What is the state pension? A future users guide
State pension introduction
Thanks to the stereotype of the old-age pensioner eking out an existence on pennies many of us think that the state pension will not be worth very much at all.
However, studies from Prudential show that, for most of us, this guaranteed weekly pay-out – currently £164.35 – will form a significant part of our retirement income. Most of the people who took part in the insurer’s research were due to retire this year and estimated that the state pension would make up around a third of their income.
With this in mind, it makes sense to find out all you can about this important part of later-life finances. This guide will take you through just some reasons why the state pension is so important.
You can rely on the state pension
The virtual demise of the final-salary pension and the advent of new pension freedoms gives most of us a lot more choice about how we build and use our retirement funds.
However, unless you buy an annuity with your pension pot, you’ll be the one in charge of how quickly you spend the money, which means tackling tricky questions about how long you’ll live and how much you’ll need in the future.
The state pension, on the other hand, doesn’t run out. It’ll be paid to you every week of your life from when you reach state pension age – and it isn’t means tested, so everyone who has paid the correct amount of National Insurance contributions receives it.
That correct level of contribution usually requires you to work for a minimum of 35 years, or to have engaged in another qualifying activity - including caring for young children - for the same amount of time.
As long as you have these qualifying years, the state pension gives you a bedrock to rely on when it comes to retirement planning.
You can find out how much your state pensions will be by visiting: www.gov.uk/check-state-pension
The state pension is index linked
Many of us forget about the rising cost of living when we’re saving for the future. But with inflation currently running at 2.7 per cent, the cost of buying basic items such as groceries, as well as paying to heat our homes, will rise throughout our retirement.
The state pension, however, is linked to inflation. This means that, if the cost of living rises, it rises, too.
At present, the state pension is protected by what is known as a Triple Lock. This means that the state pension increases each year in line with whichever of the following is highest: consumer price inflation (CPI), average earnings growth or 2.5 per cent.
There have been discussions over whether to scrap the Triple Lock in future, but at present it remains in place.
There are special allowances for carers and others
The amount of state pension you’ll get depends on your National Insurance record, which reflects how many years you’ve worked for and paid National Insurance in the UK. You usually have to have worked for 35 years to get the full amount.
However, in some cases, you can receive National Insurance credits, meaning you’ll be treated as if you’ve worked and contributed. These include being at home looking after children, if you’re ill, being a carer or if you’re unemployed. There’s more information on how to claim these credits on the government website www.gov.uk. See below for ways to top up your pension if none of these apply to you.
There are extra safety nets available
For those who are on a low income but don’t have a full NI contribution record, the government provides Pension Credit to top up the amount they receive. The Guarantee element of Pension Credit tops up your income if you receive less than £163 (if you’re single) or £248.80 per week. Those who reached state pension age before April 2016 may also be eligible for Savings Credit, which can further increase the amount you might get.
There’s good information on this from the charity Age UK at www.ageuk.org. uk/information-advice/money-legal/ benefits-entitlements/pension-credit/. To apply, call the Pension Credit claimline free on 0800 99 1234.
In some cases, you may be able to inherit a spouse’s state pension – particularly if he or she would have reached state pension age before April 2016. For more details, visit the government website www.gov.uk.
Making the most of your state pension
Ensuring that you get the very best out of your state pension can help increase your retirement income. Here are two tips that could make the most of yours – subject to your age and circumstances.
If you’re still working when you reach state pension age, you may not need the income you’d get from the state pension. One option then is to defer your pension – if you choose to do this you’ll receive more per week at a later date.
The rules differ depending on whether you reached state pension age before or after April 6, 2016. For those who did so before then, their pension increases by 10.4 per cent for every year that they defer. For those who were born later, the rate of annual increase is 5.8 per cent.
Is it worth it? It depends on how long you live after you start deferring your pension. Under the old rules you’d be best to defer for a year if you continued to claim for 10 years afterwards, whereas under the new rules the decision would take 17 years to pay off.
Buying extra credits
If you have gaps in your employment record, you may not get the full state pension when you retire because you won’t have paid enough National Insurance contributions to qualify. However, you can top them up, ensuring that you get more per week when it comes to taking the pension.
Whether this is a good idea for you will depend on whether you contracted out of the Second State Pension, as well as where and when the gaps are. The government’s Future Pension Centre on 0800 731 0175 will be able to help you work out whether it’s worth it in your case, while a state pension forecast will reveal any gaps in your record (more on this below).
What a state pension forecast would tell you
If you want to see what you might receive as a state pension, you can ask the government for a state pension forecast. Do this online through the Government Gateway at: www.gov.uk/check-state-pension or call the Future Pension Centre on 0800 731 0175 and ask for a statement.
Your forecast should tell you:
• How much your state pension should be per week when you become eligible for it
• Whether you have any gaps in your National Insurance record that could be plugged to help you receive a full state pension
• Your Contracted Out Pension Equivalent (COPE). If you contracted out of the additional state pension at any time, this shows the amount you should be receiving from elsewhere to compensate for what is missing because you didn’t pay the additional contributions.
The state pension timeline
The first state pension was introduced, paying five shillings a week to men over 70. At a time when the average life expectancy was 47, becoming an old-age pensioner was quite a feat. In today’s money, the five-shilling pay-out was worth just under £30.
The Contributory Pensions Act set up a state scheme for manual workers and others earning up to £250 a year. The pension paid 10 shillings (50p) a week from the age of 65, the equivalent of around £29 today.
The state pension age for men remained at 65, but that for women was cut to 60.
The National Insurance Act introduced a contributory state pension for everyone. This paid £1.30 a week, the equivalent of £51.80 now, and £2.10 fora married couple, the equivalent of £83.60. This was paid from age 65 for men and 60 for women, effective from 1948.
The National Insurance Act introduced a top-up state pension scheme known as the graduated pension.
It was announced that the state pension ages for men and women would be gradually equalised.
It was announced that state pension age would rise, eventually to 68.
Women’s state pension age begins to rise to gradually equalise with men’s.
The full state pension is now £164.35 a week.
The state pension equalises between men and women.
The pension age is expected to rise to 68 between now and 2039.
SERPS and the Second State Pension
• At various points in the history of state pension contributions, those who are working have been invited to contribute to additional schemes.
• SERPS (the State Earnings Related Pension Scheme) was the first of these, running from 1978 to 2002 when it was replaced by the State Second Pension, which ran run until 2016.
• Some people chose to opt out of these arrangements, a process known as ‘contracting out’. In such cases the employee and employer paid reduced NI contributions but put extra into a pension instead.
• Your pension forecast will show whether you will receive any additional pension from SERPS or the Second State Pension, and if you contracted out will show an estimate of what you should receive instead from the employer scheme.
• This estimate is called a COPE, or Contracted Out Pension Equivalent. An estimate of your COPE will be shown if you use the online Check your State Pension service or if you request a State Pension Statement through the post. The Check your State Pension Service is available here: https://www.gov.uk/check-state-pension.