NEARLY two-thirds of people due to retire next year will receive about £116 a week as their new “flat rate” state pension, rather than the full payout, a Freedom of Information (FoI) request reveals today.
The new state pension of about £151.25 a week, which starts in April, is meant to be a fairer system, particularly for women.
However, despite repeated assurances from the government that most pensioners will receive the full payout, hundreds of thousands will be shocked to discover large deductions.
Susan Waites, a partner at the pensions consultancy Hymans Robertson, said: “Deductions from the new state pension are a really complicated area and a lot of people are going to get a shock when they discover they won’t get around £151 a week.
“The push for simplicity has resulted in a complex and poorly explained transition process and many will be disappointed.”
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Today, after the FoI request by Money, the full extent of these shortfalls can be revealed. For most people who retire next year, the weekly pension will fall short of the headline figure by an average of between £35 and £55 a week, according to information obtained from the Department for Work and Pensions (DWP). Some could receive as little as £96 a week. For those who retire in 2020, the average shortfall will be between £15 and £25.
Two-thirds of the people who reach state pension age in 2016-17 will not receive the full pension, according to the DWP.
The exact figure for the flat-rate pension will not be confirmed until the autumn. The maximum basic payout is currently £115.95. Those already in receipt of the state pension will not qualify for the flat-rate pension and will not be affected by these deductions.
The cuts are all the more shocking as separate analysis for The Sunday Times suggests that £1bn could be withdrawn from private retirement pots this year, under the new pension freedom rules, by people who mistakenly believe they will benefit from the full flat-rate state pension.
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Why is the so-called flat-rate pension being cut?
The reason many people’s incomes will be slashed is because they have spent time “contracted out” of the state system.
Simply put, this means that they paid lower national insurance (NI) contributions during their working life, and this will be taken into account under the new scheme.
If you were in a final salary or career-average pension scheme, you will have paid a lower rate of NI in return for giving up your entitlement to the government’s earnings-related pension top-up. This top-up, called the state earnings related pension scheme (Serps) and later the state second pension (S2P), is currently added to the basic state pension.
It is this two-tier system that will be replaced by the flat-rate pension in April.
If you were in a personal pension or defined contribution workplace scheme, you will have paid the standard rate of NI, but some of it will have been paid back into your private pension pot.
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Contracting out for these schemes was abolished in 2012, while contracting out for final salary and career-average plans will end next April.
How much will I receive?
The DWP does not automatically send out state pension forecasts. Anyone over 55 can request one at gov.uk/state-pension-statement or by calling 0345 300 0168.
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Otherwise, you will simply receive a letter four months before you reach state pension age, inviting you to claim or defer the weekly payout. The letter does not include a forecast.
Under the new system, in theory, if you have 35 “qualifying years” — typically years in which you have paid national insurance — you will be entitled to the full pension. Under the current system, only 30 qualifying years is needed for the full basic state pension, with any Serps or S2P added on top.
For those retiring from next April, the DWP will calculate what they would be entitled to under both systems and take the higher figure as the “starting amount” before mak–ing any deductions. Incredibly, this comparison will continue for everyone who is already paying NI. Only those who start work after April 2016 will be covered by just the flat-rate system and not subject to these tricky two-system calculations.
So what about these deductions?
Money’s FoI request reveals that for those whose “starting amount” is the figure under the old system, the average loss will be £35 a week. If the starting amount comes from the shiny new system, the pensioner will receive £55 a week less than the flat-rate figure.
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By 2040, when the deductions will largely have been phased out, 85% of pensioners will receive the full payout.
Four-fifths of those due to retire in the next few years will have a starting amount calculated under the old system, according to the DWP. They face an average reduction of £35 a week. The remainder will have higher reductions averaging £55.
Will I receive extra money from my private pension?
If your state pension is lower than expected, you should receive a payout from your private pension to balance it out. Waites said: “In theory, your private pension will make up the difference. For people contracted out in final salary and career-average schemes, that should be true. For those contracted out in defined contribution schemes, it may not be — it’ll depend whether the NI rebates plus investment returns give them a big enough ‘pot’ to buy a pension income equivalent to the deduction made from their state pension.”
The government believes nearly 90% of pensioners would receive the full £151 if the contracting-out deduction were ignored. The DWP said: “The new state pension reflects a bold move to a system that is fairer, simpler and easier to understand — but decades of tinkering have left us with a legacy of huge complexity.
“The state pension will remain contributory in nature. Therefore, people who have paid less in NI contributions will see this reflected in their pension, just as they do under the current system.”
Help! I’ve already spent my pension pot
Experts fear that thousands of savers may already have blown their small private pension pots because they thought they would soon be collecting the higher weekly payout of £151.
Alan Higham, founder of the new website pensionschamp.com, estimates that 50,000-75,000 savers may cash in and spend their entire nest eggs this year. With an average pot of £20,000, that would amount to between £1bn and £1.5bn. He estimates that £500m-£1bn of this cash could have been spent by savers who expected the full state pension but will suffer a deduction because of contracting out.
Higham, formerly retirement director at Fidelity Worldwide Investment, said: “Given that virtually no one understands this issue, I don’t think it is unreasonable to conclude that large sums could be spent by savers because they think the state will pay more.
“People must check they have a reliable forecast of their state pension before cashing in their private pension, as most of those due to retire in the next five years will receive less than the headline figure of nearly £8,000 a year in state pension.
“The government needs to do more to inform people of this fact to prevent serious financial loss.”