State Pension Reform
In January of this year, a radical reform of the state pension was unveiled. The proposed reforms will affect millions, many of whom will be worse off under the new scheme.
Changes to occupational and public sector pension schemes often evoke significant backlash and protest. In some cases it has led to national strikes. The response to the proposed state pension reform in contrast has been pretty subdued. One could even say non-existent. So why such a passive response to significant reform? Well, I have a theory:
- The majority of us have absolutely no idea what our state pension is worth to us or when it will be paid.
- A common perception is that the state pension is likely to be worth very little to us.
- For many, retirement seems a long way off. We have enough to worry about in the present
I believe these factors go a long way to explain why pensions and more specifically the state pension often receive little focus in divorce proceedings.
Let’s actually consider what the state pension could be worth to you. Under the new scheme, a full state pension entitlement would be worth £144 in today’s money. If we assume that these payments retain their inflation proofing and consider that they could be paid for say 35 years. On these assumptions, a total of £262,080 would be paid in today’s terms. When viewed in this way, the dull old state pension suddenly seems a little more interesting.
State pension proposals
The Department for Work & Pensions proposal document, “The single-tier pension: a simple foundation for saving”, lays out the detail of the reforms. It is a joyful read at 108 pages. I have summarised the key points below.
- The reforms will not take effect until April 2017 at the earliest.
- For those that reach state pension age before implementation of the reforms, they will retain their existing entitlements and benefits.
- The existing complicated structure of a basic and various additional state pension entitlements will be replaced with a single tier pension
- For those reaching state pension age after implementation of the reforms, their existing National Insurance records will be translated into a “Foundation Amount”. This Foundation Amount in effect provides a level of entitlement to the new single tier pension. Further entitlement can be built up in the future.
- The full new single tier state pension is likely to be £144 per week. This amount is likely to be uprated by the highest of growth in prices, average earnings or 2.5%.
- Individuals will need 35 qualifying years of National Insurance Contributions or credits for the full pension amount.
- Individuals will require a minimum of 7-10 years to start to qualify for a proportion of state pension.
- There will be no facility to inherit state pension rights or derive them from a spouse or civil partner (subject to transitional provisions).
The devil in the state pension detail
As usual the devil is in the detail. For the purposes of this post, I would like to focus in on the implications of the reforms for divorce.
The present system facilitates the following:
- If a person on divorce does not have a full National Insurance contribution record up until that time (currently 30 years), they may apply to substitute the National Insurance record of their former spouse for their own record in relation to all tax years during their working life. They can do so up to the end of the tax year in which the marriage ended or the end of the tax year before they reach State Pension Age (SPA), whichever comes first. This process is referred to as Pension Substitution and is a benefit which needs to be claimed rather than being granted automatically. If the ex spouse subsequently remarries they will lose the benefit of any Pension Substitution top up, unless the remarriage occurs after their State Pension has already come into payment.
- Any additional state pension entitlement can be taken into account as a financial asset on divorce. This means that part of the value of any additional state pension you have earned could be shared with a former husband, wife or civil partner.
Following the implementation of the proposed reforms, the situation fundamentally changes.
- It will not be possible to claim pension substitution
- It will not be possible to share any additional state pension entitlement
The proposal document states:
“The single-tier pension has been designed to ensure that the large majority of individuals will be able to get the full rate in their own right. In steady state, there will be no rationale for allowing people to inherit or derive state pension income based on the National Insurance record of their spouse or civil partner”.
What now for pension sharing orders?
So what does this mean for those divorcing now or in the future? In my mind the following points are relevant.
- Any pension sharing orders already in place prior to implementation will be honoured. This places a deadline (likely to be April 2017) on getting additional state pension sharing orders in place.
- In order to qualify for a full state pension following implementation of reforms, it will be necessary to have 35 years of contribution history/credit in your own right
- Post implementation, divorce lawyers will need to examine the disparity between the state pension entitlement of a husband and wife and consider how this should be taken into account. The disparity may become a more significant factor in the absence of pension substitution
- It is vital for people to quantify their state pension entitlement and the contribution this makes to their future financial security
A professional financial planner will be able to incorporate an individual’s state pension benefits into a cash flow forecast. By combining state pension benefits with other income and assets, a cash flow forecast can provide important insight into future financial security and needs.
In the absence of additional state pension sharing and substitution, it will become more important than ever to consider future income needs in retirement.
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Sam Jermy works for Family Law Financial Planning Ltd which is an appointed representative of North Laine Financial Management Ltd which is authorised and regulated by the Financial Conduct Authority. North Laine Financial Management Ltd’s FCA Register number is 446522. The views expressed in this guest post are Sam’s own. Please contact your own independent financial adviser or family lawyer if you believe the issues raised by Sam impact upon you. Alternatively, please post a comment or query below and Sam will do his best to respond.