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178Personal Financial Planning Workshop 4 -State PensionsYou should refer to refer to the following in preparing for this workshop: gov/state-pension/overview gov/new-state-pension/overview The UK State Pension system has undergone radical changes in recent years  Summarise the UK pension system an...

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178Personal Financial Planning Workshop 4 -State Pensions

You should refer to refer to the following in preparing for this workshop: https://www.gov.uk/state-pension/overview https://www.gov.uk/new-state-pension/overview 1. The UK State Pension system has undergone radical changes in recent years  

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Summarise the UK pension system and compare the Basic State Pension with the New State Pension. What were the key issues driving the need for changes to the pension system? Is the pension system sustainable, or is it likely to continue changing and evolving? Is the new system more generous than the old one? Are there any winners and losers?

The summary of the UK state pension is in the table below: OLD STATE PENSION NEW STATE PENSION

All reaching State Pension Age on or All reaching State Pension Age on or th before 5th April 2016 after 6 April 2016 2021/22 weekly pension of 137.65pw 2021/22 weekly pension of 179.58pw Flat Rate pension, no additional state Additional State Pension for those pension hence no link between who were contracted in. Maximum earnings and the amount of weekly 179.41pw pension Possible reduction in pension for those 1/30th pension for each year of NI who were contracted out Possible to inherit part of partner's 1/35th SP for each year of NI pension (both basic and additional) contributions Pension entitlement based on Triple Lock individual entitlement Can pay voluntary contributions Triple Lock NI credits available for carers, Can pay voluntary contributions unemployed and long term sick NI credits available for carers, unemployed and long term sick Changes to SPA age - can get State Pension later than before

These issues are discussed in a wide range of papers and reports for example: http://www.thisismoney.co.uk/money/pensions/article3399729/Government-lays-winners-losers-new-155-65-state-pension.html http://www.independent.co.uk/news/uk/home-news/state-pension-changesage-uk-charity-70000-new-rules-a6914901.html State pension spending forecast: https://obr.uk/forecasts-in-depth/tax-by-tax-spend-by-spend/welfarespending-state-pension/ UK life expectancy: https://www.ons.gov.uk/peoplepopulationandcommunity/birthsdeathsandm arriages/lifeexpectancies/bulletins/nationallifetablesunitedkingdom/2017to2 019 UK population: https://www.ons.gov.uk/peoplepopulationandcommunity/populationandmig ration/populationestimates/articles/overviewoftheukpopulation/january2021 Latest comments on triple lock: https://www.ftadviser.com/pensions/2020/09/23/govt-confirms-triple-lockboost-despite-scepticism/ Key discussion points in no particular order: The answers to Q1 contain some additional points that go beyond what we covered in the module.

Cost & Demographics (based on additional reading): 

rising % of population over State Pension Age (SPA) with lower % of working age and paying taxes = mismatch in the ‘pay as you go’ unfunded approach used for the state pension. 2014/5 total state pension costs £86bn or 4.7% GDP, by 2033/4 projected to be £170bn and, even after all the increases in SPA. The number of pensioners per 1000 workers is set to rise from just over 300 now, to 370 per 1000 over same period.

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About 1 in 5 65 years and over in 2019 and about 1 in 4 in 2050.

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Working longer means paying taxes & private pension contributions for longer to help fund longer retirement – reduces pressure on State finances

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Principle that should not spend more than 1/3rd of adult life retired

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increasing life expectancy means those over SPA will claim for longer average life expectancy at age 65 is expected to rise from 24.2 to 28.1 (women) and 21.5 to 25.6 (men) by 2050

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Additional pension and pension credit costs have risen, are poorly understood and are complex to administer. Eg Ave weekly amount of pension credit claim in 2005 was £41.58, 2015 was £56.25

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Objective to alter the ratio of state vs private retirement incomes from 55/45 (1997/8) to 40/60 by 2050 – currently about 50/50.

Will change resolve these issues? Only in the longer term: 

‘Baby boomer’ impact is most extreme through 2020s to 2030’s

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Costs will begin to slow down in 2040’s and decrease as % of GDP as approach 2060’s

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Further changes to SPA to keep average ratio of retirement under 1/3rd life (ave life expectancy adjustments) should maintain cost ratio over the longer term

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Removal of contracting out rebates and increase in private pension provision (workplace pensions), redistributive impact of eligibility (women, carers, self-employed etc.) will reduce pension credit requirement, but also over longer term reduce % of individuals income derived from the Basic State Pension.

Winners and Losers:

Winners are : 

Women who have looked after children/been carers or had other career breaks are treated more generously in credit terms than previously, and will not be hit by the loss of the additional state pension (S2P) or contracting out rebates

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Self-employed, who were not eligible for S2P or contracting out rebates – their State Pension will be higher as the new flat rate pension has increased.

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Individuals with ‘protected payment’ elements – transition allows for two valuations - old and new system – and pensioner receives the higher amount (However, the protected elements only increase by CPI, so potential decrease in value over time compared to the BSP element).

Losers:

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Changes to SPA will mean that all of us will have to work longer

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Poor NI records – less than 10yrs get no NSP, for those reaching SPA between before 2016 there was eligibility based on 1/30th for each NI year. For full new state pension will now need 35 years of NI compared to 30.

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Women who expected to retire before age of 65 (66 now following the latest increase in state pension age)

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Spouses, widows and divorcees - new system is based on individual entitlement – can’t claim based on partners or ex-partners NI record under new system and deceased spouses BSP can’t be inherited by surviving spouse

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Contracted out employees and employers – employees have lost 1.4% rebate that was payed into their private pensions and may therefore have their contributions increased, and in addition will have their flat rate pension reduced for the impact of being ‘ contracted out’ (although in theory they should have received equal or better benefit from their private pension arrangements). Employers will lose the 3.4% rebate and may need to increase their contribution or review their occupational scheme structures.

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High earners will no longer be able to accrue extra earnings related benefits through S2P, and along with younger people will be ‘capped’ by the ‘flat rate’ approach

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Those who would have been eligible for savings credit as well as pension credit – the savings credit element is abolished wef 2016

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Those who were considering deferring will not be able to take deferred benefits as a lump sum , they can only get enhanced weekly payments and the rate has been reduced from 10.4% to 5.77% per year of deferral

2. Peter and Jane are married. Peter is 66 (d.o.b. 16/02/1955) and Jane is 60 (d.o.b. 10/01/1961). Both are still working full time on good salaries. Peter is healthy and active and intends to work until he is 70, although he may go part time before then. Peter will soon be able to claim his basic state pension but does not need the income and understands that he is able to defer his claim and get more income or a lump sum instead. Jane wants to retire at the same time as Peter but is not sure how this will affect her state pension entitlements. Jane has 22 years of NI contributions and Peter has 38. A) Explain to Peter how his state pension will be impacted if he defers his claim as long as he plans. Are there any risks involved in doing so? His State Pension Age (SPA) is 66. If he defers his pension for 4 years he will be able to claim @5.8% additional pension for each year, i.e. 4*5.8% = 23.2%. Full new state pension as of now is 175.20pw (as at 2020/21) or 9110.4pa * 1.232 = £215.85.pw / £11,224.pa (or £2,133.6 more per year -

this is in today’s money, ignoring that the SP will increase under ‘triple lock’ each year). He is not eligible for the lump sum as this ended in April 2016. He would ‘miss out’ on gross income of £9110.4 x 4 years = £36,441.6, meaning he would have to live for 36,441.6/2,133.6 = 17.08 years to regain the gross sum foregone.

B) Explain to Jane how her state pension will be affected if she stops working at age 65 to retire alongside Peter when he reaches age 70. When will she be eligible to claim her state pension, and how much will she receive? What she should consider doing in order to maximize her pension. If Peter retires at 70 this will be February 2026. Jane will not be eligible for NSP until November 2027 when she will be 66 and 10 months. Please use SPA calculator at https://www.gov.uk/state-pension-age. Therefore she will not be able to claim her state pension until this age. If she stops working in 2026 (when Peter retires at 70) she will have 28 years of contributions, and unless she has any childcare or other credits, will be eligible for only 28/35th of the full SP. She can pay voluntary NICs between which will increase her BSP entitlement if she feels this is appropriate. She can also continue working for longer. Under new pension rules she won’t get a share of her husband’s BSP on death so she may wish to maximize her own.

3. Joey is single and has just reached State Pension Age. He spent much of his younger life overseas and in low paid part time work and didn’t start to pay NI until he was 45. He has basic state pension entitlement of £107pw plus and £31pw from a private pension. He has £9,000 in savings. Calculate his eligibility for Pension Credit. https://www.gov.uk/pension-credit/overview £173.75 – 107 – 31 = £35.75pw top up. If he had no occupational pension then pension credit would be £66.75pw. Therefore gross income would be £173.75. Joey has therefore gained no advantage by having accrued benefits in the occupational scheme.

4. Explain the likely impact of the new state pension system for each of the following people: a) Mike is 27 and professionally qualified with expectations of rising salary and good career progression. Mike will not get BSP until he is 68 on current rules. However, future SPA will be amended to reflect changes in overall life expectancy, so if we continue to live longer this is likely to rise. There is every possibility that the BSP will rise to 70+ and may become increasingly means tested over the next 50 years.

b) Jenny is 58 (born 05 Feb 1963) and has given up her supermarket job to become a full time carer for her 75 year old mother who has dementia. She is single and has 24 years of National Insurance contributions accumulated. Jenny was born in 1963, so will be eligible for BSP at age 67 in 2030. As a carer she is entitled to credits to replace her NI and will therefore continue to accrue BSP years whilst her mother is alive. Jenny could accumulate a further 9 years of NI credits and claim her BSP at 33/35th full SP. c) Gurpal is 37 and has 9 years of NI contributions at the full contacted in rate and 4 years NI contributions after earned after 2016. Under current rules he will need to accumulate min 35 years on NI contributions and will contribute up to SPA of 68 , becoming eligible in 2052. However, with future SPA changes linked to longevity indicators and the first review undertaken in 2017 and further reviews in the coming years, this is very likely to change. Any additional pension (S2P) accumulated over the 9 years is likely to have negligible impact by then. Currently, he is not earning additional state pension benefits as this ended in 2016. d) Arthur is 65 and has 40 years of contracted in NI contributions. Will get full new flat rate pension when he reaches SPA plus a supplement to recognize his SERPS and 2SP entitlements if they would have taken him over the level of the flat rate pension under the old rules calculation. e) Jack is 64 and has 43 years of contracted out NI contributions. His wife Millie is 59. She has only 6 years of NI contributions as she has always been the homemaker with no NI contributions of her own. Jack - Full NSP, no SERPS or 2SP (although must have a private or occupational pension as he was contracted out – therefore contracted out deduction will apply to his pension). His wife under old rules would have been able to claim SP on her husband’s NI record even if she had little NI record herself. However, under the new system, she will not be able to do this and will have to accumulate her own entitlement, which is possible if she goes to work for a further 7 years to accumulate the minimum 10 years for entitlement, or if she has spent any time as a carer or at home with children under 16 – this is likely and will allow her to benefit from credits. The rules state: If you’re a parent who got Child Benefit for a child under 16 between 6 April 1978 and 5 April 2010, but you didn’t get Home Responsibilities Protection (HRP) automatically, you can apply for HRP Class 3 credits up to a max of 22 years. If you received child benefit for a child under 12 after April 2010 you got credits automatically

5. Ellie is 45, and he has been self-employed for a number of years. She has currently found a new job with a salary of 24,500pa, and her new employer

told her that she is eligible for auto-enrolment. Ellie is a single mum with 2 children and is finding it hard to manage her finances. She doesn’t think she can afford the contributions and knows she will always have the state pension to fall back on at retirement. She is not convinced it is worth joining. a) How would you advise Ellie? Has 23 years to retirement- is sufficient time to accumulate a decent pot of money to supplement state pension. Currently @8% total contribution – 3% employer and 5% employee. Calculated on so called qualified earnings which is salary less 6,136pa. Therefore, 24,500 – 6,240 = 18,260 – qualified earnings. Employer 18,260 x 3% = 547,8pa, and employee 18,260 x 5% = £913.2pa. Total 1,460.8 x 23 Years = 33,598.4.76 plus investment returns so might be well over £50,000. If she doesn’t take pension, would give up on 3% employer contribution and the income tax relief. Could defer a bit and increase contributions when kids a bit older? State pension is not enough to live on alone and she will have to wait until SPA, currently 67, but which may well rise to 70 before then. This saving would give her some flexibility. b) How would your advice differ (if at all) if Ellie was 24 with no children? Even stronger recommendation and also to commit more than the minimum to build up as much as she can in the early year and benefit from compounding. SPA likely to be 70. c) How would your advice differ is Ellie was 57 and had no family responsibilities? Ellie would have 10 years before reaching SPA. This is a very short time to accumulate any significant pension pot. However, she would miss out on employer contributions and tax relief on her own contributions so still beneficial to save....