Where Should the State Pension Sit in Your Retirement Plan?

By March 27, 2020Pensions

The State Pension is unlikely to provide you with a comfortable retirement on its own, but it shouldn’t be overlooked.

The State Pension for 2020-21 is £9,110.40 per year. This assumes that you reach State Pension age after 2016 and have enough National Insurance credits. Some people may even receive more than this if they built up some additional pension before the rules changed in 2016.

This may well be enough to pay the bills, while your private pension can be directed towards other things.

It’s easy to fall into the trap of either ignoring the State Pension, or avoiding retirement planning altogether on the assumption that the State Pension will be enough.

Our belief is that the State Pension is important, and that you should build up maximum National Insurance credits if you can. However, this is just one part of a retirement plan, and where possible should complement a well-funded private pension.
 

How Much is a State Pension Worth?

The average salary in the UK is around £30,000 per year. This salary would incur National Insurance contributions of £2,460. This buys one year’s credit. You need to accrue credits for 35 years to build up a full State Pension, although you can start to earn a proportional State Pension with only 10 years’ worth of credits.

If you were to invest £2,460 per year into a private pension for 35 years, and achieved investment growth of 5% per year, you could build up a fund of £233,297.35.

You could probably safely withdraw 3% of the fund value every year and increase your withdrawals annually in line with inflation. This could give you over £7,000 per year. Not only is this less than the State Pension, it is not guaranteed, as it would be dependent on investment growth.

Of course, some people earn much more than £30,000, but many people earn significantly less, and are still able to accrue the same State Pension.

To be able to buy an income equivalent to the State Pension, you would need a fund of just under £300,000.

Clearly, the State Pension is a more valuable benefit than many people believe.

 

When Would You Like to Retire?

Depending on your age and gender, the State Pension is payable between age 65 and 68.

One of the main financial goals that clients tell us about is the desire to retire early. Clearly, relying on the State Pension does not allow for this.

You may wish to build up a fund to allow you to retire at age 55. But think carefully about your spending patterns. Most people spend more in the early years of retirement while they are still fit and well. Does it make sense for your income to suddenly increase (and to rise with inflation) at age 68?

A good financial plan will account for these irregularities. Perhaps you will have a personal pension, or even an ISA to fund your expenditure from age 55, with a cash reserve to cover any ad hoc costs. Your withdrawals can then be reduced alongside the State Pension, not only to preserve the fund, but also to make the best use of your tax allowances.

 

Filling in the Gaps

If you are not employed, there are other ways of building up a State Pension. For example:

  • Receiving Child Benefit for a child under the age of 12
  • Claiming unemployment benefits
  • Claiming disability benefits

If you are not working, and not receiving any of the above benefits, you can still accumulate a State Pension by making voluntary National Insurance contributions. In 2019-20, this amounted to £15 per week.

This is overlooked by many people who are not in work but think about what you receive in return. A year’s contribution of £780 buys 1/35th of a full State Pension – approximately £250 per year. No other pension or investment provides this level of return on your money.

Company directors have an added advantage, as they can draw a basic salary from their business (between £6,144 and £8,628 per year as of 2019/2020) and take their remaining income as dividends. At this level of salary, no National Insurance contributions are actually payable but are credited nonetheless.

You can check your State Pension Forecast at:

https://www.gov.uk/check-state-pension

 

The Disadvantages

If you are a salaried employee, paying National Insurance is not optional. For high earners, there is a chance that you will pay more in National Insurance contributions than you receive in return.

Of course, the other side of this point is that many people do not have the opportunity to build up much, if any pension provision, and the current system provides a safety net.

We also cannot ignore the government’s role. Pensions are an area of continual tweaking, with retirement ages rising, and many people questioning if they will receive any State Pension at all.

It used to be possible to pass some of your State Pension on to a spouse on death, if they didn’t have a full State Pension in their own right. This was quietly removed in 2016.

Again, a sound financial plan is the answer, as changes can be made in plenty of time to account for legislative developments. It is unlikely that the State Pension will be removed entirely.

While the State Pension is not perfect, it provides a solid foundation from which to build your retirement income.

If you would like to discuss retirement planning in more detail, please do get in touch. We can help you plan for the future.

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