State Pension Age – do you want to work a lifetime?
‘Bridging the Gap’ – by Frances Giliker LLB Hons APFS, Chartered Financial Planner
The Government has confirmed the State Pension age will rise to 67 by the end of 2028, following a review published last month. The Government plans to have a further review within two years of the next Parliament to reconsider the rise to age 68. Based on the current rate of increases and the purported lack of funding, it’s likely that this will be well over the age of 70 for the younger generation of today. So how will this affect you and does this change the way we approach retirement? Let’s start with explaining what the State Pension is and how it is funded.
Subject to having 35 years worth of full National Insurance contributions (paid by workers, self employed and those claiming certain credits), when you reach a certain age you will be eligible to claim a weekly income that increases each year by inflation. The income is paid every four weeks and paid directly to your bank account. Increases are applied in April every year, and the amount of increase paid is the highest of inflation, the Average Earnings Index or 2.5%. The income will therefore always rise by at least 2.5%pa under the current triple lock.
The current full State Pension in 23/24 is around £204 a week. Not everybody receives this amount however; for pensioners who may have also been a member of a final salary pension or ‘opted out’ of SERPS prior to 2016, their State Pension may be less than this. Equally some pensioners can get an increased State Pension based on rules prior to 2016. Going forward however, the State Pension will be a flat rate for most recipients as the government simplified the rules in 2016. You will not be entitled to the full weekly amount if you have less than 35 years worth of contributions however.
The income will be paid for the duration of your lifetime and is no longer inheritable by a spouse. It’s a common misconception that the State Pension that you receive is based on your own ‘pot’ that you have contributed into over your working life; the pension is funded by current workers and not your own contributions. For example, for those working and paying National Insurance Contributions now, your contributions are paying for the State Pensioners now.
This has posed a problem in recent times for a couple of reasons: firstly, people are living longer and life expectancy has increased. This means that people are needing the income for longer. Secondly, Britain is an aging population – we have more older people than younger! This poses a problem when there is less people paying into the system to fund the income of the retirees.
Retirement before the State Pension?
This is where the planning comes into effect. Do you really want to be working until you are in your 70’s and then at that point, is there time left to enjoy retirement as you planned? The increasing State pension age is teaching us that we cannot rely on the government to fund our retirement completely. For a couple, the current State income equates to household income of £21,200pa and is likely to cover all of your household bills and food, and maybe some additional luxuries. However, being a Financial Planner and having experience with hundreds of clients in their late 50’s and 60’s, most people don’t wish to be working up to their State Pension age. I have found that the drive for early retirement is usually both mental, and physical. Client’s find they are slowing down once they approach their 60’s and their bodies can no longer cope with the demands of a job that they may have found easy for the past 30 years. Equally and probably more importantly, it seems that most people grow mentally tired of working every day – call it ’emotional exhaustion’.
So how to we bridge the gap??? The introduction of pension flexibility in 2016, came just at the right time. Personal pensions can now be drawn from in a far more efficient manner than the ‘Capped drawdown’ predecessor. For example, Flexible Drawdown or regular Uncrystallised income payments, can be paid from age 55 and there is no limit to how much can be drawndown. This doesn’t mean that we are opening up the floodgates for people going wild and using their pension pots to buy Ferrari’s, but more so to help those that are ready to retire before their State Pension age and want to use the pensions they may have built up over the years, to support them with early retirement.
For example, John is 62 and has a £50,000 personal pension or workplace pension. He has no dependents and states that the State Pension at 66 will cover his outgoings. He can therefore retire at 62 and draw £12,000 a year from the £50,000 for the next 4 years. The fund will be almost completely drained by 66 however at this point, the income will be replaced by the State Pension.
Similarly, Sandra is 60 and works for the NHS earning £1800 a month. She has an NHS defined benefit pension that will pay her £1000 a month from age 66 as well as the State pension, and a Prudential personal pension worth £120,000. Sandra wants to drop to part time hours and use her personal pension to top up her earnings. She will receive £1000 a month working part time going forward, but she can now draw £800 net a month from her personal pension, and still have the same income as she did working full time. Sandra will need to draw £72000 over the next 6 years from her pension, so she has been made aware that the pension fund will drop in value substantially. This is not an issue however as she will receive over £1900 a month from age 66 from her NHS and State Pension. Any money left in her personal pension at 66 will be used for lifestyle funds or as a savings plan in retirement.
To summarise, the key to enjoying a happy and earlier retirement, is to save into pensions during your working life, getting them reviewed regularly, and seeking advice at around 55 to put plans in place to prepare for your retirement.