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The little-understood reason you might not get the full state pension

State pension
State pension

For anyone who doesn’t follow pensions closely, the one thing that “everyone knows” about the new state pension is that you need 35 years of National Insurance contributions to get a full pension.

Except that this is not the case.

There are people with more than 35 years who don’t get a full pension.

And there are people with less than 35 years who do get a full pension.

In this article I will try to do two things. First, I will explain how the new state pension is actually worked out.  And second, I will explain why the rules are as they are.

As pensions minister between 2010 and 2015, a large part of my job was designing and implementing the “new”, post-2016 state pension, so this is something I have spent rather a long time on.

Firstly, there are two stages in working out someone’s new state pension entitlement.

Step 1: The ‘foundation amount’

The first is to work out what is referred to in legislation as your “foundation amount” at the point the new system was introduced on 6 April 2016.

In simple terms, this is the greater of the amount you had built up by that point under the old rules, and how much you would have got under the new rules.

The idea of this part of the calculation is to provide protection for people who might otherwise have seen a cut in their pension if the new rules were imposed overnight.

To be more precise, the foundation amount is the greater of:

The “old rules” calculation

A full basic pension (currently £156.20 a week) for 30 years or more of contributions, plus any additional earnings-related pension (also known as SERPS or State Second Pension) which you had built up by this point. Or,

The “new rules” calculation

A full flat rate pension (currently £203.85 a week) for 35 years, minus a substantial deduction for past periods when you were “contracted out” into a workplace pension;  I explain more about contracting out later on;

For those whose foundation amount is in excess of the full flat rate, their pension is locked at this figure (but will still benefit from inflation increases) – further contributions from the 2016-17 tax year onwards have no effect on their pension.

Step 2: Years from 2016-2017 onwards

For each full financial year from 2016-17 onwards, an extra 1/35th of the full flat rate is added to your foundation amount until you reach the full flat rate. Once these extra years bring you up to the full flat rate, no further addition to your state pension is possible.

Based on a full flat rate of £203.85 per week, each extra year from 2016-17 onwards adds 1/35th of this amount, £5.82 per week, to your state pension.

One consequence of this structure is that even those with a big deduction for contracting out can – eventually – build back up to a full state pension on top of their company pension, provided they have enough years of post 2016 contributions.

Why did the Government design the system like this?

At first glance, the two-stage process I have described for working out the new state pension looks unnecessarily complicated.

Why not just pay everyone a full pension for 35 years and a pro-rata amount if they have 34 years, 33 years, and so on?

The answer to this question comes back to the vexed issue of contracting out.

Contracting out

Contracting out” was a deal between a worker, an employer and the Government.

When the Government created the state earnings-related pension scheme (SERPS) in 1978, this gave every worker the opportunity to build up a second, earnings-related pension on top of their basic pension.

But millions of workers (including millions in the public sector) already had a second pension through their employer – and they didn’t need another one via the state pension.

To avoid this duplication, employer pension schemes were allowed to “contract out” of this second tier of the state pension.

The deal was that the employer and the worker paid a reduced rate of National Insurance.

In return, the workplace pension had to provide something at least as good as the SERPS scheme would have delivered. In recognition of these lower contributions, a deduction was made at retirement from the state pension, but this was generally more than matched by the company pension which took its place.

When the Government decided to introduce a new “single tier” state pension in 2016, there was a dilemma about how to treat people who had spent many years paying in at a lower rate.

There were two extreme options:

  • To completely ignore past contracting out and pay a full pension to anyone with 35 years in the system, at whatever rate. But this would have been grossly unfair to people who had always paid full rate contributions.

  • To permanently take account of past contracting out, always making a deduction from the state pension of anyone who had ever contracted out.

The problem with this is that for many decades after the new “simple” state pension came in, millions of people would still be short of the new flat rate because of one or more year of contracted out employment – it would have been bizarre to talk about a “flat rate” pension system when even in 2050 and beyond people were having deductions for periods of reduced contributions up to half a century earlier.

To try to strike a balance between fairness to people who did not contract out but also to try to get to the new simpler system as quickly as possible, a compromise was struck.

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Past contracting out would be recognised in the system via a one-off deduction in 2016 as part of the foundation amount calculation. But this deduction could then be “burned off” by further contributions post 2016.

The result of all of this is that the majority of people retiring today do get precisely the standard flat rate amount. And, with every passing year, the proportion who get the standard rate will grow.

It would have been great to design a new state pension system from scratch, with a blank sheet of paper and no history. But sadly, pension reform is never like that.

I believe that the new structure strikes the right balance between honouring past contributions and moving to a new simpler system as soon as possible.

Over time more and more people will know with clarity exactly what they will get from the system, men and women will be treated equally for the first time, and the state pension will provide a firm foundation for additional private pension saving.


The Telegraph’s Pensions Doctor column runs every Monday. Email your questions to Becky O’Connor: pensionsdoctor@telegraph.co.uk