Pension scheme may be a shock
Not everyone will receive as much as they are expecting when the flat-rate retirement benefit takes effect in 2016. Neasa MacErlean explains
Preparations for the single-tier pension (STP) go into their final phase this month as laws are put into place to create the new flat-rate benefit predicted to be worth about £152 a week in today's money.
But the new system, starting in April 2016, will lead us all into unexplored territory - and some potential shocks and surprises. For instance, many people will find that, instead of getting this sum, they will receive about £25 less.
In fact, the Institute for Fiscal Studies (IFS) predicts that 69 per cent of new claimants in the first four years will receive less than the £152 figure.
The IFS calculations - contained in its paper A single-tier pension: what does it really mean? - suggest that 40 per cent of people reaching state-pension age between 2016 and 2020 will get less than £135. About 60 per cent are on track to get less than £145.50.
"There is a risk that they have been misled into expecting the full amount when that's not the case," said Rowena Crawford, co-author of the IFS report.
The two main reasons for a shortfall are that the person has not accumulated the minimum 35 years of National Insurance contributions generally needed to qualify for the full sum, or that they have been "contracted out" 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. In many of these cases the person will suffer no immediate disadvantage when their pension income is totted up. In fact, Laith Khalaf of the Hargreaves Lansdown pensions research team says people who have contracted out are "among the winners" in the switch to the new system.
Contracting out means they have opted out of contributing to the state second-tier pension, were given incentives to do so (in the form of National Insurance rebates) and were invested instead in a private pension scheme. And that private pension should yield a bigger pension income than they could have expected from the state second pension.
Over the next two years the Government and the pension providers will begin explaining some of these issues in far more detail. But the complexity of pensions may mean that many people do not know what will happen to their pension in future. For instance, many who were contracted out could find they get no increases on a part of their private pension (the portion known as the GMP, or guaranteed minimum pension). This is because the Government promised to pay some of the annual increases due on the contracted-out part of a pension - but this promise is being swept away for people retiring under the new system. A big problem here is that most people have not been warned that they will not get the increases.
Another side-effect of the new system will be that "final salary" (or other "defined benefit") employer pension schemes will be under pressure either to reduce benefits to employees or ask them to pay another 3 per cent of their salary as pension contributions.
Some employees "will see a cut in their take-home pay," warns Chris Thompson, a pensioner who used to work in the financial-services sector and who has become one of the country's leading experts on state pensions.
This is because people who are currently contracted out get a 1.4Â per cent National Insurance rebate as an incentive to stay out of the state second-pension scheme. When this ends in April 2016 that 1.4 per cent rebate will also end.
Individuals who are concerned about their position can start by finding out how much pension they are likely to get. People who reach state retirement age some time after April 2016 will be able to increase their entitlement by continuing to build up National Insurance contributions - either by working or getting NI credits through, for example, claiming Jobseeker's Allowance.
Although the new system has been widely welcomed, industry experts can see pitfalls.
"Most people with a steady work history will do less well under the single-tier pension," says Mercer actuary Deborah Cooper.
IFS calculations suggest that someone who is 28 today could end up with an STP 11 per cent lower than under the current system (see case study).
The lowering of the state-pension safety net in this way will propel people to make their own pension investments through the financial markets, leading Ms Cooper to conclude that this could "potentially result in some very poor outcomes".
In a similar vein, Robin Ellison, the head of strategic development for pensions at solicitor Pinsent Masons, is concerned about some aspects of the reforms. He is particularly worried that dropping the requirement to buy an annuity will backfire. "There will be some horror stories in the press in five or 10 years' time about people not buying annuities," he forecast.
Mr Khalaf at Hargreaves Lansdown believes far more people in "defined contribution" schemes will start taking an interest in how their funds are invested.
Under these schemes - the increasingly widespread alternative to defined-benefit pensions - people have some say in how their funds are invested. At the moment, some 90 per cent are in the default option proposed by the employer, but Mr Khalaf expects that to drop sharply. He says employees are "hugely" receptive to the pension education schemes which more employers are starting to put on.
Most experts think the Government will give the new proposals time to bed in without further changes over the next two years. But there are some signs that the next set of changes could come sooner and be more dramatic than has generally been expected.
"Indexation of the STP and extending the state-retirement age are the biggest parameters open to change," says Ms Crawford at the IFS - meaning the age at which the state pension becomes payable and the rate at which it is increased each year.
Robin Ellison, a former chair of the National Association of Pension Funds, makes another suggestion.
HMRC "is thinking really, really hard about whether they want to get rid of tax relief on pensions", he says, which ties in with Chancellor George Osborne's concession in the Budget in March when he extended the Isa (Individual Savings Account) total by 26 per cent to £15,000. This surprisingly generous measure took most experts by surprise.
Mr Ellison, however, can see an explanation, viewing it as a possible prelude to a far simpler system where pension relief is abandoned and we all use Isas for our overall savings, including pensions.
Most people with a steady work history will do less well under the single-tier pension
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