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Paul Lewis: Paradox time in new state pension land

Paul Lewis

Here is an investment I promoted on my radio show recently. You pay £733 and in return you get a guaranteed annual income of £231 for life, index-linked by prices, earnings or 2.5 per cent, whichever is the highest.

Isabel wrote in: “I asked my financial adviser but he didn’t know anything about it”. I am not surprised. Nor do I blame the adviser. He was in the heady stratosphere (or perhaps the murky depths) of the new state pension. You know, the flat-rate pension that is paid at more than 20,000 different rates?

The pension that requires 35 years’ worth of National Insurance contributions to get the full amount but of which more than a million with at least 35 years’ contributions will not get the full amount? That one.

Yes, it is paradox time. Let me deal with that last one: you need 35 years’ worth of NICs to get the full flat-rate new state pension of £155.65, but even if you have paid that much you may get less than the full state pension. More than 1.7 million people reaching state pension age in the next 10 years – about one in three – will be affected.

These are people who have paid into a good workplace pension and were contracted out of Serps. To get the full amount of the new state pension – or at least approach it – they will now have to pay yet more NICs on top of whatever they contributed before 2016/17.

The biggest group affected worked in the public sector: nurses, teachers, civil servants, police and so on. Also caught are the millions who paid into one of the thousands of private sector final salary or defined benefit schemes.

“The pension that requires 35 years’ worth of National Insurance contributions to get the full amount but of which more than a million with at least 35 years’ contributions will not get the full amount? That one.”

There is another group affected by the paradox that many Money Marketing readers will recall. They were sold a personal pension and persuaded by an alliance of advisers and government incentives to contract out of Serps and pay lower NICs.

Sometimes they only paid into their personal pension the equivalent of the NICs saving they made – so-called rebate-only contracted-out pensions. They believed it was a good idea to replace an earnings-related, index-linked pension guaranteed for life by the government with a small defined contribution pension not earnings-related, not index-linked and not guaranteed by anyone.

That decision has come back to bite them, because they now face a hefty deduction from their state pension just for being contracted out. This deduction can be huge, even if they were only contracted out for a few years.

One listener, David, told me he had paid in for 47 years and was contracted out for 11. His contracted out deduction was about £32. Instead of £155.65 he was going to get £123. He asked, not unreasonably: “I paid in for 36 years without being contracted out, so surely that should entitle me to the full flat-rate pension?”

Sadly not. In this “looking glass” world step one gives him a full pension and step two deducts a large amount from it, leaving him with no more than the old state pension.

The loophole

Many of those subject to a large contracted out deduction (called contracted out pension equivalent) could reduce or even eliminate it using a new and little known scheme. Every year of NICs they pay from 2016/17 onwards earns them extra pension at the rate of 1/35th of the £155.65 flat-rate amount: an extra £4.45 a week.

As the voluntary Class 3 contributions are just £14.10 a week, the payback time, even after tax on the pension, is just three or four years. Annually, the figures are £733 for a year’s Class 3 contributions and £231 a year added to the current state pension. That amount will rise each year with the triple lock, meaning an increase of 2.5 per cent or more guaranteed until at least 2020.

It is only NICs paid from 2016/17 that count in this way, so people reaching state pension age this tax year will not be helped by it, as they are too old to pay extra contributions. You can only pay them up to the tax year before you reach state pension age.

The scheme will help women born from 6 July 1953 and men born from 6 April 1952 who reach state pension age in 2017/18 or later. If they have a contracted out deduction, they will earn more pension even if they have already paid 35 years’ worth of contributions.

The more years left before they reach pension age, the more they can boost their pension. For example, men and women born 6 July 1954 to 5 April 1955 who will reach state pension age in 2020/21 can pay four years’ contributions and boost their pension by £17.80 a week at current rates.

Many people will not need to pay the extra contributions directly. Anyone who is working and earning over £112 a week in at least one job will get NICs through their earnings.

A parent entitled to child benefit for under-12s will get credits, as will anyone registered as unemployed or on other work-related benefits. Men born before 6 October 1953 may get “man credits” (don’t ask!) to cover one tax year. Carers may be able to get credits but some will have to ask for them.

If all that fails, then people can pay the £733 a year Class 3 voluntary contributions. Self-employed people with profits below £5,965 can pay voluntary Class 2 contributions for a mere £2.80 a week.

I hope Isabel’s financial adviser is reading this. It will probably be the best investment she can make.

Paul Lewis is a freelance journalist and presenter of BBC Radio 4’s ‘Money Box’ programmeYou can follow him on Twitter @paullewismoney

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Comments

There are 15 comments at the moment, we would love to hear your opinion too.

  1. Anyone wanting information on who can top up and by how much can find a helpful guide at http://www.royallondon.com/goodwithyourmoney – even if I do say so myself!

  2. I smell another reheated article from a consumer website and I really doubt that Isobel or her financial adviser exist. Every qualified adviser would instantly spot that Lewis was talking about the State Pension from the bit about the triple lock.

    The point is entirely valid though.

  3. Never imagine that Paul Lewis will write up anything without his own distorted take on it.
    Remember that this guy is in print saying no-one should use an IFA/adviser with less than level 6 qualification, as that is the only way to avoid crooked advisers….
    And that advisers should be only be paid on results…..

    Unfortunately the general public listen to Paul Lewis as though he’s qualified to give guidance or advice….

  4. I retired from local government in 2011 and am due to get my state pension under the new system in Jan 2017 at the rate of approx £124 (I have 40 years NI contributions) – due to being contracted out. I am a bit confused as following the flow chart in the Royal London’s helpful guide, it appears that I could purchase Class 3 NICs for the years 2011-16. However the article above states only those purchased 2016 onwards are eligible. Any views? I asked DWP about this but they appeared to have no idea what I was talking about – I offered to send them a link to the Royal London guide!

  5. Paul omits to mention that until April 2017 ONLY, those who retired PRE-April 16 can top up using class 3 with dramatic consequences. This only applies to those currently in retirement, who are lucky enough to exist under the old rules.

    You can compare what is available on the open market with what the state are offering for a single lump sum top up but using these tools https://www.moneyadviceservice.org.uk/en/tools/pension-calculator/info
    and https://www.gov.uk/state-pension-topup

    You can contribute to class 3 and get DOUBLE YOUR MONEY for the same contribution.
    The maximum contribution available to you is sufficient to secure £25 pw.
    That cost is a mere £21,775 if you are 66 today, and want a 50% spouses pension.
    Check that against the open market and you’ll see it is half price.

  6. Yes it wasn’t about any of that! You are referring to Class 3A which is different from Class 3. Only for those who reach SPA before 6/4/2016 and scheme ends 5/4/2017.

  7. It’s not a ‘loophole’ – it’s an explicit part of the scheme that favours post-2016 retirees who were contracted-out vis-a-vis those who weren’t.

  8. Kenneth Thompson 5th November 2016 at 9:36 am

    A good article about some of the problems with the new state pension. The reason that we have the situation where people who have 35 years full NI and does not have the full new state pension because of some years being contracted out is that the Government wanted people who had been contracted out most of their working life and were a few years away from their working life to be able to build up extra state pension so that they would reach the full new state pension fairly quickly either by continuing in work or state top up.

    In my opinion under the new state pension the DWP should have calculated a persons pension as follows which would have been fairer to everyone and would have reflected what happened when a person was contracted out.

    Assume a person was aged 60 and the new state pension as at 6 April 2016 was £ 155.A person had been contracted out with a contracted out pension of say £50 and the basic pension entitlement of say £120 they would not have been allowed to build up any more state pension because their GMP plus state pension came to more than the new state pension of £155.

    This would have also applied to a person who had been contracted in all their working life with the same basic pension of £120 and a state second pension /SERPS of £50.

    For some reason the DWP designed a system that would favour people who had spent time contracted out of the state second pension which as it happens now favours people mainly in the public sector who form about 75 % of people who were in contracted out schemes as at 6 April 2016.

    People who were contracted out should only be allowed to build up extra state pension under the new state pension if their basic state pension, contracted out state pension (GMP) and any state second pension came to less than £155. It was completely unnecessary for contracted out people to by back or earn extra state pension for the years contracted out if their total pension came to more than £155 when including the contracted out pension.

  9. @ Kenneth Thompson. Your suggestion in the last paragraph is actually how the new system works. If the “starting amount” is less than the new flat rate then further qualifying years will add 1/35th up to but only up to the new flat rate, not over. Anyone whose starting amount is higher than £155 will not earn further increments (except if they have missed years where they can back pay, which would increase their starting amount.)

    In this case article this feature of the new state pension is being described as unfortunate, whereas it’s actually a big improvement on the old system. Those who contracted out are essentially being allowed to “have their cake and eat it”. (And some might question whether that is fair, as mentioned above.) However, there are other features of the new system that are more deserving of criticism – for example, the changes to what a spouse will inherit. There are now some circumstances where a spouse will inherit no state pension on death, where they would have received significant amounts under the old system.

  10. John Simpson.

    I agree that people who have been contracted out are being allowed to “have their cake and eat it”.
    Why do you think it was allowed to happen? and at what cost.

    (However, there are other features of the new system that are more deserving of criticism – for example, the changes to what a spouse will inherit. There are now some circumstances where a spouse will inherit no state pension on death, where they would have received significant amounts under the old system.) I completely agree with this statement especially as those that divorced prior to 6 April 2016 and the divorcee settlement took into account state pensions that they will no longer receive.

    Another loss that people are not being told about is the loss of cost of living increases on their contracted out pension (GMP) which will no longer be paid via the state pension. Possible loss of up to about £20,000.

    The worst future loss is for people who are contracted in who will receive between £43 pw to £67 pw less state pension depending on if a low or high earner and if just starting to work and you compare the maximum under the old system compared with the old. No one is telling them this. I doubt if auto enrollment will ever make up this loss.

  11. I think I have at last grasped this deal. However those sitting on the phones at HMRC or wherever it is, have not. When I call they have little to no idea what I am talking about and very little idea about how I should pay for this. They keep trying to make me add to my 37 years of NI credits; pointless.
    How do we pay for it?

  12. After reading
    Paul Lewis: Paradox time in new state pension land

    I contacted the department of working pensions, and ordered a claims form which I filled in. Before sending it off I again contacted the department by telephone asking when was the best time to start it. They claim I should wait until April 2nd, as contributions would not be allocated owing to not being a complete year. I was born on 09/09/1953, and as such would not get a full year in before my official retirement date. I am planning on staying on for a period of time. But the department keeps telling me different facts, some say I can fill the form in other say I cannot.

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