Why does my friend get a bigger state pension when I earned more?

This is Steve Webb’s 200th pension column for This is Money. Look out for special coverage this week about Steve’s time as our agony uncle, and all he has done to help readers.

I started to take my state pension in August 2018 at the age of 65 years. I am getting £666.52 per 28 days or £166.63 per week.

I was contracted out of the ‘state earnings-related pension scheme’ (or Serps) for the first 16 years of my working life and have worked for a total of 47 years, plus three years when I was unemployed but claiming National Insurance credits from the DHSS.

A friend is due his UK state pension in September 2020. He says his pension forecast is £1,025 per 28 days or £256.25 per week.

I believe he has had similar working years as myself but I believe I will have paid more National Insurance as I will have earned more.

Why is there such a big difference between our payments please?

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Steve Webb replies: The new state pension system is based around a flat rate figure, currently £175.20 per week.

With every passing year, more and more of the people who come up to retirement will get precisely that figure.

But during the transition to the new system, there is still considerable variation.

People can get more than the flat rate (in your friend’s case, a lot more) if they had substantial rights under the old system which are protected under the new one.

And people (such as you) can get less than the flat rate if they contributed at a reduced rate of National Insurance for a period because they were in a ‘contracted out’ pension scheme.

Let me start with how your friend can be getting a pension way in excess of the standard ‘flat rate’ amount.

Under the old system, which applied until 6 April 2016, the state pension had two components.

The first was a ‘basic’ state pension, payable in full for those with 30 years of more of National Insurance contributions or credits. The current rate of that full basic pension is £134.25 per week.

Second, there was an ‘additional pension’, commonly known as Serps (the state earnings-related pension scheme) or more recently S2P (the state second pension).

The key word here is ‘earnings-related’. Whereas anyone with 30 years in the system could get a full basic state pension regardless of earnings, the Serps pension was (up to a limit) proportional to how long you worked and how much you earned.

And whereas anything beyond 30 years added nothing to your basic state pension, every additional year could add to your SERPS pension.

Someone who wasn’t a member of a company pension scheme or similar, built up Serps rights for every year they contributed.

Someone such as your friend, who reaches pension age this year could have 38 years in Serps, from 1978/79 when the scheme was introduced to 2015/16 after which it was abolished.

The way in which contributions into Serps turned into state pension were complex and changed over time, but the bottom line is that someone with a full work history and a good Serps pension could build up a generous total state pension.

For example, in February this year there were nearly 400,000 people with weekly state pensions of more than £250 per week, of whom nearly 70,000 were on more than £300 per week.

All of these people are getting a substantial Serps pension.

Although for those retiring now the standard flat rate is £175.20, those who had already built up more than this amount by April 2016 could get a pension under the old rules instead.

This is how your friend comes to get a pension of over £250 per week.

In terms of your pension, you mention that you had 16 years as a member of a ‘contracted out’ pension scheme.

This means, in essence, that during those years you were building up no additional state pension.

You benefited by paying a reduced rate of NI contributions during those years, as did your employer.

When you retire, the Serps pension you would have got for those years is in effect delivered via your company pension.

So a fairer comparison between you and your friend would be to add your state pension to the part of the company pension which was designed to replace your state pension – sometimes shown on your statement as a ‘contracted out pension equivalent’ or COPE.

You may find that your state pension plus your COPE is much closer to the amount that your friend is getting.