Negotiate the pensions maze

Anyone approaching pension age will have to get to grips with the state pension. And it can be a nightmare. There seems little logic – and no sense – to many of the rules and at the end of it the amount you get will probably not be enough to live comfortably on.

It is impossible for any individual to work out how much state pension they will be entitled to. So you can ask the Pension Service for a state pension forecast. That will tell you how much you have earned already and what you can expect to get at pension age. Call 0845 3000 168 or print out or fill in a form on the Pension Service website. You can also get a forecast immediately online. To do that you have to register with the government’s e-service. Make sure you have got your National Insurance number - and a lot of patience. More at www.thepensionservice.gov.uk.

The state pension is made up of several bits.

Basic pension – normally earned on your own National Insurance contributions. The full pension is £82.05 a week from April. To get that you normally have to have worked and paid contributions for around 40 years. Some unemployed and disabled people get contributions credited when they are not working. A man aged 60 to 64 gets them credited automatically if he is not working. If you are under pension age and working you have to pay contributions even if you have already paid enough to get a full pension. Contributions stop at pension age.

The reduced contributions paid by some married women do not count towards the pension. If you are paying those contributions now it is probably worth changing to pay full contributions.

Women who looked after children or cared for a disabled relative after April 1978 may get their pension boosted by what is called Home Responsibilities Protection. Married women who paid reduced contributions immediately before stopping work will find they cannot get HRP – at least for some of the years they did not work.

A widow or widower can get their own pension increased through the contributions of their late spouse. A divorced person can use the contributions of their former spouse up to the date of the divorce. That can help many divorced women get a better pension. It does not affect the pension the former spouse can claim. Separated women can boost their pension if they divorce.

A married woman can claim a reduced basic pension on her husband’s contributions if she is aged at least 60 and he has claimed his own pension. That pension – called Category B – is £49.15 a week from April. If she has also earned a pension on her own contributions she gets the one that is higher – not both.

If a man gets his own Basic State Pension but his wife is under 60 he may be able to get extra pension of £49.15 a week for her as a dependant. This extra is not paid if she has earnings or a company or private pension of her own which is £56.20 a week or more.

Additional pension is earnings related and is now called state second pension or S2P – previously it was called SERPS. It can be more than £140 a week. But the average is around £16. Many people ‘opted out’ so instead of paying a small part of their National Insurance contributions into S2P they paid it into a personal or company pension. Your pension statement will show the full amount of additional pension you would have got if you had paid into S2P and that figure is then reduced by a ‘contracted out deduction’ leaving a small amount of additional pension. Your company or personal pension is supposed to pay you at least as much as the ‘contracted out deduction’. But not all of them do.

If you are in your fifties and paying into a personal pension you should always opt back into S2P. If you are paying into a company pension you may be able to opt back in and if you can, you should. Married women paying the reduced contributions do not earn additional pension. They should always change to the full contributions if they can pay into S2P.

Graduated retirement benefit is a small earnings related pension paid to people who worked from 1961 to 1978. Even women who paid the reduced married woman's contributions then will get graduated retirement benefit. It cannot be more than £8.50 a week and is usually far less, sometimes just a few pence.

Widows or widowers can inherit half of their late spouse’s additional or graduated pension. Married women can claim their additional or graduated pension even if they get no basic state pension. It is also paid on top of the married woman’s basic pension.

Putting off retiring
New rules begin in April which will make it more worthwhile to delay drawing your state pension. At the moment your pension is raised by 1 per cent for every seven weeks you delay claiming it after pension age. But from April these rules become more generous.

Your pension will be increased by more than 10 per cent for each year you delay claiming it, boosting it by £8.53 a week for each year you delay. If you don’t draw your pension for five years (until 70 for a man or 65 for a woman) it will be more than 50 per cent higher. There is no longer a limit on how long you can defer drawing your pension. So if you wait another five years your pension will more than double.

The table shows the amounts of a full basic pension. If you have less than this – or more through additional pension or graduated retirement benefit – it will be increased in the same proportion.

Alternatively when you finally do retire you can choose to keep the weekly pension at the same rate but have the pension you have given up paid to you as a lump-sum. The Government will add to it as if it had been invested and grown by 6.75 per cent a year. The Government promises that rate will always be 2 per cent above the base interest rate set by the Bank of England – currently 4.75 per cent. If you don’t claim your pension at 65 but wait for five years, you could get a lump-sum of more than £25,000.

If your annual income is less than £7090 a year you will pay no tax on the lump sum and up to around £9150 you will pay just 10 per cent. If your income is more than that you will pay 22 per cent of your lump sum in tax unless you are a higher rate taxpayer when you will be taxed at 40 per cent.

If you defer your pension, there is of course a risk that you may never live to enjoy it. If you die before you retire, no-one can claim the lump sum. The only person who may benefit is your spouse who will get the extra basic pension and half the extra graduated and additional pension you have earned by deferring. If you have no spouse then everything is lost.

You can avoid that risk by drawing your pension and investing it yourself. You can do that even if you carry on working full time. If you drew your pension and put it in a high interest deposit account at 4 per cent after tax, you would end up with a couple of thousand pounds less than the state would give you after five years – around £23,000 rather than £25,000. But of course the money in that account would form part of your estate and could be inherited in full by your spouse or children.

Pension age is 65 for a man and 60 for a woman. But that age will rise in stages for women who retire from April 2010, reaching 65 for women born from April 1955 who will get their pension at 65 in April 2020.

When you reach pension age you do not normally get your pension paid from your birthday. Instead it is paid from the next Monday. So if your birthday falls on a Tuesday you lose nearly a week’s money. Every year this arrangement costs newly retired people about £18 million.

Payment
When you retire you will normally get your pension paid directly into a bank account. You can choose to have it paid weekly in advance, four weekly in arrears, or thirteen weekly in arrears. There is absolutely no reason to have it paid in arrears, so make sure you ask for it to be paid weekly in advance. Then you will get a credit into your bank once a week for the rest of your life.

Claiming
You only get a state pension if you claim it. Normally you will be sent a claim form around four months before you reach pension age. However, if the DWP does not know your address you may not be sent a form. If you claim your pension late it can only be backdated for up to three months, though that will rise to 12 months by April 2006.

Pension credit
Because the state pension is usually not enough to live on, there is a complex system of extra help for people with low incomes. If you are aged 60 to 64 pension credit will make your income up to £109.45 (single) or £167.05 (couple). Once you reach 65 pension credit is more. You can get your weekly income topped up if it is less than £150 (single) or £220 (couple). Savings of more than £6000 will reduce the amount you get.

March 2005

e-mail Paul Lewis on paul@paullewis.co.uk