A new era
The introduction of the single tier ‘flat rate’ state pension in April 2016 is designed to bring about a new era of pensions simplicity whilst offering a fairer deal to the UK’s retirees.
The new state pension rate of £155.65 per week from April 2016 is, on the face of it, an improvement on what most individuals are expecting to receive.
However, there remains a real concern that many people will end up receiving much less than this, and as a result, it could have implications for their financial plans, given the extent of the relatively new pension freedoms which have been available from April 2015.
The complicating factor that many retirees may struggle to understand is the impact that contracting out will have on the amount of state pension they will receive.
Part of the reason behind this is that any calculations to establish their state pension will include a deduction to represent the period the individual was contracted out, and this is designed to allow for the reduction in national insurance (NI) payments the individual would have benefitted from whilst they were contracted out. As a result, trying to understand how the former and new regimes work in transition to arrive at an income figure will leave most retirees in need of guidance or advice.
A drive for simplicity
The drive for a more simple approach to replace the basic pension, state earnings related top-ups and state second pensions into one flat rate single tier state pension will, in practice, result in confusion.
Many retirees will assume that they will qualify for the maximum amount because they have made contributions over the requisite number of qualifying years.
The process operating behind the scenes for those people entering state retirement will essentially consist of two calculations. The first will be to calculate how much of the new single tier pension they are entitled to, taking into account contributing years as well as deductions for contracting out. Secondly, a calculation using the old regime will look at what that individual would have been paid, and then a comparison is made to ensure that they would not get any less than the old regime.
The reality is that only those people who start work after April 2016 will be assessed solely under the new single tier regime, and that means the transition period for people retiring on or after April 2016 will continue for some considerable time.
The key danger is for those people who make plans on the expectation that they will receive more from the state pension than they actually will – and as a result overspend their defined contribution (DC) pension pots.
This could be a particular problem for people who start to draw from their DC pots before they are aware of the amount of their state pension, utilising their new found pension freedoms to withdraw additional lump sums but not securing a ‘Guaranteed Income or Life’ solution. Also, individuals who have an overly optimistic expectation of their state pension entitlement may be less concerned about making additional contributions during their working lifetime, in the mistaken belief that they will be receiving a generous pension from the state.