National Insurance contributions do not pay for your state pension. They are simply contributions to government coffers to be spent as the government sees fit. Under current rules, those contributions do entitle you to a state pension (eventually). Those rules can, however, be changed as can anything related to a state pension. Here we look at retirement options for future plans.
The basics of state pensions
Fundamentally, the rules around retirement and state pensions are the same as they were when the state pension was introduced. You pay National Insurance contributions. Those National Insurance contributions entitle you to a state pension. The more contributions you make, the higher your entitlement becomes up to a maximum limit.
In reality, there have been a lot of meaningful changes to the state pension. Most notably, the age at which you can claim it has been increased. It’s also a safe bet that there will be more changes in the same vein.
The simple truth of the matter is that state pensions are a huge expense for the government. Abolishing them outright would be highly controversial (albeit not impossible). Quietly dismantling them, by contrast, would potentially save the government a lot of money with less pushback.
In fact, the signs are that the state pension is already starting to be phased out. The government implemented auto-enrollment to encourage retirement savings through workplace pensions. It’s raised the qualifying age and broken the triple lock. In short, it’s made it very clear that relying on the state pension is a very risky move.
If you’re in qualifying employment, then you’ll automatically be enrolled in a pension scheme unless you actively opt-out. The advantage of this approach is that it’s a convenient and tax-efficient form of saving. The disadvantage of this approach is that it has zero flexibility.
The government mandates the minimum contributions made by the employer and the employee. You can contribute more but not less. If you cannot afford the full contribution then you need to drop out of the scheme completely. You can always rejoin it later but your employer may have limits on how often you can change your enrolment status.
If you are not able to pay the full contribution, you can try asking your employer to pay their contribution into a private pension instead. They are not obliged to do this but you lose nothing by asking. Private pensions can also be used by people not in employment, for example, the self-employed and home-makers.
The advantage of private pensions is that they are more flexible than workplace pensions while still being tax efficient. The disadvantage of private pensions is that, barring extraordinary circumstances (like terminal illness), the money you put into them is locked away until you reach retirement age as set by the government.
The Lifetime ISA
The Lifetime ISA can be used either to save for your first home or to fund your retirement (or both). You can open one if you are between the ages of 18 to 39 (inclusive) and contribute up to £4KPA to it until you reach the age of 50.
The government will top up your savings to a maximum of £1KPA. This means that you could get a total pot of £155K of which £31K would come from the government. You would also benefit from interest. It’s impossible to predict how much that would be but it would presumably be something.
While the 25% bonus may look attractive, it might not be as generous as it first appears. If you use income from employment to contribute to a pension, it is discounted for tax purposes. Contributions to a Lifetime ISA, by contrast, are made out of post-tax income.
This means that the 25% rebate may be more tax-efficient in your lower earning years. As you move up the tax brackets, however, it soon becomes less tax-efficient than just making regular pensions contributions.
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