Chipping away at the prudent person's pension pot

Many savers may lose out with the new means-tested pension credit

From October men will need to save nearly £75,000 in their pension fund in order to take them above the Government’s new means-tested benefit, Pension Credit, which starts in October. Women will need even more – over £80,000 and a married man with a dependent wife will need at least £130,000. The average pension fund at retirement is just £25,000.

At the moment the pension bought by the average pension pot is completely worthless. From April the government will guarantee single people aged 60 or more a weekly income of £102.01, nearly £25 on top of the basic state pension – which by then will be £77.45. So it is not worth saving up for a pension which gives you no more than this so-called minimum income guarantee. Figures provided to the Daily Telegraph by independent financial advisers Annuity Direct show that a man of 65 would need a pension fund of £30,952 to equal the extra means-tested income which the state will give him anyway, escalating at 5% a year (the rates for these means-tested benefits go up in line with earnings). A woman at 60 would need £43,958. The Government revealed in its recent Green Paper on pensions that the average size of a pension pot is just £25,000. That means the average pension fund is of no value at all – from April you will still get your income topped up by the state to £102.10 a week whether you save nothing or £10,000 or £25,000 or £30,000 (more than £40,000 for a woman).

the Pension Credit is one of the most complex bits of arithmetic ever devised by the mathematical Torquemadas of the Department for Murk and Incomprehension.

For couples where the woman is financially dependent on the man the figures are even more alarming. From April a couple can get their joint weekly income topped up to £155.80 through the minimum income guarantee. That is £32 a week more than the total basic state pension they would get. To buy an annuity of that amount, escalating at 5% per year, with a widow’s benefit, the husband would need a pension pot of £51,790. Anything less would give him no more than living off the state.

From October the Government is hoping to soften this harsh arithmetic with its new Pension Credit. The new benefit will pay back a proportion of pension savings on top of the basic £102.10 a week. It will bring half the pensioner population into the means-tested embrace of the Department for Work and Pensions. Even the government admits that more than a million of the five million who will be entitled will not claim it. One reason is that the Pension Credit is one of the most complex bits of arithmetic ever devised by the mathematical Torquemadas of the Department for Murk and Incomprehension.

Pension Credit will extend means-tested help to single people aged 65 or more with an annual income up to £7219 or a couple with an income up to £10,584. It will come in two parts. The minimum income guarantee will continue under the new name of ‘guarantee credit’ and make sure that no single person over 60 will have a weekly income of less than £102.10. For a couple the figure is £155.80 between them. So people aged 60 to 64 will still find they are no better off unless they have around £40,000 in their pension fund. At 65 though, they will become entitled to the second part of the new Pension Credit. Called ‘savings credit’ it will be a top-up to a top-up, giving extra money to people who have up to £61 on top of the basic state pension – or up to £79 for a couple. The total Pension Credit will start at £24.65 a week for someone with no income above the state pension and taper off as income rises until it disappears when total weekly income exceeds £138.38 (£7219 a year). For a couple it can add a maximum of £32 a week to the state pension and tapers off to nothing when total income exceeds £203.55 (£10,584 a year).

The arithmetic means that people will keep just 60% of their personal pension up to these levels. In other words the pension they have bought will be taxed at 40%, a rate normally reserved for people who earn more than £34,500 a year. Some will also be paying income tax as well. A 70-year-old with a gross income of £60.07 on top of the basic state pension will pay £1.04 a week with their left hand to the Inland Revenue in income tax – and will be eligible to get back £1.04 Pension Credit in their right hand from the DWP.

To save enough to be above the means-test a man aged 65 will require a pension fund of £73,312, a woman will need £81,776. A man with a dependent wife five years younger than him will need a pension pot of £131,540 to be above Pension Credit. These amounts are all at current rates. Stuart Bayliss of Annuity Direct warns that people are aiming at a moving target. "Those rates are down by about 15% on last year. The key to the rates falling is the risk of people living longer in other words the cost of the guarantee to pay the income for life. In the past insurers have underpriced increasing longevity. They want to make sure they do not do that again."

Of course, people who are eligible for Pension Credit and claim it will be better off than they are now, sharing in the extra £2 billion a year it will cost. Instead of losing 100% of any extra pension income up to £25 a week they will lose 40% of any extra pension income up to £61 a week. Whether financial advisers will be able to work out the value of saving when the benefits at the low end will effectively be taxed at 40% remains to be seen.