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The state pension: everything you need to know

If you have managed to save a decent amount for retirement, you may think that the state pension is almost an irrelevance. But if you look at the size of the lump sum you’d need to replace it, you’ll see that it’s a very significant amount.

The state pension may also be your only source of guaranteed, index-linked income for life. It’s therefore important to check that you are in line to receive the full payment – and to be prepared to take action if not.

Check your state pension entitlement

So far our aim has been to help you to get the most out of your own retirement savings. But it’s important not to forget the other significant source of income in later life: the state pension. The state pension can get a bad press; it is often criticised as inadequate.

But some of this criticism misses the point. Yes, on its own the state pension is not enough for most people. However, it can still make a huge contribution to your total income. Better still, it is guaranteed, involves no risk (you are not investing the money yourself) and it rises in line with inflation every year.

We think it’s best to view the state pension as a vital pillar of your retirement income. As such, it’s worth putting considerable effort into ensuring that you will receive the maximum amount possible, because the rules are complex and even small mistakes could result in a significant reduction in what you get.

Crucially, you should check as early as possible that you are on track to receive the maximum entitlement – don’t leave it until you are on the point of retirement. In fact, check right now (we explain how to below).

Here, in seven questions and answers, we explain how to do this and cover all the key angles of the state pension and the part it plays in your retirement income plans.

1. How valuable is the state pension?

Under a new system that took effect in April 2015, anyone who retires after that date receives a flat-rate state pension – £168.60 for the 2019–20 tax year – if they have made enough National Insurance contributions. The system is called flat-rate because previously the state pension consisted of two parts: a basic pension and various top-ups, which included the State Earnings Related Pension Scheme (SERPS).

However, the flat-rate description can be misleading because it implies that everyone gets the same. In fact, not everyone will get the same because of complications designed to ensure that people who would have received more under the old system do not lose out – and that people who did not make full National Insurance contributions do not unfairly benefit.

However, if you are entitled to the full weekly amount, you will get an annual income from the state of £8,790 (in 2019–20) – which, don’t forget, will rise every year in line with inflation. To get a sense of how valuable this secure, rising income is, we can look at how much it would cost to buy that same income on the annuity market.

At the time of writing, you would need to hand a lump sum of £239,000 to an annuity company in return for an inflation-linked equivalent income for life from age 65. In other words, the value of the state pension when converted to a single sum is almost certainly significant in relation to your own overall pot.

It’s important to remember that the state pension is taxable, in that it forms part of your taxable income. However, confusion often arises because the government normally pays it without deduction of tax. This is because the annual state pension is normally less than the tax-free annual allowance (£12,500 in the 2019–20 tax year). As a result, anyone whose only income is the state pension does indeed have no tax to pay.

However, it often doesn’t take much income on top of the state pension to push people into the basic-rate tax bracket. Tax codes for pensioners are normally adjusted to take account of the taxable status of the state pension, but it’s important to check that your tax code is right.

There is advice on how to do this on the website of the Low Incomes Tax Reform Group: www.litrg.org.uk/tax-guides/pensioners.

2. How can I find out about my own entitlement?

The government can tell you how much you are on track to receive in state pension. There are several ways to get a forecast:

• Online at: www.gov.uk/check-state-pension
• By phone on: 0800 731 0175 or 0191 218 3600
• By post to: The Pension Service 9, Mail Handling Site A, Wolverhampton WV98 1LU

We have tried the online service and received our forecasts within minutes, with no fuss. There is also a complete breakdown of your National Insurance (NI) record to date, showing any years in which our contributions were incomplete and indicating where you may still be able to make them up now. 

The forecast will state that it is based on the assumption that you will continue to work until your state pension age, although no one accrues more state pension entitlement after they have 35 years of full NI contributions (based on the law as it stands).

If you spot anything that doesn’t look right in your NI record, it’s best to call the service to double check that you really are entitled to the full amount, or whether there is any scope for filling the gaps in your record.

3. When will I receive the state pension?

For years the answer to this question was simple: 65 for men, 60 for women. Now things are changing.

Men and women already receive the state pension at the same age and the state pension age is now rising for both sexes. The process is gradual, so many people will find themselves retiring at the age of, say, 65 and six months.

In summary, the state pension age for men and women will increase to 67 between 2026 and 2028. There is a detailed table, which will show the retirement date for your own birthday, at https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/310231/spa-timetable.pdf.

4. Is there any way to get more state pension?

There are two ways in which you may be able to increase what you get. The first, as we mentioned, is to make additional National Insurance contributions if your record is not complete.

But don’t assume that you should automatically do this if you have some incomplete or missing years – the only thing that matters is having 35 full years of NI contributions by the time you are eligible to claim the state pension. If you are on course to do this, it would be a
waste of money to buy the missing years.

If you do need to make up some missing years, you can make additional voluntary National Insurance contributions. HMRC has extended the usual deadlines for making these voluntary contributions for the tax years from 2006–7 to 2015–16 – you will have until 5 April 2023 to make the contributions, so you don’t need to decide now. You should contact HMRC to make the payments.

The other way to increase your annual state pension is to put off claiming it. For each year you delay, the pension rises by just under 5.8%. 

This may sound like a good idea, but it does mean that you will, in the end, receive the pension for one year fewer than otherwise. This has to be balanced against the fact that the annual pension will be higher for your entire retirement.

Broadly speaking, the longer you live, the greater the benefit of deferring.

After all, if you were unlucky enough to die one year after taking the state pension, and had delayed by a year, you would have received one year’s pension instead of two in total, in exchange for 5.8% more in the one year – clearly a terrible deal.

At the other end of the scale, imagine that you live long enough to claim your state pension for 35 years. If you don’t defer, the total amount you receive over the course of your retirement is £291,200 (disregarding inflation for simplicity’s sake). If you defer for one year and claim the pension for 34 years instead, you’ll get just under £300,000 in total – about £8,800 more.

If you don’t want to take what amounts to a bet on your longevity, there is another option for those who could afford to defer: you simply claim the pension as soon as you are eligible and add it to your own pension pot instead of spending it.

This gives you a good outcome either way: if you live for a long time and your pension investments perform well you will get as much in total as you would by deferring (or possibly more), thanks to investment growth on the first year’s state pension income. But if you die early, you don’t lose that first year’s income.

5. I plan to retire at 60, several years before I receive the state pension. How do
I bridge the gap?

As we have explained, the guaranteed, index-linked state pension is a benefit of great significance for all but the richest savers. But this very fact can complicate matters for some people, especially those who retire before or after the state pension date.

Let’s imagine that you have accumulated a decent pot of pension savings by the age of 60 and decide to retire then. You will need that pension pot to produce all your income for the next five, six or seven years (the exact period will depend on your age, thanks to the increases in the state pension age), and then a reduced income once you start to receive the state pension.

How can you ensure that the pot produces the income you need for those first few years while at the same time ensuring that there is the right amount left when the second period begins? When, in other words, the role of your personal savings pot changes from providing all your income to augmenting what you receive from the state pension?

There are various ways to answer this question, but we believe the simplest is to establish the sum that needs to remain in your pension pot at the point that you start to receive your state pension and then tailor your withdrawals in the years before that point to achieve that sum. (If this tailoring results in the income being less than you need, the sums are telling you that you can’t really afford to retire so early after all!)

How do you establish this figure? First, establish how much income you’ll need in retirement, using the steps we outline here. Subtract from that figure the income you will get from the state pension to arrive at the amount that needs to be generated by your pension pot. Decide which of our three portfolios suits you best in terms of the balance between income for you during your lifetime and your wish to leave money to others when you die, then use the percentage income from that portfolio to arrive at the capital sum needed.

For the 5% portfolio, multiply the annual income you need by 20. For the 4% portfolio multiply by 25 and for the 3% portfolio multiply by 33.

For example, let’s assume that your budgeting exercise shows that you will need £25,000 a year. Deduct the state pension, roughly £8,700 (but use your own figure if your state pension forecast gave a different one), to arrive at £16,300 as the sum that needs to be generated by your investments.

To generate this annual income will require a pension pot of £326,000 if you use the high-income (5%) portfolio, £407,000 with the compromise (4%) portfolio and £538,000 from the inheritance (3%) portfolio.

But you should also increase these figures to account for inflation. If you will receive the state pension in five years’ time, for example, assume an inflation rate of 2.5% and use an online calculator (there is one at www.calculator.net/inflation-calculator.html) to discover the inflation-adjusted figure. For example, £326,000 today is equivalent to £370,000 in five years’ time – so this last figure would be the one to aim for.

The last step is to watch your rate of spending during those years between retirement and receiving the state pension to ensure that the value of your pension pot declines roughly at the rate required to meet the target value at the latter point.

6. I want to carry on working after the state pension age. How does this affect my
pension planning?

If you are thinking of carrying on in work after the state pension age, you may wonder how this affects your state pension planning. This depends to some extent on why you want to carry on working. If you are doing so because you think you can’t afford to retire, eligibility to receive the state pension is likely to make a big difference.

As we discussed above, you have the choice of claiming your state pension straightaway or deferring it in exchange for an increase of about 5.8% a year. Assuming that your financial situation is not causing you current difficulty as long as you carry on working, in other words that you don’t need the state pension income to support your living expenses now, you could choose to defer, perhaps for several years.

This would give you a bigger state pension when you do eventually retire. However, as mentioned above, the other way is to claim the pension anyway and simply add it to your existing savings. This deals with the danger of dying early and receiving less, or nothing, of the state pension you are entitled to.

If you consider the effect of this on the amount you are saving and then take into account the fact that each year of extended working life reduces the size of the pension pot you will need for your shortened retirement – and the fact that once you reach state pension age you don’t pay National Insurance contributions, even if you continue to work – you can see that prolonging your career changes significantly the balance between what you need and what you have, so with luck your retirement will not be long delayed.

A third possibility is taking the state pension and using the additional income to cut the number of hours you work, while you continue to save for the time when you can retire fully.

If, on the other hand, continuing to work is a choice rather than a necessity, you still have the options of deferring or claiming. Again, to avoid the danger of getting a poor return from your state pension should you die relatively early, you might consider claiming the pension anyway and adding the money to your pension pot. But do consider the tax implications of boosting your income in this way.

7. What about the threat to the state pension triple lock?

The triple lock is a commitment made by the government in 2010 to increase the state pension every year in line with the higher of price inflation or wage inflation, subject to a minimum in any event of 2.5%.

This is seen as a very valuable guarantee for pensioners. The other side of the coin is that the promise is expensive for the government. As a result there have been persistent fears that the triple lock will be scrapped or watered down.

If this were to happen, it would make the state pension less valuable over the course of a retirement, which implies that savers should accumulate a bigger pot of their own pension money to compensate.

However, politicians will tread warily: upsetting pensioners can cost a lot of votes. We think the most likely outcome is that the triple lock will be weakened slightly by removing the 2.5% floor to increases. In recent years, when inflation has been low, this element of the guarantee has been called into play, but there are likely to be many occasions when price or wage rises are higher.

Scrapping the 2.5% floor is therefore unlikely to make too much difference to your eventual income.

‘The state pension is vital – so check your entitlement regularly’

By Ros Altmann, the economist, long-standing pensions campaigner and former pensions minister

The word pension covers two separate concepts. Firstly, state pensions provide income that ensures citizens are not abandoned into poverty in retirement. Secondly, private pensions are long-term investments that can provide extra money for spending in later life. The amount you receive depends on how much is paid in, interest rates and investment returns, so higher earners tend to have more.

Britain’s state pension is a crucial part of most people’s retirement income. A full state pension under the new single-tier system promises around £24 a day from pension age – just enough to avoid poverty.

If you want more than this you need private pensions or other assets. Regardless of previous earnings, a bedrock of guaranteed, taxpayer-funded lifelong income can be an important base on to which people can build extra private income.

The new state pension has no earnings-related payments; the amount paid depends on the number of years of NI contributions. Of course, as working life and life expectancy change, NI rules covering elements such as state pension starting age, number of years of contributions needed for a full pension, or the amount or structure of the state pension itself, will change over time.

It is therefore vital to ensure that people know how the state pension works. Unfortunately, governments have not always properly informed people about rule changes.

For example, a few years ago, before I became pensions minister, I received a letter from the Department for Work & Pensions informing me that I had achieved the 30 years’ NI contributions required for a full state pension [Telegraph report of the letter here]. But at that very time legislation was going through Parliament to increase the required number of years to 35.

Of course, I knew this because I was involved in pensions, but most people would have had no idea and would find out only years later that their NI record was incomplete.

Far worse than this, after changing the law in 1995 to significantly increase future state pension ages of women then in their 40s, governments failed to ensure that those women all knew that they would have to wait longer for their state pension. Many are now facing real hardship because they are not receiving their state pension when they expected to.

You should check your expected state pension entitlement and NI record regularly – every couple of years perhaps – to help you plan your future retirement income.

Some say the state pension in its current form will not be around for future generations, but I disagree. Means-testing state pensions undermines incentives to save, thus reducing future private provision. Having a base of income from the state above means-tested poverty levels ensures that people have clear incentives to save for their own retirement to supplement the state pension.

There is, however, one glaring omission from 21st century retirement social welfare: NI does not cover social care costs. One in four elderly people will need paid-for care, so national pooling of risk makes sense. But successive governments have ducked this difficult decision and failed to set aside money for care funding. Billions of pounds are earmarked for pensions, but nothing for later-life care.

This crisis is worsening and needs urgent solutions to ensure dignity for millions of vulnerable elderly people in future.