There can be lots of reasons why you might not get the maximum State Pension.
If you’ve taken time out of work to raise children or care for elderly parents, if your earnings have been very low or you’ve worked for yourself, or if you’ve spent time living and working abroad - all can be reasons why you may not qualify for the full amount.
If that’s the case, it could cost you dearly in retirement. That’s because the State Pension is extremely valuable income - and very expensive to replace.
How expensive? According to the latest market prices, replacing the current maximum State Pension (available to those retiring after 5 April 2016) would cost slightly more than £205,430. That’s based on buying an annuity to replace the income provided by the State Pension.
The reason it costs so much to replace is obvious - the State Pension is both guaranteed and protected against inflation, two things that are precious and difficult to replicate any other way.
The current rate on an annuity paid to a healthy 65-year-old is around 5.16%. That’s with income payments escalating by 3% a year to combat rises in prices – not the full protection against inflation that the State Pension enjoys thanks to the ‘triple lock’ (the promise to raise the payment by the greater of inflation, wage rises or 2.5%), but still very valuable.
On the basis of that rate, it would require £205,430 of pension savings to replace the current full State Pension of £203.85 a week.
As you are almost certainly aware, annuities are not the only way to get an income from retirement savings. Income drawdown is another option. A rule of thumb used by many is that someone can withdraw around 4% a year from their drawdown pot and still have a good chance that their savings will last for 30 years. I won’t go into this here but the ‘4% Rule’ is much misunderstood and in many cases much higher withdrawals can be sustained.
However, if we go with the ‘4% Rule’, just for illustrative purposes, an individual would need £265,005 of pension savings in drawdown to recreate the State Pension income - more than an annuity and without the guarantee that income will last until you die, BUT with the benefit that the money remains available to you, whilst you are still alive, or your family when you die.
Why the State Pension is so valuable
Given the high cost of getting it any other way, it makes sense for most clients to maximise the income they get from the State Pension. Your entitlement to the State Pension is, of course, based on your National Insurance (NI) contributions. To get the full State Pension you need to have made NI contributions for 35 complete years by the time you retire.
An additional calculation suggests that one would have needed to have paid approx. £160.00 per month, increasing by 2.50% per year and with investment growth of 4.0% per year, to arrive at a figure of £205,430 after a period of 35 years. It might be interesting to work out whether that means the NI contributions we have paid in over the years have represented good value …..or not?
The government has an online service that lets you check your NI record for any gaps and to see whether you’ll get the full amount. You’ll need a government Gateway account, which you can sign-up for using details from your passport, payslips or P60. If you have gaps in your record, you may be able to pay voluntary NI contributions to fill them, or else fill them with NI credits that apply in some circumstances.
I hope you have found this interesting but, if you have any questions about this piece or any other finance related matter, please do not hesitate to get in touch.
Yours sincerely,
Graham Ponting CFP Chartered MCSI
Managing Partner
