Introduction
Another type of defined income in retirement familiar to many is the state pension. There are many people in the UK that are dependent on state pensions at retirement age because they have not had the benefit of employer pensions or made additional payments to a personal pension. Changes to the state basic pension have allowed people the option from 6 April 2005 to defer taking benefits in return for a lump sum at the end of the deferred period.

Since the introduction of the state basic pension the value of this benefit has reduced in real terms and will continue to do so in the future as annual increases are not keeping up with the growth in earnings or even the retail price index (RPI). To supplement the basic pension the government introduced the state earnings related pension scheme (SERPS) as an additional pension, this being replaced by the state second pension (S2P).

With SERPS it was in most individuals interest to opt for contracting out and direct the money to private pensions, although for S2P the opposite is true and people should in general remain contracted in. For pensions on divorce, state pensions can be considered for sharing between the parties and where pension sharing is applied, any protected rights portion of the pension transfer is now called safeguarded rights and ring fenced accordingly.


Basic state pension
Contributions of National Insurance (NI) are compulsory being charged on earnings from employment or profits from self-employment above certain minimum amounts. NI contributions will fund in part the National Health Service and provides protection against sickness and unemployment. Payment of enough contributions towards NI will entitle the member to receive a basic state pension at retirement.

The state basic pension will be paid in full if an individual has been credited with NI contributions for the majority of that individuals working life. However, a reduced state pension or possible no pension would be payable if insufficient NI contributions have been made. To be entitled to the full state pension an individual must have nine out of ten years of their working life as qualifying years. For the basic state pension on divorce, an individual may be able to use the NI contribution record of their former spouse to enhance their own state pension up to the single persons maximum.

In terms of the retirement age, the state retirement pension is paid to people who reach the state pension age of 65 for men and 60 for women and who fulfil the conditions of the National Insurance contributions. The amount you receive is not affected by your income and savings but is taxable.

As a result of article 119 of the Treaty of Rome and the European Court of Justice (ECJ) ruling in Barber v GRE (1990) concerning equalisation rules, Parliament has passed legislation to equalise the state retirement age at 65 for both men and women. Under section 126 of the Pensions Act 1995, this is to be phased in over ten years beginning on the 6 April 2010. No women born before 6 April 1950 will be affected by these changes. Those born after 5 April 1955 will attain pensionable age at 65 and there will be a sliding scale for women born between these dates.

By submitting the BR19 form a members state scheme rights can be determined in terms of the basic pension earned to date and projected basic pension at the retirement age, assuming continued future contributions. Where applicable this will include SERPS showing the amount of SERPS already earned and projection to retirement date. A lump sum valuation of SERPS can be obtained by submitting BR20 form.


Additional pensions
In 1978 the Government introduced SERPS as an earnings-related top-up to the basic state pension. SERPS has been financed by an increase in the National Insurance contributions made by both employees and employers. The benefits from SERPS have been significantly reduced for those employees retiring after the year 2000 as a result of Government legislation.

However, SERPS will be phased out and replaced with the state second pension. S2P started on the 6 April 2002 and it is the Government's intention that S2P will double the amount of those earning up to £9,000 a year would have received from the basic state pension and state earnings related pension scheme. As with SERPS, there will be an opportunity for members to contract out of S2P.


Contracting out
Instead of paying into the state earnings related pension scheme employees can join a contracted out occupational pension scheme or take out an appropriate personal pension (APP) and are called protected rights benefits. A contracted out occupational pension scheme will provide a pension income at retirement related to earnings if operated as a final salary pension, or a pension income related to the member's fund value if operated as a contracted out money purchase scheme (COMPS).

The member and employer will pay lower National Insurance contributions than if they had not contracted out. An APP will provide a pension income at retirement linked to the members fund value, this being the sum of the contributions made and investment return. An employee contracting out by way of an appropriate personal pension will pay NI contributions in full.

Effective from 6 April 2005, Protected rights benefits in payment do not need to increase each year by either 3% or LPI when it is paid.

From 6 April 2006 Pension Simplification alters the way the proceeds from the protected rights portion can be taken. As a result a tax free lump sum of 25% can be taken and the remainder must purchase an annuity to provide an income from the age of 50. The Retirement age limits applying from 6 April 2010 will raise the age protected rights can be taken to age 55. Before making a decision regarding a pension income, learn more about annuities, compare annuity rates, and secure a personalised annuity quote offering guaranteed rates.

Previous to A-Day, protected rights benefits were treated in a different way from the non-protected rights part of the pension fund. Government rules relating to SERPS earned before 6 April 1997 had to provide an annuity income with a fixed rate escalation of 3% per year. For SERPS rebates earned after 6 April 1997 the annuity income had to increase by LPI escalation although if the annuitant did not have a spouse, a survivors pension was not compulsory. There was also no possibility to commute any funds to tax free cash.


Deferring state pension
From 6 April 2005 the government are encouraging individuals who do not need to commence their state pensions at the state pension age of 65, to defer this date for a year or more.

In return for deferring the state pension, the individual would receive a lump sum and the Department for Work and Pensions have determined the lumps sums available given a state pension of £105 per week and a given deferred period is as follows:

Alternatively, the individual could receive a higher weekly income. Someone with a full basic state pension at of £82.05 per week will be able to get an enhanced weekly pension of:

Pension sharing
It is important to remember that the state basic pension cannot be subject to pension sharing and the former spouse will have to apply directly to the Benefits Agency to amend the members state basic pension benefits payable at the state pension age.

As the result of divorce or nullity and the making of a pension sharing order, the government wants to ensure that the safeguarded rights as part of the pension credit are securely protected and applied for their intended purpose of providing an income at retirement. This has been achieved by section 36 of the Welfare Reform and Pensions Act 1999 (WRPA) inserted as a new part III of the Pension Schemes Act 1993 (PSA 93). This is further outlined in subordinate legislation through the Pension Sharing (Safeguarded Rights) Regulations 2000.

The spouses pension rights derived from the pension scheme member of a contracted out occupational pension scheme or appropriate personal pension must be transferred to the former spouse as safeguarded rights and distinguished from the contracted out rights of the scheme member. Safeguarded rights will have been financed by National Insurance contributions and will be subject to the same conditions that apply to post-1997 earnings related contracted out or protected rights.

A scheme will not be required to offer survivors benefits from safeguarded rights and benefits will not be tracked or monitored by the contracted out employments group (COEG). This means that the employer or scheme trustees must keep a record of the former spouses rights as well as details of the original pension sharing order and record the percentage of the share against the members pension.

On divorce an individual will have to rely on a pension sharing order to claim benefits from the state earnings related pension scheme. To determine the value of SERPS the individual can submit the BR 19 form to the Benefits Agency and it will be possible to obtain a statement of retirement benefit, up to 4 months prior to state pension age. The statement will forecast expected basic pension plus SERPS based upon contributions made to date and likely future contributions. By submitting the BR 20 form to the Benefits Agency it will be possible to obtain a lump sum valuation of SERPS.