The problem with pensions…

Over the last few years we have been subjected to a mountain of pension changes.  Not just changes to do with private pensions but also we have the advent of the new so-called “flat rate” state pension.  It turns out, however, that descriptions like “flat-rate” and “single tier” probably don’ t best describe the new state pension.  Originally, it was thought that under the new and simplified state pension (due to be introduced from April 2016) new pensioners would all receive a flat rate of around £151 per week.  However, if you have *contracted-out  during your working lifetime, then it’s likely that the government will implement a one-off deduction called a “rebate derived amount” which will be used to calculate how much state pension you will actually receive.  Simply put, those who have contracted-out during their working lives will get a lower state pension.  It has been estimated that only around one in three people hitting the state pension age in the 12 months following April 2016 would be able to claim the new full state pension amount of £151 per week.  The self-employed are likely to be one of the winners in terms of the new state pension.

Although state pension  forecasts are now available from DWP,  it would appear that the “rebate derived amount”  might not have been calculated yet (although there is debate over this).  My own recent  forecast did not include any calculation reflecting contracting out and therefore my estimated state retirement pension was vague.    Therefore,  many people are still currently in the dark about exactly how much state pension they are going to receive.    

Looking at the government’s long term planning on the state pension, it might be considered that the current changes are probably just a bit of short term jigging.  Over the long term, the figures for funding, in particular, are looking unsustainable.  Although costs will dip in the short term, over the longer term the government is only estimating the pension costs as 8.5% of GDP  (currently it is 6.4% of GDP)** and the longer term realistic funding figures will no doubt be higher. The retired population is set to increase massively (because Baby Boomers are now coming to retirement) and we are all living longer and the number of individuals over state retirement date is expected to increase significantly.    Additionally, there will possibly be fewer younger workers paying National Insurance.  The government will no doubt have a number of strategies it can use, including increasing retirement ages again, means testing, or a shift towards serious compulsory workplace savings.

The new pension freedom provisions will probably not help because individuals may spend their pension funds much more rapidly than before (since there are no barriers on pensions).    It has come to light that some of those coming up to retirement are considering using their entire pension funds to pay down not just small debts, but also to pay off the capital on interest only mortgages, thus leaving them with no long term retirement income.  There is also reports that retirees are not really understanding the fundamentals of retirement income and planning with some perhaps considering the new pension freedoms of sort of a “windfall” and simply cashing-in all the fund and then depositing the proceeds in the building society.  In my own experience, there appears to be a fundamental lack of appreciation by investors about the tax efficiency of pensions and many are persuaded by the press that pensions are simply a rip-off.

However, the need for retirement planning  has never been more pressing.  State pensions look vulnerable, final salary schemes are retreating into history and pension freedoms (whilst they fill the Treasury’s coffers) mean that individuals may erode their pension funds.

*contracting out is where employers and employees paid a reduced national insurance contribution in return for the pension scheme replacing the income which they would have received under the state second pension.

** source government Green paper

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