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.
- 1. No savings
Figures from charity Age UK show that 29% of those over 60 feel uncertain or negative about their current financial situation - with millions facing poverty and hardship. Even though saving for retirement is not much fun, the message is therefore that having to rely on dwindling state benefits in retirement is even less so. To avoid ending up in this situation, adviser Hargreaves Lansdown recommends saving a proportion of your salary equal to half your age at the time of starting a pension. In other words, if you are 30 when you start a pension, you should put in 15% throughout your working life. If you start at 24, saving 12% of your salary a year should produce a similar return.</p>
- 2. Unsecured debts
Around 427,000 households in the over-70 age groups are either three months behind with a debt repayment or subject to some form of debt action such as insolvency, according to the Consumer Credit Counselling Service (CCCS). Its figures also show that those aged 60 or older who came to the CCCS for help last year owed an average of £22,330. Whether you are retired or not, the best way to tackle debt problems is head on. Free counselling services from the likes of CCCS and Citizens Advice can help with budgeting and dealing with creditors. Importantly, they can also conduct a welfare benefits check to make sure you are receiving the pension credit, housing and council tax benefits, attendance and disability living allowances you are entitled to.</p>
- 3. Mortgage debts
Recent research from <a href="http://globalcare.aviva.co.uk/">Aviva</a> found that 17% of over-55s are still paying off a mortgage, with an average of £63,555 left to clear. And figures from equity release lender More 2 Life suggest that more than 100,000 over-65s are still struggling to pay off their mortgages. The pre-recession popularity of interest-only mortgages and the poor performance of linked investment vehicles, as well as the average age of a first-time buyer rising to 35, are among the reasons why. But meeting monthly mortgage repayments during retirement can have a big impact on day-to-day living costs such as food and household bills. Ways to avoid being caught out include taking out a mortgage over a shorter term that leaves you well clear by retirement age and overpaying on your mortgage when you can. If it is too late for that, downsizing could be an option, while equity release plans could also be worth a look.</p>
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- 4. Huge care costs
The cost of a room in a care home in many parts of the country is now over £30,000 a year, according to figures from Prestige Nursing and Care. So even if the prime minister announces a cap on care costs - last year the economist Andrew Dilnot called for a new system of funding which would mean that no one would pay more than £35,000 for lifetime care - families will still face huge accommodation costs. Ways to cut this cost include opting for home care rather than a care home. Jonathan Bruce, managing director of Prestige Nursing and Care, said: "For older people who may need care in the shorter term, home care is an option which allows people to maintain their independence for longer while living in their own home and should be included in the cap." However, the only other answer is to save more while you can.</p>
- 5. Fraud
Older Britons are often targeted by unscrupulous criminals - especially if they have a bit of money put away. For example, many over 50s were victims of the so-called courier scam that tricked into keying their pin numbers into their phones and handing their cards to "couriers" who visited their homes. It parted consumers from £1.5 million in under two years. Detective Chief Inspector Paul Barnard, head of the bank sponsored dedicated cheque and plastic crime unit (DCPCU), said: "Many of us feel confident that we can spot fraudsters, but this type of crime can be sophisticated and could happen to anyone." The same is true of boiler room scams that target wealthier Britons with money to invest, offering "once-in-a-lifetime" opportunities to snap up shares at bargain prices. Tactics to watch out for include cold calling, putting you under pressure to pay up or lose the opportunity for good, and claiming to have insider information that they are prepared to share with you.</p>
- 6. Unpaid taxes
The average UK pensioner household faces a £111,400 tax bill in retirement as increasing longevity means pensioners are living on average up to 19 years past the age of 65, according to figures from MetLife. And every year in retirement adds an extra £5864 in direct and indirect taxes based on current tax rates to the costs for the average pensioner household. You can be forced to go bankrupt if you fail to pay your taxes, so it is vital to factor these costs into your retirement planning.It is also important to check that you are receiving all the benefits and tax breaks you are entitled to if you want to make the most of your retirement cash.</p>
- 7. Rule changes
Even the best laid plans can be derailed should the government change pension rules - especially for those already in retirement. Take income drawdown. About 400,000 individuals have set up their pensions on this basis that allows them to keep their fund intact while drawing an income, rather than buying a poor value annuity. The income they can take is therefore linked to the 'GAD rate' – set by the Government Actuary's Department and determined by the prevailing yield from a 15-year Government bond (gilt). But despite 15-year gilt yields falling sharply, the government last year slashed the maximum income that could be drawn down from 120% to 100% of the GAD rate due to fears that savers were depleting their pension pots too quickly. Many pensioners have seen their incomes plunge by more than 50% as a result - and there is very little they can do about it.</p>