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Your Money > Pension Planning Articles > The state pension...
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By Richard Evans
Both of these benefits - the basic state pension and the State Second But broadly speaking, the basic state pension is paid at the maximum rate (currently £87.30 for single pensioners or £139.60 for couples) to those who have made NI contributions for almost their entire working lives. Those who have patchy records of paying NI (through spending a period abroad, for instance) will receive a smaller pension. The basic state pension rises each year in line with inflation, although it will be increased in line with average earnings from 2012. The State Second Pension works differently. For each year you are employed (the self-employed cannot participate in the scheme), you are credited with a fraction of your salary, although earnings above an upper limit, currently £34,500, are disregarded. Your contributions to the second pension come out of your overall NI deductions, so you don't pay extra. One of the many complexities of the system is that different slices of your salary accrue benefits at different rates, with the result that the lower-paid benefit more from S2P. This is the main difference between the current scheme and Serps, its predecessor, whose benefits were more directly in line with earnings. On retirement, the Government tots up your yearly credits and calculates the pension that they entitle you to. For example, for someone on average earnings with a full contribution history, it might typically work out at around £65 per week, while the maximum S2P payout this year is £151 a week. "This will be rare, but there will be people out there receiving second-tier state pensions of £6,000 or £7,000 a year in addition to their basic state pension, which is worth having," says Tom McPhail, the head of pensions research at Hargreaves Lansdown, the financial adviser. Contributions made while Serps was in operation (1975-2002) will be treated according to Serps rules, not those of the current scheme. "It's very complicated to work out what you'll get," says Mr McPhail. "But if you contact the Pension Service they will work it out for you. You can do this over the phone without any form-filling. It's not a bad idea to do this every few years so you know where you stand." Under current rules, you can delay taking your state pension if you wish. Those who do this receive an extra 10.4 per cent for every year's delay; alternatively, they can opt for a lump sum that equates to the pension they would have received, plus generous interest. This applies to entitlements under Serps or S2P as well as the basic state pension. While you cannot simply opt out of the second pension and pay less in National Insurance contributions, it is possible to channel that part of your NI into a company or personal pension instead. This is called "contracting out". Doing this will not affect any entitlement to Serps or S2P built up in previous years, and you can contract back in whenever you like in the future. However, you cannot later pay to reinstate any missed years, as you can with the basic state pension. "If you belong to a final-salary pension scheme you are probably contracted out," says Mr McPhail. But, he says, most money-purchase schemes (also known as defined-contribution schemes) are contracted-in, meaning that you are still building up your entitlement to S2P. You can choose to contract out, in which case you will put that portion of your NI contribution into a personal pension. So is it better to be contracted in or out? "Contracting out gets less attractive as you get older because of a ceiling on the amount rebated to your other pension. Once you're past your early 40s, you are very unlikely to benefit from contracting out - you would need very good investment performance from your money-purchase or personal pension to beat the second state pension," says Mr McPhail. "Even below this age, it's unlikely to be worthwhile in purely financial terms. But some people have specific reasons for contracting out. For example, some do not trust governments and would prefer to have more control over their savings. I would say it's not impossible that a government could change the rules in future and cut entitlements already accrued, but it's unlikely. "Another reason to contract out is that a personal or occupational pension can be taken earlier than the state's, at the age of 50, although this will rise to 55." You cannot take your state pension until 65 (for men) or 60 (for women), and these ages are to be increased further. Furthermore, says Mr McPhail, a quarter of your private pension pot can be taken as a tax-free lump sum at the age of 50 - again, this is not possible with a state pension. The Government plans further changes to the Second State Pension and contracting out. "S2P will switch to a flat-rate payment some time after 2012, but we don't know exactly when yet," says Mr McPhail. "And it will eventually operate only on earnings up to a low ceiling, currently set at £13,000. This means that the Second State Pension will diminish in significance - which reflects government efforts to shift the pension burden away from taxpayers and onto individuals. "And within a few years there will be no contracting out, except to final-salary schemes." These generous pensions have already become much rarer; abolishing their ability to use contracted-out payments would be the last straw for the remaining schemes, he says. The Government will use the £4 billion saved in contracted-out contributions to restore the state pension's link with earnings. For more information on pensions click here |
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