Malcolm McLean looks at who benefits most from the new state pension.
The part of the new state pension scheme that seems to attract most criticism from those affected is the deduction they are told has to be made to the starting level of their pension in its first year (2016/17) to take account of past periods of contracting-out.
After all, they complain, wasn't the new state pension supposed to be a flat-rate amount of £155.65 a week for everyone who had at least 35 years of national insurance (NI) contributions?
It is estimated that there are about 1.5m individuals who will reach pension age in the next ten years who will get less than the full rate, even if they have 35 years or more NI contributions.
The transitional arrangements expose surprising generosity towards members of contracted-out defined benefit (DB) schemes (mainly in the public sector) compared to those in other schemes who didn't contract out and spent the bulk of their career paying into the state second pension (formerly SERPS) instead.
How does this work?
Everyone under state pension age with a pre-6 April 2016 record of NI is given a starting level figure for the new pension at that date.
The contracting-out deduction is a one-off deduction made against what would have been their entitlement under the new scheme rules, as if those rules had been in existence throughout.
It cannot, however, reduce their starting figure below what they would have received at that stage under the old basic state pension scheme rules. For example, someone with 30 or more years of NI behind them would have a starting level of at least £119.30 a week – regardless of how many of those years had been contracted out.
The rationale for the deduction is that, in lieu of the state second pension, they had been allowed to pay lower NI contributions and receive a Guaranteed Minimum Pension with their occupational scheme, or, in the case of an approved personal pension plan, a cash rebate paid directly into their pot.
As the new pension is effectively a combination of the old basic and state second pensions they couldn't expect to get the benefit twice.
However, many will have the opportunity to benefit twice. Assuming they still have a few years ahead of them before they reach their state pension age, they can claw back the reduction and increase their pension up the full £155.65 'flat-rate' by simply continuing in work and making NI contributions to secure the additional qualifying years needed – even if in total that takes them above 35 years.
Alternatively even if they have retired early from work they may be able to claim NI credits or purchase voluntary NI contributions to achieve the same result.
There are potential heavy costs for the government here, with thousands of public sector workers with DB pensions who have a current job retirement age of 60. They will now be able to increase their state pensions up to the full rate at their state pension age of 65 or 66 by making voluntary NI contributions at subsidised cost.
In contrast, for older workers with little or no contracted-out pension service, their joint basic and state second pension entitlements will often produce a starting level for the new pension at 6 April 2016 at, or slightly higher than, the flat-rate figure of £155.65.
They will not be allowed to increase this further despite still being liable for full rate NI contributions while continuing to work through till state pension age.
There isn't a level playing field between contracted-out and contracted-in schemes. It is arguably those contracted in, not those who have been contracted-out, that should be complaining loudest about unfair treatment.
Malcolm McLean is a senior consultant at Barnett Waddingham
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