Chartered Financial Planner Gary O’Brien gives a summary of proposed changes to state pensions which come in from 2016.

Why is reform necessary?

Sorting out the UK’s state pension system was never going to be easy. State pensions are a complex mix of various benefits, including basic state pension, state second pension and means-tested Pension Credit. So the Government’s plan to create a flat-rate state pension for all should bring much-needed simplicity to individuals looking to plan for their retirement. However, it is rare to introduce change on this scale without some pain and while there are many winners from the reforms there may well be some people who will be ultimately worse off.

What are the planned changes?

• A flat-rate weekly pension will be introduced in April 2016 worth £144 in today’s money, which will increase in line with the highest of either price inflation, wage inflation or 2.5 per cent. The current state pension is £107.45 a week.

• Pension age will rise to 66 for both sexes by 2020 and 67 by 2028.

• The Government is to carry out five-yearly reviews of the pension age but has pledged to give ten years’ notice of any future changes.

• People will have to make 35 years-worth of National Insurance (NI) contributions to qualify for the higher new pension, up from 30 years now.

• At the moment an individual begins to build up state pension entitlement after one year of NI contributions, but under the new system this will be increased to ten years.

• The minimum state pension will be £41 a week in today’s money, based on ten years of NI contributions.

• Taking a career break to raise a family will count towards the 35 years of NI contributions needed for a full state pension.

• Couples will qualify for the full new payment as individuals, rather than receive the current less generous joint couple's rate.

• Contracting out will end when the new single-tier state pension is introduced, so these employees will need to start paying full NI contributions – an increase of 1.4 per cent of relevant earnings.

Who gains?

Many women have suffered from a damaged pension record, having taken significant career breaks to care for children.

But this will change under the new single-tier pension, as more women will be able to receive a full state pension in their own right. The same applies to other types of carer. The move will also benefit a lot of lower-paid workers who often find themselves without a decent state pension under the current rules. The changes will also be good news for self-employed workers, who can find it extremely difficult to earn a full state pension under the current system.

Summary

Pension reform is needed and some of these proposals are steps in the right direction. However, state pensions are not usually a retirement solution in isolation and they should, where possible, form part of a bigger financial plan for retirement.