The State Pension comprises two principle elements, the Basic State Pension and Additional Pension.
Basic State Pension (BSP) or State Retirement Pension (SRP)
Qualification for Basic State Pension is a “contribution based” benefit, and depends on an individual’s National Insurance (NI) contribution history. For someone with the full number of qualifying years (years in which NI contribution was paid) typically 44 for a man and 39 for a woman, although this reduced to 30 years on 6 April 2010. Less pension is paid for someone with fewer qualifying years.
State Pension can be claimed from State Pension age: currently 65 for men and 60 for women, however this is changing, under current legislation the State Pension age is planned to increase to:
- 66 between November 2018 and October 2020
- 67 between 2034 and 2036
- 68 between 2044 and 2046
The government has announced that the increase to 67 will now take place between 2026 and 2028. This change to the timetable is not yet law and will require the approval of Parliament. It is also possible to defer claiming the SRP at pension age. Deferring claiming in this way currently gives an enhancement of approximately 10.4% to the pension per year deferred, or a lump sum and an unenhanced pension. The enhancement is actually 1% per 5 weeks the pension is not claimed, and the lump sum is the amount not claimed plus interest at 2% over the Bank of England’s base rate.
The Basic State Pension (or State Retirement Pension) is indexed each year for those pensioners living in the UK and also for 535,000 pensioners living overseas. However 525,000 pensioners living in certain other overseas countries have their pensions frozen at the rate at which they are first paid. This is seen as discriminatory by many because all of the pensioners have paid in the same contributions to the National Insurance Fund which pays out all pensions. People intending to retire overseas should research this issue carefully.
Three different state schemes have existed to provide extra pension provision above the Basic State Pension. These are collectively known as Additional Pension. This has been available only to employees paying National Insurance and certain exempt groups (not including the self employed). The three schemes are/were:
Graduated Pension or Graduated Retirement Benefit ran from 6th April 1961 until 5th April 1975. Qualification was based on payment of a number of fixed National Insurance payments (‘stamps’). Graduated pension typically pays a small amount (a pound or so per week) to those affected.
State Earnings-Related Pension Scheme (SERPS) ran from 6th April 1978 to 5th April 2002. As the name implies, the level of pension payable was related to the recipients earnings via their National Insurance contributions. Qualification was based on band earnings above a Lower Earnings Limit (LEL) in each year. The LEL is usually set at the same level as the BSP and increases when the BSP does. Band earnings lie between the LEL and an Upper Earnings Limit (UEL) at which National Insurance contributions ceased to be payable by the employee, although the UEL now refers to a threshold where reduced NI payments are made, as opposed to payment ceasing. The UEL is also adjusted annually.
State Second Pension (S2P) was introduced on 6th April 2002. As with SERPS, the level of pension payable is related to the recipients earnings via their National Insurance contributions. Qualification is based on earnings at, or above, the LEL, but no band earning calculation is made until earnings reach a higher base called the Lower Earnings Threshold (LET). Earnings below the LET (but above the LEL) are credited up to the LET.
Unlike the Basic State Pension, participation in the Additional Pension schemes was voluntary. Those who did not wish to participate could “contract out”. This option was introduced with SERPS in 1978 and removed in 2012.
You could choose to leave SERPS/S2P at any time during your working life. This was called ‘contracting out’. You could do it by joining a contracted-out occupational scheme or by taking out an Appropriate Personal Pension (APP). The fund that accumulated in an Appropriate Personal Pension from the National Insurance rebates, is known as Protected Rights.
Contributions you have already made to SERPS/S2P are protected and will give you extra pension income when you retire.
The criteria for making a decision regarding contacting out has changed over the years. In general, the younger the client and the greater their income, the more likely it was that the individual would have benefited from contracting-out. However, other factors, considered were:
- Attitude to risk
- Attitude to state benefits
- Future career prospects
- Retirement age
- Death benefits