Goodbye, state second pension

October 7th 2009

What the government is trying to achieve here is a State Second Pension that is the same no matter how much you earn. Eventually everyone who earns above a certain amount (£4,940 in this year) will build up the same State Second Pension for each year that they work, irrespective of whether they earn £5,000 or £50,000. The amount that everyone builds up will be around £80 a year, so after working for 10 years you will have built up a State Second Pension of £800 that you are entitled to draw each year in retirement (this is all in today's terms).

That £80 doesn't represent much of a change for those who earn about £19,000 or less because that's approximately what they get at the moment. But anyone earning above this level gets more from the current system, for instance someone earning above £40,000 currently builds up around £140 of State Second Pension for each year that they work. If you roll this over a working life of 40 years, that is the difference between a State Second Pension of £5,600 a year on the current system and a State Second Pension of £3,200 a year on the new system, quite a sizeable difference.

Some people opt out of the state second pension (called 'contracting out') and so might be less affected by these changes. From 2012 onwards the government plan to abolish contracting out for all pensions apart from final salary schemes, so it will only be the few people left in these increasingly rare schemes who will be in this situation.

The shift towards a universal level of £80 is taking place gradually over the next 20 years. However there is a pretty sharp fall that takes place from April 2010 which will mean anyone earning more than £31,800 builds up less State Second Pension next year. Once the universal level is in place it would make sense for the government to close the book on the State Second Pension, and simply roll it into the Basic State Pension. From the point of view of simplicity, that would be a positive thing.

Having said that, as a result of the changes many people will find themselves with a smaller state pension. These people will be medium and high earners and therefore less likely to be facing financial hardship in retirement. From the government's perspective therefore they are simply re-allocating valuable pension resources to those who need it most. From the individual's point of view however, that doesn't really help with the missing chunk of your state pension: there is still a big gulf between avoiding financial hardship and being comfortable in retirement.

Increasingly people are becoming more responsible for their own retirement, and can rely less on the state and employers to provide their income in retirement. That is one of the reasons that SIPPs (Self Invested Personal Pensions) have become so popular.