There are major reforms in the pipeline for the State Pension, which claim to simplify the system and provide greater clarity for people about what they will receive during retirement.
The reforms will create a flat rate pension, the full level of which will be set above the basic means test currently set at £148.35. The government expects that in the first 10 years after implementation, around 650,000 women will benefit from the single-tier valuation of their pension in 2016; receiving on average £8 a week more in State Pension.
Some low earners, who previously received limited funding much by way of additional pension, should receive more in this reform. Plus, self-employed people, who have limited involvement in any additional pension under the current arrangements, will be brought fully into the State Pension system for the first time; securing a more comfortable retirement.
Ten qualifying years of National Insurance contributions will be required to receive any State Pension under the new reforms. For people who started their National Insurance record after the reforms are introduced, the full level of the new State Pension will be based on 35 years of National Insurance contributions.
Minister for Pensions, Steve Webb, has said; “The new State Pension will replace the current complex mix of basic and additional state pensions, which successive governments have tinkered with so much over the decades.”
Transitional arrangements have been designed to protect people’s contributions prior to 2016, provided that they meet the minimum qualifying period.
The government has also introduced the triple lock guarantee, to ensure value of basic State Pension will rise by highest of inflation, earnings or 2.5 percent for the duration of this Parliament. In addition the State Pension is now a higher share of national average earnings than at any time in over 20 years. Nevertheless, the Institute for Fiscal Studies (IFS) predicts that 69% of new claimants in the first four years will receive less than the £152 figure.
The main reasons behind the shortfall are due to that the people who fell dropped short of the accumulated minimum of 35 years of National Insurance contributions, who previously needed to qualify for the full sum, or those that have been contracted out for most of their working life.
Contracting out happens when someone has their own; extra pension, either a personal pension or a collective scheme run through their employer. This means they opted out of contributing to the state second-tier pension, and were given incentives to do so in the form of National Insurance rebates. Over the next two years the Government and the pension providers will begin explaining some of these issues in far more detail than they have done in the past.
For instance, many people who were contracted out could find that they get very limited increases on a part of their private pension. This is because the Government’s promises to pay some of the annual increases due on the contracted-out part of a pension. However, these promises are being swept under the carpet for people retiring under the new system.
Although the new system has been widely welcomed by experts, those same experts can point out flaws. IFS calculations suggest that someone who is 28 today could end up with a STP, which is 11 percent, lower than a similar pension would be under the current system.
From April 2015, savers will be given total freedom over how they withdraw pension money. Savers will be able to access the entirety of their pension at any time after age 55, subject to income tax at marginal rates on three-quarters of the money.
In Australia, where people are already able to withdraw lump sums easily, recent evidence suggests that most retirees invest the money or use it to clear debts. However, a few choose to buy holidays or cars. The ability to claim the whole pension as one lump sum of income would mean someone with a £100,000 pension could take £25,000 tax-free and then withdraw the remaining £75,000 to spend or invest as they saw fit.
The £75,000 would be treated as income for that tax year, pushing the individual into the higher-rate tax band for the year.
What action could you take to improve your pension, for example investing in ISA’s or bonds and lifetime mortgages?