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!