5.1.2 State pensions
We now turn to a particular and very important way that we can invest in funds: pension products. But before we look at the products we can enter into, it is important to understand how much we will get from the state pension scheme. Clearly, the greater the financial support availed by state pensions, the less we need to ensure that we provide pension income ourselves through building up a pension fund ahead of retirement.
Limited state retirement pensions were first paid in the UK in 1908. These were improved by the 1946 National Insurance Act which brought in flat-rate universal state pensions (with effect from 1948).
While various developments in state pensions have taken place since then, the main thrust of policy in recent years has been to limit public expenditure on state pensions.
The UK government has planned staged rises in the age at which people can receive their state pension, to reach 68 years in the mid-2030s, with further increases likely. Many predict that the state pension age will eventually rise to 70 years. One aim of these moves is that, on average, no more than a third of adult life should be spent in retirement. So, the longer the population lives on average, the higher will be the state pension age.
There are actually two state pension schemes in place in the UK. The ‘old’ scheme for those who reached state pension age before April 2016 and the so-called flat-rate pension scheme for those reaching state pension age from April 2016 onwards.
The ‘old’ scheme has two parts. The first part is the basic state pension which amounted to £156.20 per week for a single person in 2023/24. This amounted to circa 25% of average full-time earnings in 2023 compared with 28% in 1980. The reason for the decrease was that during the period from 1980 to 2011 state pensions were normally increased in accordance with the rate of price inflation which tended to be lower than earnings inflation.
However, from 2011 onwards, the basic state pension has increased each year with the higher of either earnings inflation, consumer price inflation or 2.5%. This is known as the ‘triple-lock’ – an arrangement that is proving to be politically controversial. Whilst this ‘triple-lock’ remains in place the basic pension should retain its value relative to earnings (or even rise a little faster).
Entitlement to the basic state pension depends on paying, or being credited with, National Insurance contributions (paid by employees and the self-employed) during working life. Credits are given for certain periods out of work, such as being ill, unemployed or caring for children.
People reaching state pension age before 6 April 2010 needed to have National Insurance covering roughly nine-tenths of their working life to get the full basic state pension. For people reaching state pension age on or after 6 April 2010, the required contribution record was reduced to 30 years – although this rose to 35 years from April 2016.
A shorter record means a reduced pension – although from April 2016 a minimum number of 10 years for those reaching state pension age has become required to get any state pension.
Wives – and, since April 2010, husbands and registered civil partners – can claim a basic pension of up to £93.60 (in 2023/24) based on their spouse’s or partner’s record if their own basic pension would come to less than this. From 2016 this stopped for those new to reaching state pension age.
The second part of the state pension – the additional state pension (or state second pension) – is restricted mainly to employees. It was first introduced in 1978, when it was called the State Earnings Related Pension Scheme (SERPS).
Whilst this additional state pension can materially add to the basic state pension large numbers do not benefit from it. Many people have been ‘contracted out’ of the state additional pension, which means that this part of their state pension has been replaced by a workplace or personal pension scheme in return for reduced or refunded National Insurance Contributions.