Pension Basics and the Basic State Pension
December 1, 2010
The prospect of saving for your retirement can seem daunting. Pensions have rarely been out of the news in the last few years, due to numerous scandals and even more numerous rule changes. But the need to take the initiative when it comes to your own retirement planning has arguably never been more pressing. Fret not, as with a little Foolish help, anyone can get their retirement plans on the right track.
In this pension guide, we'll cover all types of pension ranging from the state pension to Self Invested Personal Pensions (which many Fools are now using to take control of their retirement plans).
What is a pension?
In its simplest form, a pension is essentially an income that you receive when you retire. To build up a big enough pot of money to provide that income, someone has to do some saving. What makes one pension scheme different from another is down to how this money is saved, whom it is saved by and how the income is eventually generated.
To encourage us to save enough for our retirement, the Government provides a tax break. So, as long as a pension scheme fulfils the criteria they have set down, then the money that goes into it comes out of your pre-tax earnings. Think of it this way: you put some money in, then the Government chips in the tax that you have paid (or would pay) on that money. There is a limit, of course, on how much you can pay in. The limit will depend on what type of pension scheme you are contributing to. In the case of some schemes, the older you are, the more you can put in.
These contributions form a pension fund, which is invested over the years until your retirement. In theory all this seems fine and dandy. In practice, life is about to take a shot across your bows. Pension rules are far more complex than they need to be and the new rules due to come into effect soon are adding to the confusion as there a number of transitional issues to deal with.
It is worth bearing in mind though that a pension is only one way of saving for your retirement. You need to balance the pros and cons and compare various options. The benefits of pensions are:
- The tax break;
- The fact that you aren't able to succumb to temptation and spend the money prior to your retirement.
Offsetting this are the two main flaws:
- The charges tend to be more complex and higher than other long-term investment schemes;
- They aren't particularly flexible, particularly in respect to how you receive your pension money once you retire.
To start with, let's take a look at what the government provides. Currently, the State provides just over half of all the income received by pensioners. We'll look at two sources here -- the Basic State Pension and Pension Credit. In the next article, we'll look at the State Second Pension.
Basic State Pension
The value of the Basic State Pension has slowly been eroded in recent years. It's also worth bearing in mind that not everybody qualifies for it -- you have to have made a minimum level of National Insurance contributions, although there are plans to change this a residency requirement instead.
You can get a state pension forecast to see what you're entitled to. If it looks like you're not going to get a full state pension, you can top up your National Insurance contributions to catch up for lost time.
But don't rely on the Basic State Pension too much when you're making your retirement calculations, as it's unlikely to provide all the retirement income you'll need. It's currently worth around £100 per week. Married couples currently get around £155 per week but, if you qualify for more than this with two single pensions, then you get those instead.
Up until recently, men qualified for their state pension from the 65th birthday onwards, while women got theirs from their 60th birthday. However, the retirement age for women is now rising and will increase to 65 in 2018. After that date, the retirement age for both men and women will rise to 66 and could eventually reach 68. You can find out your state pension age here.
When you do reach state pension age, you have make a claim to start receiving payments. You should be sent the relevant forms around 4 months beforehand. Once these are completed, you will receive your state pension direct to your bank account every 4 weeks.
It is also possible to defer your state pension now as well. You will receive a higher weekly payment but for shorter period of time of course.
In 2003, Pension Credit was introduced to help combat pensioner poverty (it replaced a similar benefit called the Minimum Income Guarantee). It's a means-tested benefit which sets a floor to what the government will give you in retirement.
The floor is a little some way above the Basic State Pension, so if that's the only income you get, then you'll qualify for additional money (although the benefit reduces rapidly if you have any significant savings). Currently, Pension Credit ensures you'll get a minimum of around £130 as a single person and £200 as a couple.
It's reckoned almost 5m of the UK's 11m pensioners are entitled to claim Pension Credit, but only around 3m actually do so, either because they are unaware of its existence, find the application forms too complex or don't wish to disclose their financial details. Despite the fact that it's helped to reduce pensioner poverty, it's widely criticised as it provides a powerful disincentive for people on lower incomes to save money for their retirement.
The coalition government has recently said it plans to introduce a new universal state pension for people who become pensioners from 2015 onwards. It seems this will replace the pension credit system, but we're still waiting for the details of how it will work.