We look at a real-life example of someone entering the shambles that is the pensions and state benefits system. How can it be that two pensioners in the same situation can end up with different benefits?

A few months ago I wrote about how someone who saves almost nothing for retirement can easily be as well off – or even better off – when they stop working than someone who scrimped and saved all their lives in Saving in a pension? You're as well off on benefits.


How it works in practice
Today I'd like to show you what actually happens based on a real story, because it appears to be even more muddled than this hypothetical situation.

I'm not basing this on John Crawford's story, which appears to be similar. In the comments under my first article, John wrote that after saving for 30 years in a pension he finds himself just £8 per week better off than if he hadn't saved and was on benefits (although he did get a 25% lump sum up front, which can't be overlooked).

Instead, I have been contacted by another man with a lot of similarities to the hypothetical man in my first article. Let's call him Bill.

Bill recently stopped working. He told the Government he has no prospect of working again, and they accepted these words at face value. He's a renter between 62- and 64-years-old with precious few savings, so he's entitled to housing benefit, Council Tax benefit and pension credit. These benefits, which he has been receiving for about a year, add up to a low, five-figure annual income. He says it's on the meagre side, but he's happy.

Here are the important facts:
  • Bill started claiming benefits last spring.
  • A few months later he chose to take his 25% lump sum from a private pension pot of less than £50,000, and decided to start taking a monthly income from the remainder.
  • He could have started getting an income from his private pension earlier, if he had chosen to do so.
  • The Government reduced his benefits as a result of his new private income, although he is a few pounds per week richer overall, since the benefits were not reduced one for one.
That's a lot to take in, so let me point you to the bits that make this a shambles:

Saving in a private pension is costly
Firstly, this shows that in real life, as per the first part of this story, getting a private pension can make very little difference to your weekly income than if you were just on benefits. Despite saving a five-figure pension pot, Bill's just a few pounds per week richer.

He will hopefully live a few more decades, but during that time he can probably expect to receive less than half his savings back, when you include both the 25% lump sum and the lost benefits. He'd have been better off spending most of the money and saving the rest outside a pension.

Those who choose to stick to benefits could be better off
Secondly, Bill has been told that he's entitled to lower benefits from the point he chose to take a private pension income.

That is a serious problem.

What if a second man in a similar situation decides not to start taking an income from his private pension? He could continue to live on benefits while Bill has to use his private savings. This encourages people not to pay for themselves.

This second man also has the advantage of leaving his entire private pension pot till later, giving it more time to grow and giving him a better income later on. Plus, if he were to die before taking it, his heirs would be allowed to inherit it. Bill, who's claiming less taxpayer-funded benefits, can't do this.

Or, what if someone in the same situation decided to take the private pension income even earlier than Bill? This would be even more unfair on them.

Finally, what if Bill had chosen to go for income drawdown, taking the 25% lump sum but setting the income to zero? Would the Government then continue to pay him the full benefits? read What's wrong with income drawdown? for more on income drawdown and how it works.

Inconsistency adds to the pension shambles
The rules are complicated, but it appears that benefits should be reduced from the point that a retiree is able to start getting an income from a private pension. They're not supposed to be reduced at the point the person chooses to take the private pension income, as they have been in this case.

Otherwise, you have this unfair system where some are paying for themselves, while some canny people are choosing to live on benefits and keep their savings pots.

The Government made a mistake, then, but Bill says they did not at any time or in any way ask any questions to establish when he could have started receiving a private pension, if he had chosen to do so earlier. I have received conflicting answers to questions about this from different departments, which hints at widespread confusion.

So it appears that the Government and local Government departments are not following their own rules. With apparently no standard checklists or other checks to ensure fairness, it could well be that they're applying the rules inconsistently to millions of pensioners.

In addition to being deeply unfair, this adds an extra complication to any older person who wants to plan and understand what their situation is.

For example: do you delay claiming your private pension income for a few years, and hope that the civil servant who deals with it later doesn't decide to claim back your benefits right from the beginning? Or do you bite the bullet and start claiming your private pension income now, in the knowledge this makes you worse off than others who, possibly unknowingly, have been let off by an inconsistent system?


A flat-rate pension changes nothing
Some have commented that many of these problems will disappear for people who reach state-retirement age with the new flat-rate State Pension, due to begin in 2017. I fail to see how. People who have scant private savings will still qualify for benefits over-and-above the flat-rate state pension.

The only fair solution, which I think this country is moving towards, is making it compulsory for most people to save a proportion of their income in a private pension.

I'm not slating saving
It would be deeply reckless to use the examples in this article as an excuse to go wild and save nothing for your futures. We have to take responsibility, because there's no guarantee that the Government will when the time comes. (And, if you don't save, you might never have that foreign retirement you dream of!)

But the obvious flaws in the system, and the apparently even worse ones in practice, are another reason to think carefully about how we go about saving.

While a pension can be a good way in some circumstances, we should be considering share ISAs, peer-to-peer lenders and other means as alternatives, or in addition. These other savings options will still leave you with many of the same problems, but you're probably more likely to retain better control of when and how you can spend your long-term savings.



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