The UK state pension

My last post was about Child Trust Funds, which are relevant to young people and this post goes all the way in the other direction. It’s mostly for the older demographic, who are in their 60s. So, let’s talk about the UK state pension.

It looks like somebody is checking her state pension forecast.

In order to “earn” a UK state pension, you need to pay National Insurance Contributions (NICs)- these are automatically deducted from your monthly salary. A certain amount needs to be paid each year to lock in your “qualifying year”.

You need to pay NICs for at least 10 years to get any state pension. The maximum state pension you can get is currently £179.60 per week i.e. £9,339.20 p.a. and requires you to pay NICs for 35 years.

If you are in your early thirties, then the state pension is expected to start at age 68 or maybe even later… it’s around age 66 for most people today. The government is broke, as is often the case, and there’s a good chance there will be further extensions to the starting age for the state pension.

However, the income itself is very valuable. It is guaranteed by the government and inflation-protected by the “triple lock”. Each year the state pension increases by the greatest of 2.5%, average UK earnings or inflation (CPI). Therefore, at least 2.5% each year. That’s really good and very expensive for the government. Any politician who decides to get rid of the triple lock will commit political suicide as that poor chap will be voted out by the older demographic.

The thing about needing 35 years of NICs isn’t the entire story. There are many people who have paid NICs for longer but won’t qualify for the full state pension. There’s a big bureaucracy involved in calculating your state pension and it’s very complicated (so I’ve been told) to find out why your entitlement is reduced even though you’ve paid in for more than 35 years.

You should request a state pension forecast to get an idea of what you might get at your state pension age. Please note, that forecast can look deceptive as on its first page it can say in big letters that “you will get £179.60 p.w.” [i.e. the maximum] but then in smaller letters qualify it with “if you continue working until your state pension age” or something like that (sorry, it’s been a while since I’ve seen a statement). That’s a bit sneaky but I think the current entitlement was mentioned somewhere as well.

It’s easy to find out what your NI record is if you have a gov.uk account. That record will identify how many NIC qualifying years you’ve got and which tax years you’ve missed out on. It also details, how much it would cost you to plug a missing year – it’s around £800 for each year by the way but can be less if you partially paid in in a particular year.

Generally speaking, plugging those holes in the NI record represents fantastic value. Let me illustrate: if you have 34 years, then your state pension should be circa £9,339.20 / 35 = £266.83 less each year compared to having a full state pension. You would need to plug that 1 year with a one-off payment of circa £800 and in exchange, you will receive an additional £266.83 p.a. of inflation-proofed guaranteed income for the rest of your life. You will be in profit after about 3 years. This additional income would represent an annuity rate of 33%, which is insanely high. It is fantastic value.

So, if you (or your parents) aren’t far from their state pension age, make sure they check their NI record and plug any holes in it. Remember, this needs to be done before reaching your state pension age.

Bureaucracy warning! The actual mechanics of plugging the missed NIC years can be complicated. Essentially you need to call HMRC, fill in a form, get them to provide you with a reference number (for one-off payment), etc. It’s all made very difficult – I wish you could simply look at your NIC record and click on the monetary amount next to the tax year in question and then enter your card details. That’s what it should be… but this would mean that an army of bureaucrats would be out of a job and we can’t have that.

If you are still relatively young and know that you have many years of employment ahead of you, then you should bookmark this post and come back when you are 60+.

Have a good weekend!

Bonus sacrifice

HR sent a bonus sacrifice form recently to all employees at work. The form is to instruct HR to sacrifice a certain portion of my potential bonus into my pension. For example, if my bonus is £3,000 then, I could opt to have a portion or all of it paid into my work pension.

Doing so makes a lot of sense as I’m a good little saver anyway. I spend less than I earn and my savings rate is something between 50%-60% of my net salary. Therefore, the bonus would be extra for my living needs and I’d rather have it all tucked away nicely for the future. The added benefit is that if the bonus is sacrificed, rather than paid as salary, the employer can choose to pay their NI savings (13.8% usually) into the pension as well. This gives a further boost to my pension pot and is therefore totes worth it.

The only downside with bonus sacrifice, and pension savings (in general), is the long wait until I can access the monies. I will need to wait 25+ years until I reach 57 or 58, which is going to be the likely age pensions can be accessed at in the future – the minimum age requirement is currently 55.

I, of course, plan to live into my late 50s and well beyond that. Therefore, I am happy to delay gratification and invest the bonus for the long term. This is why I decided to sacrifice 100% of my bonus. HR confirmed that it will be processed in the March payroll.

PS: Don’t take this as advice to sacrifice your bonus, your circumstances could be very different from me. There are situations where sacrificing your bonus could be a very bad idea and lead to loads of tax to pay – for example where individuals hold Fixed Protection or Enhanced Protection for the lifetime allowance or where individuals have already “flexibly” accessed their pensions and are subject to the money purchase annual allowance of £4,000 (way below the standard £40,000 most people have). This stuff can be complicated and isn’t really the point of this blog.

My plan is to continue sacrificing my bonus into my pension each and every tax year whilst gainfully employed. This will be an even easier decision once I become a higher rate tax payer (assuming my salary will increase in the future) as sacrificing the bonus avoids paying roughly half to the taxman (accounting for income tax and employee national insurance contributions).

Don’t forget that you have the flexibility of sacrificing a smaller portion of your pension. It doesn’t have to be all or nothing.

Happy bonus season!