WEEK 9

Learning Objectives

• Obtain a broad understanding of key factors influencing retirement planning:

  • Demographic, social, and economic factors

• Understand the nature of State Pension schemes

• Gain knowledge of private pension provisions

• Be aware of “Pensions Simplification” legislation

Overview of Retirement Planning

• Changing Expectations:

  • Increased life expectancy

  • Improved health outcomes

  • Enhanced standards of living

  • Changes in family structure influencing planning

State Pensions

• Basic Provision:

  • Designed for essential living costs

  • Not funded; operates on a "pay as you go" (PAYG) system:

  • Current workers' contributions fund current retirees' pensions

• Demographic Challenges:

  • Negative impacts on support and dependency ratios due to an aging population

  • Increase in life expectancy leading to longer retirement durations

  • High costs of State Pension, comprising nearly half of welfare spending and rising

State Pension Age

• Equalisation of State pension age for men and women

• Women born after 5 April 1955 have an increased pension age to align with men

State Pension System: Pre and Post 2016

• Before 6 April 2016:

  • Basic State Pension + Additional earnings-related state pension (options include graduated pension, SERPS, or S2P)

• On or After 6 April 2016:

  • Single tier State Pension introduced

  • Entitlement based on National Insurance (NI) contributions:

  • 35 qualifying years required for full pension

  • Minimum ten years to receive any pension benefits

  • Means-tested ‘top up’ for those with insufficient contributions

Possible Solutions to Pension Challenges

• Should future generations pay higher National Insurance contributions?

• Should benefits be reduced?

• Should State Pension age be increased?

State Pension Reform Principles (UK)

• Guiding Principles for Reform:

  • Personal responsibility for retirement savings

  • Fairness: adequate support for vulnerable individuals

  • Simplicity: making the State Pension easier to navigate

  • Affordability: reforms must be cost-neutral to avoid strain on taxpayers

New State Pension Key Points

• Set above basic means-tested support:

  • £164.35 per week in 2018/19; £179.58 in 2021; £203.85 in 2023

  • 35 qualifying years for full pension, proportionally reduced for fewer contributions

  • No benefits derived from spouse or civil partner

The ‘Triple Lock’ Mechanism

• Pension increases each year based on the higher of:

  • Change in National Average Weekly Earnings

  • Change in prices (CPI)

  • Guaranteed minimum increase of 2.5%

Occupational Pension Schemes

• Employers are not legally required to offer pensions, but seldom do not for large firms

• Stakeholder Pension:

  • No obligation for employer contributions, but includes automatic enrollment

  • Provides employee benefits and tax advantages

Types of Occupational Schemes

• Defined Benefit (Final Salary):

  • Known formula for pension calculation (e.g., 1/60th of final salary for each year)

  • Employer bears risk and costs

• Defined Contribution (Money Purchase):

  • Contributions determine retirement income

  • Risks associated with investment and market fluctuations

Additional Contributions and Limits

• Additional Voluntary Contributions (AVCs):

  • Employer-approved additional funding to enhance pensions

• Simplified Regime Post-2006 (A-Day):

  • 25% tax-free cash on retirement

  • Annual allowance cap at £60,000 or qualifying earnings, whichever is lower

• Upcoming changes: Lifetime allowance to be abolished from April 2024

Leaving an Occupational Scheme

• Options on leaving:

  • Return of contributions

  • Preserved benefit

  • Transfer value to another employer or personal pension

Stakeholder Pensions

• Designed as a type of personal pension that is simple and low-cost, adhering to CAT standards

Self-Invested Personal Pensions (SIPPs)

• Approved personal pension allowing for greater control over investments

• Eligibility to invest in a variety of assets, including commercial property

Conclusion

• Broader economic and social factors shape pension provision and individual retirement planning decisions.

• Increased life expectancy and higher living standards necessitate personal retirement savings beyond the State Pension.

• Occupational schemes are generally the most effective for retirement savings due to employer contributions.

• Defined Benefit schemes are diminishing in favor of Defined Contribution plans.

• Stakeholder Pensions offer flexibility for those without employer-sponsored schemes, while SIPPs serve informed investors.

• Seeking professional advice on pensions is crucial for individuals starting their careers.

Overview of Retirement Planning

Retirement planning is becoming more complex as expectations and demographics continue to shift. With increased life expectancy, improved health outcomes, and enhanced standards of living, people are living longer, which means retirement plans need to account for longer periods of time. Additionally, changes in family structure, such as smaller families and different caregiving dynamics, are influencing how individuals approach their retirement planning.

State Pensions

State pensions are meant to cover essential living costs during retirement. However, they are not funded like a private savings plan. Instead, they operate on a “pay as you go” (PAYG) system, where the contributions of current workers fund the pensions of retirees. This system faces several challenges due to an aging population. As life expectancy increases, people are spending more years in retirement, putting pressure on the state pension system. The rising cost of the State Pension is a growing concern, as it now accounts for nearly half of welfare spending and continues to increase.

State Pension Age

One significant change in recent years has been the equalization of the State Pension age for men and women. Women born after April 5, 1955, now have a pension age that aligns with men’s, meaning they will retire later than previous generations.

State Pension System: Pre and Post 2016

Before April 6, 2016, the UK had a dual system that included the Basic State Pension and an additional earnings-related pension, which could be part of graduated pensions, SERPS (State Earnings-Related Pension Scheme), or S2P (State Second Pension). After April 6, 2016, the UK introduced a single-tier State Pension system. This system is based on National Insurance (NI) contributions, and individuals need 35 qualifying years to receive the full pension. Those with fewer contributions will receive a proportionately reduced pension, and there is a minimum of ten years of contributions required to receive any pension benefits. A means-tested “top-up” is available for those who don’t meet the contribution requirements.

Possible Solutions to Pension Challenges

To address the challenges facing the State Pension system, several solutions have been proposed. These include raising National Insurance contributions for future generations, reducing benefits, or increasing the State Pension age to reflect longer life expectancies.

State Pension Reform Principles (UK)

Reforming the State Pension system involves balancing several principles. The focus should be on promoting personal responsibility for retirement savings, ensuring fairness and adequate support for vulnerable individuals, simplifying the system to make it easier to understand and navigate, and ensuring affordability to avoid overwhelming taxpayers.

New State Pension Key Points

The new State Pension system, introduced in 2016, is set above basic means-tested support. In 2023, the weekly pension is £203.85. To qualify for the full pension, individuals need 35 qualifying years of National Insurance contributions, and the pension will be proportionally reduced for those with fewer contributions. This system also eliminates benefits derived from a spouse or civil partner.

The ‘Triple Lock’ Mechanism

The Triple Lock is a mechanism that ensures pension increases each year are based on the higher of three factors: the change in National Average Weekly Earnings, the change in prices (Consumer Price Index or CPI), or a guaranteed minimum increase of 2.5%. This mechanism aims to ensure that pensions keep up with inflation and wage growth.

Occupational Pension Schemes

While employers are not legally required to offer pensions, large firms typically do. Occupational pension schemes come in two main types: Defined Benefit and Defined Contribution.

1. Defined Benefit (Final Salary): This type of pension provides a known formula for pension calculation, usually based on a percentage of the final salary for each year worked. In these schemes, the employer bears the risk and cost of providing the pension.

2. Defined Contribution (Money Purchase): In these schemes, the amount of retirement income depends on the contributions made and how the investments perform. The risk is borne by the employee because the final amount depends on market conditions.

Additional Contributions and Limits

Many employees can make Additional Voluntary Contributions (AVCs) to enhance their pensions. Since the simplification of the pension regime in 2006 (A-Day), individuals can take 25% of their pension savings as tax-free cash when they retire. The annual allowance for pension contributions is capped at £60,000, or the qualifying earnings, whichever is lower. In April 2024, the Lifetime Allowance is set to be abolished, which will remove the limit on the total amount of tax-advantaged pension savings an individual can accumulate.

Leaving an Occupational Scheme

When individuals leave an occupational pension scheme, they have several options. They can either receive a return of contributions, preserve the benefits in the scheme, or transfer the value of their pension to another employer’s scheme or a personal pension.

Stakeholder Pensions

Stakeholder pensions are a type of personal pension designed to be low-cost and simple. They must meet certain standards, including low charges, to make them accessible to a wide range of individuals. Employers are not required to contribute, but automatic enrollment ensures employees have the opportunity to join.

Self-Invested Personal Pensions (SIPPs)

SIPPs are personal pensions that give individuals greater control over their investment choices. They allow for investment in a wider range of assets, including commercial property, making them ideal for individuals who want to have more say in their retirement planning.

In conclusion, retirement planning in the UK is a complex issue, with various challenges and opportunities. The State Pension system continues to face financial strain due to demographic changes, and reforms are necessary to ensure its sustainability. At the same time, occupational and personal pension schemes provide additional options for people to save for retirement, and the introduction of flexible, low-cost pension schemes like SIPPs and stakeholder pensions offer people greater control over their retirement planning.