The carrot and the £80k black hole

MAJOR changes to the state pension kicked in last week, which will force women to work longer and tore an £80,000 black hole in many employees' retirement planning.

The age at which women can pick up a state pension will rise from 60 to 65 by 2020. However, it will be easier for women to receive a full basic state pension, currently 97.65 weekly, when they finally qualify.

From last week, anyone can qualify for a basic state pension after making National Insurance contributions for 30 years, rather than the 39 for a woman and 44 for a man, which were previously required.

However, the government's pensions reform dealt a major blow to the expectations of many higher earners, which will cost them more than 3,000 a year in retirement. Yet few have any inkling that their state pensions have been cut, and they will have to find an extra 80,000 to fill the gap.

Most employees contribute towards a scheme which entitles them to receive more than the basic state pension. They pay a percentage of their salary in NI contributions to qualify for a top-up or weekly bonus pension, paid by the state and linked to their earnings related.

It was introduced in 1974 to allow blue collar workers to enjoy the security available to those further up the pecking order via final salary pensions, and was initially called Serps (the State Earnings Related Pension), and later renamed S2P.

With so few employees in private industry now able to look forward to a final-salary pension, an S2P pension is a vital part of most individuals' retirement planning.

However, the government wanted to reform S2P so that rather than have it related to salary like the National Insurance contributions paid to earn it, everyone ultimately gets paid the same. This benefits those at the bottom end of the wage scale, but hits hard anyone earning more than about 30,000.

Hargreaves Lansdown's Laith Khalif says: "You can argue whether what the government is doing is right or wrong, but that's not really the point. The point is this is happening, people need to know about it, and they need to do something about it."

The change is significant, as the S2P was worth up to 140 per week on top of the basic state pension for anyone earning about 40,000. The plan is that it should be capped at 80 per week, but paid at that level to all.

This is being achieved in a series of steps. Last year, the government introduced a cap of 40,040 on eligible earnings. Last week, a new ceiling of 31,800 was introduced, penalising anyone earning above this level.

Younger people, who will accrue the bulk of their S2P under the new regime, are heading for a 60 per week smaller pension, which will have to be replaced by their own personal savings.

Even those in the middle of their career are facing a shortfall of 16 to 20 a week at retirement.

These changes affect only pension arrangements which are contracted into the state scheme, which these days most are. However, from 2012, all pensions will be required to be contracted back in with a few exceptions. Final-salary schemes have been exempted from the new arrangements.

But the change in the female retirement age is presenting some final salary scheme members with a headache. Women who were due to retire from such a scheme at 60 would have expected their S2P to make up a significant chunk of their pension. The deal was that the government would be responsible for the annual increase to this pension.

However, if they retire early, they must now wait until they are 65 for the government to fulfil this part of their bargain and for the retirement income to be increased by inflation. This will deflate their expectations of what they would have to live on in retirement.