What you need to know about the Flat-rate state pension

Next year a flat-rate state pension will replace the existing two-tier system, but while its creation was hailed as a triumph by removing huge complexities and creating greater incentives to save into private pensions. The single-tier pension is now mired in criticism over the way it is being introduced. Not only will most pensioners not qualify for the full flat rate, but the way their deductions are decided by the government has left many wondering if they are being short-changed.


The Current System


It is worth reminding ourselves how complex the existing state pension system is.


Currently there is a basic state pension of about £115 per week and an additional pension known as the state second pension (S2P), formerly SERPS. The amount of S2P received by pensioners varies according to past earnings and it is this part of the state pension that savers may have opted out of in the past, known as contracting out, to save into a private pension instead.


On top of the entitlement from the basic pension and S2P, there is a means-tested top-up called pension credit, made up of guarantee credit and savings credit, each of which have their own rules and reductions.


Confused? Don’t worry, that just means that you are normal. Only the highest order of pension geeks truly understand how the state pension works at the moment.


The New System


The new single-tier system will pay a minimum of around £151.25 a week, with the final amount to be announced in the autumn.


To be eligible, individuals will need at least 10 ‘qualifying years’ of national insurance contributions (NICs) to qualify for any state pension at all and 35 qualifying years to receive the full amount.


For those in employment, a ‘qualifying year’ is where earnings exceed £155 per week from a single employer, or if the individual is self-employed and paying voluntary NICs.


For those not in work, the government offers national insurance credits for people who care for others or where people are claiming benefits for illness, disability, or unemployment. People can also fill gaps by paying voluntary NICs.


However, under the new system, due to a one-off deduction applied to anyone who has contracted out, not just those due to retire next year, there will be several years in which people will have had to buy NIC top-ups or work longer to qualify for the full rate. The window for top-ups is from 12 October 2015 to 1 April 2017.


Why has the Government taken this Route?


The government says it has introduced deductions to strike a balance between those who have been contracted out of the state pension in the past and those who have not.


If the new single-tier system ignored all past contracting out, those who had paid reduced NICs to accrue private savings instead would essentially receive a boost to their state pension for free and still have their private savings.

Alex Newton
Senior Wealth Manager