women Savings Credit is not available until age 65 The intention of means-tested benefits is to target the provision of benefits towards those most in need, so the money available can do the most good However, costs are high and means-testing is seen by many as intrusive, with the result that some who are eligible decide not to claim The existence of these benefits can make it difficult for advisers to recommend savings and pension arrangements Any such arrangements could prejudice the availability of benefits