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14 January 2013 last updated
Retirement annuity income to benefit with simpler flat rate state pension

The government is introducing a simpler flat rate state pension to replace the current basic pension with means tested top-ups although pensioners can benefit with extra retirement annuity income to help improve their standard of living.

The new flat rate state pension of £144 per week will replace the current rate of £107 per week with various means-tested top-ups starting from 2017 or later according to the White Paper.

For half of those retiring before 2050 and in particular the self-employed or mothers benefits will be improved over the current system and the other half will be worse off as they cannot build further benefits from the state second pension.

This means pensioners should contribute to a personal pension to provide a pension annuity income when they retire to suppliment the flat rate state pension without the fear of losing benefits through means testing.

Retirement annuity benefit with flat rate state pension
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No means testing allows for additional annuity income

The current means tested system can increase the basic state pension of £107 per week with pension credit to £142 per week for a single person. By replacing this complicated system with a flat rate of £144 per week it gives pensioners the opportunity to save to a pension plan for additional income by purchasing retirement annuities without deductions for means testing.

Currently if you receive a retirement annuity income this is taken into account for the calculation of pension credit so any additional income under the flat rate system can add directly to the state pension. For pensioners with savings at retirement making a contribution to a pension and purchasing an annuity immediate would result in tax relief at source, a tax free lump sum and income.

For example, a male aged 65 with taxable earning of £25,000 and cash of £20,000 could invest in a pension and receive 20% tax relief at source making a contribution of £25,000. If he used the whole fund to purchase an income at current annuity rates it would be £1,378 pa gross on a single life level basis or £26.50 per week. Compared to the initial investment this would provide a return of 6.89% pa which is greater than the interest from a savings account of 3.0% pa.

State pension still represents good value for money

The state pension at £144 per week or £7,488 per annum will continue to increase each year by the higher of 2.5% or with earning. To match this level of income by purchasing an annuity with a private pension plan a pensioner aged 65 would need a fund of approximately £180,000.

Some of the rules of the state pension are going to change such as the number of years of National Insurance contributions (NIC) will increase from 30 to 35 years. For those that have been loking after children aged 12 or under, claiming unemployment benefit or caring for disabled or sick adults during the 35 years will be entitled to £144 pw and more women will now get the state pension.

For couples the current system where a womam with a poor history of NIC can be linked to her husbands and receive 60% of his state pension may be also be abolished. This would mean a husband receiving £107 pw could have this increased to £172 pw and after the flate rate state pension is introduced this will be limited to £144 pw. For widows she would be entitled to her husbands state pension and half of any state second pension and SERPs if her existing level of NIC would entitle her to a smaller income.

The changes should encourge people to save more for their future as they will not be penalised as with means testing. All extra income generated from retirement annuities would add to the income to pensioners improving their standard of living.

Related internet links:
BBC - Simpler flat-rate state pension unveiled
BBC - State pension the overhaul and you
Telegraph - Flat-rate pension to cost couples £1,500 a year
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