If there is one thing you are almost guaranteed in a sitting of R04 or J05, it is one or more State Pension questions. But how many of us really understand the full historic workings of the scheme? Here the Brand Financial Training team delve into what is a more complex pension that we might first expect.
The State Pension has been around in one form or another since the Old Age Pensions Act of 1909, albeit only paid at that point to those over the age of 70 at a rate of five shillings a week. Which evidently meant that it was a far lesser cost than today, since comparatively few people lived to that age. It was also means tested.
The universal Basic State Pension was introduced in 1948 and funded by National Insurance Contributions (NICs) from working people. It was paid at 65 for men and 60 for women. At this point, you might be forgiven for thinking that the whole thing was relatively straightforward.
The complications started with the introduction of the Graduated Pension Scheme in 1961. This was an additional entitlement over and above the Basic State Pension, which was based on earnings. The Graduated Pension Scheme ran until 1975 and three years later in 1978, it was replaced by the State Earnings Related Pension Scheme (known informally as ‘SERPS’) and later in 2002 by the State Second Pension. The State Second Pension ran until 2016 when the system was revamped under the Conservative government.
To complicate matters further, it was possible for individuals to ‘contract out’ of the Additional State Pension schemes. This option was originally offered to those who were members of a defined benefit occupational scheme and, from 1988 to 2012, was also made available via an appropriate defined contribution scheme.
Contracting out via a defined benefit scheme meant that the member would pay a lower rate of NICs. Those contracted out via an appropriate defined contribution scheme would receive a rebate of part of their contributions to be paid into an appropriate personal pension (known as ‘protected rights). All of which meant that members reaching their state pension age before April 2016 could have a bewildering range of entitlement tranches. Contracting out via a personal pension was abolished with effect from 6 April 2012, at which point contracted-out members were contracted back in and protected rights became simply normal rights.
As of 6 April 2016, significant changes were made to the State Pension. The entire concept of an additional state pension was abolished and members reaching state pension age after 5 April 2016 were simply entitled to the New State Pension. This required 35 qualifying years of NICs in order to benefit from the full New State Pension, which commenced at a rate of £155.65 per week and currently stands at £230.25 as of April 2025. A minimum of 10 qualifying years are required to obtain any entitlement. All of which can make class 3 NICs (see below for more details) appear a very attractive investment.
Those who had already reached State Pension age prior to 6 April 2016 retained their entitlement under the old system. They continued to receive their Basic State Pension and Additional State Pension entitlements.
But what of those who had already built up an entitlement to a higher rate of State Pension than the maximum offered under the new system, you might ask? Does the transition to the new system not unfairly disadvantage them? In order to ensure that this was not the case then the concept of a ‘protected payment’ was introduced. This allowed members who, at the time of the changes, had built up an entitlement higher than the maximum permitted under the new system to continue to benefit from that entitlement.
The excess over the New State Pension entitlement was the protected payment. It should be noted that protected payments only increase in payment in line with inflation as measured by the Consumer Prices Index. This is distinct from the New State Pension and Basic State Pension, which are subject to the Triple Lock guarantee introduced in 2011 by the Conservative/Liberal Democrat coalition government.
State Pension Age is currently 66 for both men and women, albeit due to rise to 67 between 2026 and 2028. It is also subsequently intended to rise to 68, although the precise timescale for this move is the subject of ongoing review and debate.
The pension must be claimed and should the pensioner opt to defer claiming it, then the amount paid will increase by 1% for every 9 weeks of deferral, an effective rate of just under 5.8% per annum. This is markedly less generous than the 1% for every five weeks (effectively 10.4% per annum) that was on offer to those who deferred their State Pension prior to 2016. It should also be noted that the option to take a lump sum payment in exchange for the deferral is no longer available as it was prior to the changes. In addition, following the changes, where a pensioner dies during the deferral period then there is no longer the facility for their spouse to inherit the deferred entitlement, although up to three months’ worth of arrears may be claimed by the estate.
The payment of the State Pension is funded by NICs. Following recent cuts, these are payable by employees (class 1 contributions) at 8% on earnings between £12,570 (the Primary Threshold) and £50,270 (the Upper Earnings Limit), with 2% rates applying to earnings above that band. Employer rates are 15% for earnings above the Secondary Threshold (£5,000 in 2025/26) without upper limit. The self-employed pay 6% on profits between £12,570 and £50,270, with profits above £50,270 subject to the same 2% rate as employee contributions.
However, any employee earning above the Lower Earnings Limit (£6,500 in 2025/26) but below the Primary Threshold, or any self-employed trader with profits above the Small Profits Limit (£6,845 in 2025/26) but below the Primary Threshold, will be credited with National Insurance contributions. They will therefore accrue a qualifying year for State Pension purposes despite not actually paying any contributions.
Whilst class 2 NICs are no longer compulsory for the self-employed, they can be paid on a voluntary basis by those with earnings under the Small Profits Threshold to achieve a qualifying year.
Class 3 NICs can be paid by anyone with a shortfall in qualifying years to build their entitlement up to the maximum permitted by law. Typically, these need to be paid, at latest, within six years of the end of the tax year to which the shortfall relates. However, as a concession following the increase from 30 years to 35 to achieve a full New State Pension, the facility was temporarily introduced to make payments covering years as far back as 2006. This scheme finally closed on 5 April 2025, a date which was previously deferred on multiple occasions due to processing backlogs.
Finally, with the freezing of the personal allowance until April 2028, many people with Additional State Pension entitlements (and quite shortly those with full New State Pension Entitlements) will exceed that threshold. However, whilst the State Pension is a taxable source of income, it is not actually taxed at source. Instead, recipients can opt to have the tax collected via adjustment to their tax code from any other pension scheme they are taking income from or any employment earnings if they are still working. If neither of those apply then the member can pay the tax via self assessment tax return, although this can be an onerous process for what may be a relatively small amount of tax due.
This presents a brief overview of what is a complex system developed over the course of more than a century. However, a full understanding is essential – those few marks might just get R04 or J05 students over the line!
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