Pension provision in the United Kingdom
UK Pension Provision falls into seven major divisions; Basic State Pension, State Second Pension (S2P), Occupational Pensions, Stakeholder Pensions, Group Personal Pensions and Personal or Individual Pensions.
Personal Accountsautomatic enrolment and the minimum employer contribution will be new policies joining these from 2012.
stateprovides basic pension provision intended to prevent poverty in old age. Menover the age of 65 and womenover the age of 60 are entitled to claim state pension, although from 2010 the state pension age will start to be equalised and for women will rise, eventually reaching the age of 65 by 2020. [ [http://www.thepensionservice.gov.uk/pensions-reform/act.asp#age The Pension Service - Changes to State Pension Age.] ]
State pension comprises three main elements - the basic pension, additional pensions, and pension guarantee. These are described in the following sections.
Basic State Pension (BSP) or State Retirement Pension (SRP)
Basic state pensionis a "contribution based" benefit, and depends on an individual's National Insurance(NI) contribution history. For someone with the full number of qualifying years (years in which NI contribution was paid - typically 44 for a man and 39 for a woman, [ [http://www.thepensionservice.gov.uk/approachingretirement/introduction.asp How many qualifying years do I need?] ] although this reduces to 30 years on 6 April 2010 [ [http://www.thepensionservice.gov.uk/pensions-reform/act.asp#basic Pensions Act 2007] ] ), it is payable at a flat rate of £90.70 per week (2008/09). Less pension is paid for someone with fewer qualifying years. An "Age Addition" was introduced in 1971, with 25p per week added to the State Pension for people aged 80 or over. It remains at this level.
State Pension can be claimed from State Pension age: currently 65 for men and 60 for women (rising to 65 by 2020). It is also possible to defer claiming the SRP at pension age. Deferring claiming in this way currently (2008) gives an enhancement of approximately 10.4% to the pension per year deferred, or a lump sum and an unenhanced pension. The enhancement is actually 1% per 5 weeks the pension is not claimed, and the lump sum is the amount not claimed plus interest at 2% over the
Bank of England's base rate [ [http://www.thepensionservice.gov.uk/statepensiondeferral/choices.asp The Pension Service - State Pension Deferral - What are my choices at State Pension age?] ]
The table shows how the basic state pension for singles and married couples has changed between 1996 and 2008.
The Basic State Pension (or State Retirement Pension) is indexed each year for those pensioners living in the UK and also for 535,000 pensioners living overseas. However 525,000 pensioners living in certain other overseas countries have their pensions frozen at the rate at which they are first paid. This is seen as discriminatory by many because all of the pensioners have paid in the same contributions to the National Insurance Fund which pays out all pensions. People intending to retire overseas should research this issue carefully.
Three different state schemes have existed to provide extra pension provision above the Basic State Pension. These are collectively known as Additional Pension. This has been available only to employees paying National Insurance and certain exempted groups (not including the self employed). The three schemes are/were:
* Graduated Pension or "Graduated Retirement Benefit":Graduated pension ran from 6th April 1961 until 5th April 1975. Qualification was based on payment of a number of fixed National Insurance payments ('stamps'). Graduated pension typically pays a small amount (a pound or so per week) to those affected.
State Earnings-Related Pension Scheme(SERPS) :SERPS ran from 6th April 1978 to 5th April 2002. As the name implies, the level of pension payable was related to the recipients earnings via their National Insurance contributions. Qualification was based on "band earnings" above a Lower Earnings Limit (LEL) in each year. The LEL (£84 per week /£4368 pa in 2006/07) is usually set at the same level as the BSP (£84.25) and increased when BSP did. Band earnings lie between the LEL and an Upper Earnings Limit (UEL) at which National Insurance contributions ceased to be payable by the employee (this is £645 per week/£2,795 per month in 2006/07, although the UEL now refers to a threshold where reduced NI payments are made, as opposed to payment ceasing). The UEL is also adjusted annually.
* State Second Pension (S2P):S2P was introduced on 6th April 2002. As with SERPS, the level of pension payable is related to the recipients earnings via their National Insurance contributions. Qualification is based on earnings at, or above, the LEL, but no band earning calculation is made until earnings reach a higher base (£12,500 pa in 2006/07) called the Lower Earnings Threshold (LET). Earnings below the LET (but above the LEL) are credited up to the LET.
Unlike the Basic State Pension, participation in the Additional Pension schemes is voluntary. Those who do not wish to participate can contract out. This option was introduced with SERPS in 1978 and is only available to those who have made alternative pension arrangements through Personal or Occupational schemes.
Reforms introduced by
Gordon Brown, then Chancellor of the Exchequer, designed to lift a large number of the poorest retired people out of poverty, introduced the Minimum Income Guarantee in 1997, replacing it in 2003 with the Pension Credit. Pension Credit has two elements: Guarantee Credit is a "means tested" benefit which is paid if the income of the claimant and partner (plus a notional income from savings) is below a certain level (£124.05 for a single person in 2008/9). It is payable from age 60. In effect this is Income Support for the over 60's.
When the claimant or partner reaches 65 then the second element, Savings Credit, is also payable. Savings Credit is designed to "reward" people who saved for their pension during their working life. It therefore provides additional benefit to retired people who are not well off, but do have savings or a personal pension.
Anyone who is in receipt of the Guarantee Credit part of Pension Credit is also eligible for full Council Tax Benefit and Housing Benefit. This can be a significant amount, ensuring that a retired person in this position has their Council Tax and rent paid in full. This must be claimed separately.
The amount of Pension Credit is increased if the claimant and/or partner are in receipt of disability benefit, such as Disability Living Allowance (DLA) or Attendance Allowance.
Occupational pension schemes are arrangements established by employers to provide pension and related benefits for their employees.
Defined Benefit/Final Salary Schemes
Traditionally, a large number of UK employers offered their employees access to a
Defined benefitor Final salaryoccupational pension scheme. In such an arrangement, the employee was promised a fixed level of pension based on their final salary to which he or she would become entitled on retirement. The amounts payable are restricted by taxation rules, but are typically either a pension of one-sixtieth of their final salary for each year of membership or a pension of one-eightieth of their salary plus a tax free lump sum of three-eightieths.
Defined Contribution/Money Purchase Schemes
Over recent years, many employers have closed their defined benefit schemes to new members, and established
defined contributionor money purchasearrangements. In this arrangement, the occupational pension pays into a fund, and the fund is used to buy a pension (typically an annuity) when the individual retires. The pension is therefore determined by the value of the fund and the health of the annuity when the individual retires, as opposed to their salary.
UK occupational pension schemes are typically jointly funded by the employer and the employees. These are called "contributory pension schemes" since the employee contributes - typically something in the region of 6% of salary, tax free. "Non contributory pension schemes" are where the employer funds the scheme with no contribution from the individual. Contributions are typically put into a separate trust, whose assets will be used to provide benefits in due course.
Most schemes are also registered for tax purposes, which gives the scheme various tax advantages - assets grow free from income tax, capital gains tax and corporation tax, employees can normally make contributions out of their gross (untaxed) income, and employer contributions are generally tax deductible. Only funded schemes can be registered.
Prior to April 2006 schemes were 'approved' by
HMRCrather than registered. Approval placed certain limits on the benefits which could be provided, which led to a growth of 'unapproved' (i.e. without the generous tax treatment) retirement arrangements - these unapproved schemes were commonly distinguished by reference to their funding status ( Funded unapproved retirement benefit schemesFURBS and Unfunded unapproved retirement benefit schemesUURBS.
Individual or Personal pensions
It is also possible for an individual to make contributions under an arrangement they themselves make with a provider (such as an insurance company). Similar tax advantages will usually be available as for occupational schemes. Contributions are typically invested during an individual's working life, and then used to purchase a pension at or following retirement.
Various names are given to different types of individual arrangement, but they are not fundamentally different in nature. The generic term
personal pensionis used to refer to arrangements established since the rules were liberalised in the 1980s (earlier arrangements are usually called retirement annuity contracts), but can be subdivided into other types (such as the Self-invested personal pension, where the member is allowed to direct what their contributions should be invested in).
Stakeholder pensions are a form of pension arrangement designed to be easily understandable and available. Stakeholder pension are in effect personal pension schemes set up on terms which meet standards set by the government (for example there are restrictions on the charges the provider may make).
Although a stakeholder pension is a personal pension, they can (and in some circumstances must) be offered by an employer as a cost-effective way of providing pension cover for their workforce.
Group Personal Pensions
Group Personal Pensions are another pension arrangement that are personal pensions, but are linked to an employer. A Group Personal Pension Plan (GPPP) can be established by an employer as a way of providing all of its employees with access to a pension plan run by a single provider. By grouping all the employees together in this way, it is normally possible for the employer to negotiate favourable terms with the provider, thus reducing the cost of pension provision to the employees. The employer will also normally contribute to the GPPP.
Pension provision by age group
The Family resources survey [ [http://www.dwp.gov.uk/asd/frs/2005_06/index.asp Family Resources Survey 2005-06] ] from the UK
Department of Work and Pensions, details levels of income, saving and pension provision for a representative selection of UK households and is the source for the table below for UK employees (Table 7.12):
Most employees over the state pension age of 65 would not have pension provision as part of their salary and benefits - they may well however be receiving income from a pension from previous employment
*Aging of the United Kingdom
Pension simplification, also known as 'A' day
Pensions Act 1995
Minimum funding requirement
* [http://www.ampsonline.co.uk Association of Member-Directed Pension Schemes (AMPS)] - The principal body for discussing changes involved in the area of pension planning.
* [http://www.thepensionservice.gov.uk/home.asp U.K. Government website for The Pension Service]
* http://www.dwp.gov.uk/pensionsreform/pdfs/PensionsBillImpactAssessmentDec07.pdf - this is the impact assessment released in December 2007 for the pension bill 2008. It provides a complete appraisal of the reforms. There are also factsheets on individuals and employer reactions which have implications for the UK pension industry.
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