SCOTS faced with a lower state pension under government reforms set out last week have been told to bridge the gap by boosting their own pension savings.
Millions of people retiring from April 2017 will get less from the basic state pension after the government finally published its plans for a single-tier payment.
The current system of the basic state pension plus top-ups will be replaced by a flat-rate pension worth £144 a week in today’s money. The biggest change to the state pension since its creation seeks to simplify the system by guaranteeing people the single-tier rate.
But workers will need 35 years of national insurance contributions to get the full £144 a week, up from 30 years; while those who have paid NI for less than ten years won’t get anything, compared with the one-year requirement now.
The shake-up means that in the long run, most people will receive a lower state pension than they would under the present system. They include those born since 1970, many high earners and members of final salary schemes.
That’s partly due to the abolition of contracting out (where workers have opted out of the state second pension or its predecessor, the state earnings related pension, and paid lower NI in return).
The move will hit thousands of Scottish public sector workers in final salary schemes, said Kevin Mackenzie, a pensions specialist at Acumen Financial Planning.
“At present, final salary pension scheme members who are contracted out through the pension scheme pay a lower NI rate of 10.6 per cent instead of the standard 12 per cent,” he said. “Under the new flat-rate system, these same people, including all public sector workers, will have to pay a further 1.4 per cent in NI.”
High earners who build up a state second pension (S2P) can boost their state pension by up to £150 a week. That opportunity will also disappear.
In all, the changes mean 43 per cent of retirees will be worse off by 2050, compared with their entitlement under the present system, rising to more than half of pensioners by 2060, according to the Institute for Fiscal Studies. It warned that “the main effect in the long run will be to reduce pensions for the vast majority of people”, with those born from around 1970 onwards being hardest hit.
So if you’re among those who stand to lose out, the onus is on you to boost your pension savings if you want a comfortable retirement.
“If you don’t think that £7,500 a year will be enough to live on in retirement, you need to get your skates on and start saving more to fund a more enjoyable retirement,” said Mackenzie.
The good news is a few simple steps can take you a long way and give you a retirement income well above that provided by the £144-a-week rate.
Kevin Garfagnini, director of financial planning services at Mazars, said: “Even for those entitled to the new maximum state pension, £144 a week will not stretch far and will barely cover the essentials.
“If you want a more comfortable retirement, the rule change should act as a call to take action and start planning now to self-fund your retirement or you could face working for longer than you wish.”
One advantage of the universal pension is that it won’t be means-tested, so there’s no need to worry about being penalised for saving.
Ideally, if you can, you should view the state pension as a retirement income foundation on which to build.
A 35-year-old now can expect a weekly state pension of £317 in 2045 when they turn 68 (based on the projected rise in the pension age). To double retirement income they would need a fund of £525,000, which would mean putting away £5,100 (gross) a year, according to MGM Advantage.
A 45-year-old retiring in 2034 would need to save £9,000 a year to effectively double their state pension.
Starting to save as early as possible improves your chances of a comfortable lifestyle in retirement, as those figures show.
“Statistics from Legal & General show that a 65-year-old man who started his pension at the age of 25 could have nearly £5,000 a year extra income compared to a man who started his pension at the age of 30,” said Garfagnini.
So what’s the best way to generate those savings? Saving money without paying unnecessary tax is the key, which is why pensions and Individual Savings Accounts (Isas) are the first port of call.
Take advantage of any pension scheme offered by your employer, as it will almost certainly make its own contribution to your pension pot (most pay around 5 per cent of your salary a year).
“Some generous employers will even match your contributions up to a specified limit. If they do, bite their hand off and add this money to your own contributions to swell your pension pot,” said Garfagnini.
Then there is the tax relief paid on contributions at your marginal rate of income tax, which means the government effectively adds more money to your pension savings..
“So 20 per cent taxpayers receive 20 per cent tax relief, 40 per cent taxpayers receive 40 per cent and 50 per cent taxpayers receive 50 per cent,” said Garfagnini.
“Effectively therefore, a £10,000 pension contribution, would cost a 50 per cent taxpayer £5,000, thanks to the tax relief available.
“This relief could be worth an additional £1,020 every year to a higher-rate taxpayer.”
You can maximise the tax savings from pensions by sacrificing some of your salary in exchange for more employer contributions to your fund, with the added bonus of reducing your taxable income.
“A pension is one of the few savings products to offer you something back in this way, so you should take advantage as fully as possible,” Garfagnini added.