In a nutshell
For people reaching state pension age from April next year, the current basic state pension and the additional state pension (formerly the state earnings related pension) will be merged into a single unit. And, from 2018, state pension age will start to rise for men and will continue to rise for women until it reaches age 66.
Need a recap on the present system?
It’s a good idea to refresh your knowledge on the current state pension to better understand the ways in which the new system will be different. You can read our article The state pension – how it stands now.
Who will be affected?
The new state pension will apply to anyone who reaches state pension age on or after 6 April 2016. This means it applies to women born on or after 6 April 1953 and men born on or after 6 April 1951.
After 6 April 2016, to get any state pension at all, you’ll need at least 10 years worth of National Insurance credits.
Another change from the current rules is that you will need 35 years worth of credits (up from 30) to qualify for the maximum. Even then, you may get less than this if you have spent part of your working life contracted out in an employer’s scheme, or receiving rebate contributions paid into your own personal pension.
The ‘starting amount’
On 6 April 2016, everyone will be given a ‘starting amount’ for the new state pension. This will be the higher of:
a. the amount you would get under the current State Pension rules
b. the amount you would get if the new State Pension had been in place at the start of your working life.
The calculations work like this:
Maximum pension (under the current rules)
First, calculate how much basic state pension you are due under the current rules. As mentioned earlier, the maximum is £115.95 per week for those with 30 years worth of credits. For those with less than 30 years of credits, the maximum is reduced by £3.86 and ½ pence for every year you are short. For example, if you have 25 years worth of credits you would be due £96.63.
Then add on any SERPS and additional (state second) pension you are entitled to receive under the current rules. Whilst not impossible, this part is hard to calculate on your own, as you would need a complete record of your earnings history on which National Insurance Contributions have been paid from 1978 or when you started working, if later. The Department for Work and Pensions should calculate this for you when working out your ‘starting amount’ for the new single state pension. Remember also that you will get no SERPS/additional pension for any years you were contracted out via an employer’s pension scheme or using your own personal pension.
This equals "A" - Entitlement under current rules and the minimum you will get when the new state pension starts.
Maximum pension (under the new rules)
First, calculate the number of years – up to a maximum of 35 – of National Insurance credits gained from working or receiving Child Benefit, Jobseekers Allowance, Employment and Support Allowance or Carer’s Allowance.
Multiply by £4.32 for each year. For example, if you have 25 years of NI credits this would give you £108 per week i.e. 25 x £4.32
- Then deduct an amount broadly equivalent to SERPS/additional pension for each year you were contracted out. As with Step 2, this is virtually impossible to calculate on your own without knowing your past earnings history and the complex rules for SERPS/additional pension.
This equals B - Amount of new state pension had the new system been in place when you started work.
The higher of "A" & "B" equals the starting amount of new state pension.
It’s possible that your starting amount will be higher than the new single state pension of £151.25 a week (35 times £4.32). This would be the case if you have spent a large part of your life ‘contracted in’ and building up SERPS and additional pension.
It’s also possible that your starting amount will be less than the new single state pension of £151.25 a week. This would be the case if you have less than 35 years worth of National Insurance credits or you have spent a large proportion of your working life contracted out via an employer pension scheme or your own personal pension.
Bear in mind that the sum of £151.25 isn’t yet set in stone – it’s just the current indicative figure for the maximum weekly single state pension. This amount is expected to be clarified in autumn 2015.
Brian is aged 56 and has been in full-time work since age 18. He was a member of a final salary pension scheme, but that stopped in 2001 and was replaced by a workplace personal pension (defined contribution scheme). Since 2001, Brian has built up an additional state pension of £27.50 a week – and between 1978 and 2001, when he was in the final salary scheme, his contracted-out SERPS equivalent pension was £45 a week (this amount is built into Brian’s final salary pension).
Brian’s calculation is as follows:
Step 1 – calculate entitlement under the current rules. As Brian has 30 years’ worth of NI credits, he qualifies for the full basic state pension of £115.95 a week and he can also add on the £27.50 of additional pension he has built up since 2001, giving him a total of £143.45. The starting amount for his new state pension will be no less than this.
Step 2 – calculate the state pension under the new rules. As Brian has more than 35 years of NI credits he is entitled to the full new single state pension of £151.25. However, he must deduct his SERPS equivalent pension for the years he was contracted out which amounts to £45 a week. This leaves him with £106.25.
Brian’s starting amount for his new state pension will be the higher of these two steps i.e. £143.45 and he can continue to build up further entitlement up to the maximum of £151.25 a week between April 2016 and his state pension age.
Margaret is aged 52 and has had a mixture of full-time and part-time work since the age of 16. She also spent 10 years away from the workplace after she had children. Between NI contributions and caring credits, Margaret has more than 30 years worth of NI credits. She only joined a pension scheme recently, when she was automatically enrolled in a workplace pension, and has never been contracted out. Margaret has built up an additional state pension of £41.50 a week from the years when she was working and earning more than the Lower Earnings Limit.
Margaret’s calculation is as follows:
Step 1 – calculate entitlement under the current rules. As Margaret has 30 years worth of NI credits, she qualifies for the full basic state pension of £115.95 a week. She can also add on the £41.50 per week of additional pension built up over her working life, giving her a total of £157.45 a week. The starting amount for her new state pension will be no less than this.
Step 2 – calculate the state pension under the new rules. Margaret has 33 years of NI credits – under these rules, she didn’t earn credits for some of the years she was working part-time as her earnings in these years were below the Lower Earnings Limit. This gives her a new state pension entitlement of 33 x £4.32 or £142.56 a week. Margaret has never been contracted-out, so there is no SERPS equivalent deduction.
Margaret’s starting amount for her new state pension will be the higher of these two steps i.e. £157.45 a week. As she is over the maximum amount of the new single state pension, she is not allowed to build up any further entitlement after April 2016. However, her starting amount will be indexed in line with inflation between April 2016 and her state pension age.
If your new single state pension ‘starting amount’ is equal to or more than the maximum amount of the new state pension (£151.25 or other amount set in Autumn 2015), you will not build up any further state pension in the future. Any excess amount over £151.25 will be protected and rise in line with inflation. As mentioned, people who have spent most of their working age life ‘contracted in’ are likely to fall into this category.
If your new single state pension ‘starting amount’ is lower than the maximum amount of the new state pension (£151.25 or other amount set in Autumn 2015), you can continue to build up more state pension up to the maximum amount. You can do this up until you reach state pension age and even if you already have 35 years worth of credits or NI record. People who have spent most of their working age life ‘contracted out’ are most likely to fall into this category.
Anyone who hasn’t built up the maximum new state pension will gain another £4.32 for every additional year of NI contributions or credits.
Deferring your state pension
It’s possible to defer the state pension under either the current rules or the new rules. In return, you would receive a higher pension (or a cash lump sum in lieu of the increase, if you defer for at least 12 months). However, the rate at which your state pension increases in deferment is reducing from 10.4% a year to 5.8% a year.
Whether it’s a good idea to defer your state pension depends on a number of factors. These include your state of health – with those people who have the highest life expectancy most likely to gain. For people in normal health, the starting amount of an index-linked single life private annuity increases by an average of 5.2% a year between 65 and 70. This compares to a (reduced) rate of 5.8% for state pension deferral, meaning it will still compare favourably at this time with current private annuity deferral rates.
Actions to consider
1. Get a state pension statement to see how much state pension you have built up. At the moment, you can only get an accurate estimate of what you are likely to get from the new state pension if you are 55 or over. The state pension statements for the under-55s still show you what you’d get under the current system. However, even under-55s should consider getting an up-to-date statement as this would at least show the minimum amount they would get when the new rules start.
2. Get current values for your private pensions, showing how much they are worth today.
3. Work out whether your state pension, together with your private pensions, will give you enough to live on when you reach state pension age. You can use the My Retirement Planner tool to estimate how much your private pensions might be worth when you retire.
Find out how long you'll have to wait for your state pension.
Read more about the current state pension which will give you a good background to help you understand next year's changes.
Visit Savings and Retirement.