Is it time to check your state second pension payment?

This blog is about a rather complex area of the state pension system, so it may be of particular interest to financial advisers and others who work with the public and have a working knowledge of pensions. We hope you will use your expertise to identify any of your clients who might fall within the group we identify below.

The money pages of the national press have been full in recent years of stories about errors in people’s state pension entitlements.

So far, most of the focus has been on errors in the basic state pension or in failure to pay inherited amounts to widows and widowers. In all, more than 200,000 people have been found to have been underpaid and are collectively owed around £2 billion in arrears payments.

This, in turn, prompts a further question: If all these errors went undetected, could there be more errors lurking out there?

State Second Pension (S2P)

One area where further checks could be needed relates to the State Second Pension (S2P). This was the version of the additional state pension introduced in 2002-03 as a modified version of the SERPS (state earnings related pension scheme) system which had run since 1978-79.

There is one particular aspect of S2P where errors could go unnoticed.

This relates to something called S2P top ups, particularly as far as they relate to people who were in contracted out workplace pension schemes (such as many millions of public sector workers).

In simple terms, between 1978-79 (when SERPS was created) and 2001-02, anyone who was a member of a contracted-out salary-related pension scheme built up rights in that scheme instead of rights under SERPS, at least as far as their pension at retirement was concerned.

However, from 2002-03 onwards, when S2P was introduced, things changed. The two steps to work out your S2P from 2002-03 onwards were as follows:

1. Work out your entitlement under the State Second Pension rules for the year.
2. Deduct the SERPS you could have built up if you had not been contracted out.

The importance of this change is that the State Second Pension was worked out slightly differently from your SERPS figure. Specifically, it was tilted so that those with low and modest earnings would get more than those under SERPS.

The result of this more generous accrual of S2P for lower and middle earners is that when their SERPS figure was knocked off, they were left with a positive entitlement – known in the trade as an S2P top-up. As DWP themselves put it:

“In April 2002, low to moderate earners began to accrue S2P whilst still members of their contracted out scheme.”

Because of this, there are millions of people who were in employment at some point post 2002-03 who have built up an S2P entitlement, perhaps without realising it or expecting it. And if they were due some money but it didn’t appear in their pension, they may well not have thought to query it.

For this reason, we are suggesting that those who are now drawing a pension and have reached pension age before 6th April 2016 might want to look at their pension breakdown and check that they have S2P entitlement.¹

In order to check, there are two separate periods to consider:

a) The period of 2002-03 to 2011-12 – (low and modest earners)

For this period, the specific group of people we are talking about are those whose earnings were between the lower earnings limit and the upper threshold. The table below gives these figures for each year between 2002-03 and 2011-12.

In simple terms, anyone with annual earnings in the bands shown above in any year between 2002-03 and 2011-12 would have accrued more under the S2P rules than under the SERPS rules.

They would therefore have been potentially entitled to an S2P top-up for such a year even if they were in a contracted out pension scheme.²

b) The period of 2012-13 to 2015-16

Over this period, the rules changed again, making the calculation of S2P top-ups even more complex. However, as a general principle, lower earners - such as those earning below around £30,000 - who reached pension age before April 2016 could still accrue an S2P top-up during this period.

The reason that all of this is important is that many people may have assumed that if they were contracted out they would build up no additional state pension. They may therefore not have been surprised (or thought to question) if their post-2002 additional pension (which is how S2P is shown on state pension breakdowns), was NIL.

So, the key question is, did the system work properly?

On the face of it, there is no particular reason to think that it didn’t, but the lesson of the last few years is that state pension systems that ought to have worked correctly did not always do so in practice.

How can you check your State Second Pension entitlement  

The good news is that it is relatively easy for people to check for themselves if they:

• Were a low or moderate earner (i.e. earned within the range shown in the tables above) for one or more years from 2002-03 to 2015-16;
• Reached state pension age before 6th April 2016;
• Have a state pension breakdown showing NIL for the post-2002 additional pension.

There is a potential problem, and this is true even if you were one of the millions of people who, at the time, were in a contracted-out workplace pension scheme.

I would encourage people in this age group – typically women now aged over 71 and men now aged over 73 to check their state pension breakdowns for post-2002 additional pension.

If it is NIL, despite the fact that you were on a low or modest wage at some point between 2002-03 and 2015-16, we would be keen to hear from you.³

Footnotes

1. This issue could also carry forward into the new state pension because in some cases the 2016 Starting Amount reflects rights built up under the old rules.  However, for simplicity, at this stage we are focusing on those who reached pension age under the old system.
2. The main exception to this would be someone who became a higher earner (above the upper threshold) in either 2010-11 or 2011-12 which could generate a negative S2P figure which could negate some or all of the pre 2010 accrual.
3. There are also other groups who should have a non-zero S2P, even if they were not in work. This includes people getting Child Benefit for raising young children post-2002 and many carers.