‘How are increases in pensions worked out?’
How are state pension and lifetime allowance annual increases decided?
Both the state pension and the lifetime allowance – the total amount you can save tax-free in a pension – have been subject to significant change in recent years.
The state pension was reformed in 2016, with the previous means-tested system replaced by a flat-rate payment for any UK resident with a complete 35 years’ National Insurance (NI) record.
A deduction is made for every year below this, with a minimum 10-year NI record required to qualify for the benefit.
Those who had already retired by 2016 will continue to receive payments under the old system, while people who build up rights under a combination of the old and new system will receive the higher of their two entitlements.
If you ‘contracted-out’ under the old system – which just means you paid lower NI in exchange for a lower state pension entitlement - a deduction will be made to your flat-rate payment.
Those are just the basics, so if you want to check your own state pension try this government tool.
Whether you built up entitlements under the old or the new state pension system you’ll benefit from the ‘triple-lock’, which guarantees the payment rises by the highest of growth in average earnings, prices or 2.5%.
The government uses the average earnings figure for the three months to July and the Consumer Prices Index (CPI) inflation figure for September to determine which part of the triple-lock kicks in the following tax year.
For the 2020/21 tax year, pensioners will enjoy a bumper 3.9% increase in their state pensions, in line with the growth in average earnings.
As a result, the ‘old’ basic state pension will rise by £5.05 a week to £134.25, while the ‘new’ state pension will increase by £6.60 a week to £175.20.
Note that it is only these two elements that are protected by the triple-lock. If you built up any earnings-related pension (SERPS or state second pension) under the old system this will rise in line with CPI. This is also true of any amount you receive above the ful flat-rate amount of £175.20, referred to in the jargon as a ‘protected payment’.
THE LIFETIME ALLOWANCE
The lifetime allowance has been cut several times since 2010, being reduced from £1.8m to £1m in 2016. Each time the allowance was reduced people were allowed to apply for ‘protection’, meaning they could retain the previous higher allowance subject to certain conditions.
Since 2016 the lifetime allowance has increased in line with CPI inflation, protecting savers against rising prices.
So in 2020/21 the lifetime allowance is expected to rise by £18,000 to £1,073,000, meaning an extra £4,500 of tax-free cash (a quarter of £18,000) will also be available.