People who reach State Pension age from 6 April 2016 will do so under the new State Pension system. Everyone who reached State Pension age before this point will be in the old system.
Either way, their whole National Insurance (NI) record has been or will be taken into account when working out what they are entitled to.
Last autumn, I published a number of blog entries to help explain how the old system worked. Through this entry, which focusses on the period up to 5 April 2016, I want to show how people may have paid different amounts of NI over their working life through to the end of the tax year 2015/16, and how this has contributed to the State Pension they are or will become entitled to.
In particular, this entry will be of greatest interest to those people who reach State Pension age under the:
- old system, who might want to know how the State Pension they are receiving was calculated; and
- new system, so they can understand how their NI record built-up under the old system will be taken into account in the new system.
This summary shows how things stood at the end of the 2015/16 tax year. It describes features of the old system, like the State Second Pension (S2P), which ended on 5 April 2016 as we go into the new system.
However, the figures and rates used in the examples are current for 2016/17. So those parts of the system which continue for those who reached State Pension age before 6 April 2016, like the basic State Pension, are shown at the latest rate of £119.30 a week.
The State Pension system before 6 April 2016
The old State Pension system had two parts:
Basic State Pension + Additional Pension (called S2P)
The old State Pension system consisted of the basic State Pension and an Additional Pension (called S2P for short – previously called SERPS between 6 April 1978 and 5 April 2002). The basic State Pension paid a particular amount of pension income for each qualifying year on people’s NI record, up to a maximum of 30 years. In other words, every complete year of NI contributions paid for 1/30th of the full basic State Pension, regardless of how much people were earning. However, the amount of S2P people could get depended on how much they earned and whether or not they were ‘contracted-out’ of the Additional Pension system. I will explain more about this in a moment.
How did my NI contributions add towards my State Pension?
If you were paying NI contributions (other than the reduced married women’s stamp), or receiving NI credits, then you will have contributed to the basic State Pension.
If you were earning between £112 a week and £154 a week you were treated as paying NI contributions.
All NI contributed to the basic State Pension
Contracted-in, an average earner paid NI at 25.8%
You paid full NI at 12%, your employer paid NI at 13.8%
So someone earning £25,000 a year would pay NI of £2,028 and their employer would pay £2,330.
Additional Pension and contracting-out
You could not opt out of the basic State Pension, but you could pay less NI to the State and opt out of the Additional Pension. This was called ‘contracting-out’. If you were contracted-out in 2015/16, you paid NI at the lower contracted-out rate. You were opting out of the Additional Pension and would have been building up an occupational pension in your employer’s scheme to replace the Additional Pension (for the years 1978 until 2002 you would have been contracted-out of SERPS). Therefore, these people were only contributing to the basic State Pension of the NI pension system.
Contracted out, an average earner paid NI at 21% (instead of 25.8%)
You paid lower NI at 10.6% and your employer paid NI at the lower rate of 10.4%
This 4.8% lower NI payment was allowed because you were opted out of the Additional Pension. You would have been building up an occupational pension to replace this.
So someone earning £25,000 a year would pay NI of £1,760 and their employer would pay £1,679.
Your NI payments to the State were reduced to reflect the fact that you were not contributing to the Additional Pension.
Please note: There is a slight complexity here because if you earned less than £33,000 a year, even though you were contracted-out, you would still be adding a bit of Additional Pension. So you were not getting most of the Additional Pension, but would still get a little more on top from the State.
To summarise:
If you were contracted-out, you would only be contributing to the basic State Pension and not the Additional Pension (unless you were a low earner).
If you were not contracted-out, your contributions would go towards both the basic State Pension and the Additional Pension.
So, I have explained the rates of NI that you would have paid if you earned £25,000 a year, depending on whether or not you were contracted-out of the Additional Pension; but do not forget you could not contract out of the basic State Pension, only the Additional Pension. Of course, the actual NI you paid depended on your own earnings. If you earned £15,000 a year, you would have paid £830 as full rate NI but only £702 if you were contracted-out. On a £15,000 salary, your employer would have paid £950 for you as full rate NI, but only £639 if you were contracted-out.
How much would I get from the basic State Pension?
The amount of basic State Pension you could get was relatively easy to understand. If you had a full 30 year NI record, the full basic State Pension was a flat rate payment (£119.30 a week in 2016/17). That means each year on your NI record gave you £3.97 of basic State Pension for later life, up to the full weekly rate of £119.30.
Full basic State Pension = £119.30 a week
If you had one year less than the full record your pension would be 29/30ths of the full rate; if you had two years less than the full 30 year record you would get 28/30ths of the full rate; and so on.
How much would I get from the Additional Pension?
Unfortunately, the amount you got from the Additional Pension was very complicated to calculate. It depended on your earnings, and whether you were contracted-out of your employer’s scheme. It also depended on the rules of the Additional Pension at the point you were paying your NI – this changed on 6 April 2002 when S2P replaced SERPS. In 2015/16 for instance, people would get a flat rate amount of £1.80 a week pension for earnings between £5,824 and £15,300. They would then get 10% of their earnings between £15,301 and £40,040 – but this would then be divided by 44 (44 is our definition of the years in a working life) and then worked out as a weekly amount. So someone on £25,000 in 2015/16 would have got, when they reached State Pension age, £1.80 a week flat rate Additional Pension plus £0.42 a week earnings related Additional Pension (£25,000 - £15,301 x 10% / 44 / 52).
I have shown you which bits of the State Pension you have been contributing to, depending on whether and when you were paying full NI or contracted-out NI.
I have also tried to explain contracting-out and how you and your employer were paying lower rate NI because you were contracted-out of the Additional Pension – this is summarised below.
Hopefully this helps you to see how your NI contributions in the old system go towards your State Pension.
Contracted-in, an average earner on £25,000 paid NI at 25.8%
You paid full NI at 12% and your employer paid NI at 13.8%
So you and your employers would have paid £4,258 NI
Contracted-out, an average earner on £25,000 paid NI at only 21%
You paid NI at 10.6% (instead of 12%)
Your employer paid NI at 10.4% (instead of 13.8%)
So you and your employers would have paid £3,439 NI
So contracted-out NI = 21% (instead of 25.8%)
This 4.8% lower NI payment was allowed because you were opted out of the Additional Pension. Instead, you would have been building up an occupational pension to replace the Additional Pension.