Why your state pension could fall short

Governments never stop tinkering with pensions, but the changes coming up in April 2016 are significant by any standards. Those who reach state pension age after this date will receive a new "flat-rate" pension in the place of the existing two-tier system. This will pay roughly £2,000 per year more than it does at present, meaning the weekly state pension will rise from £115.95 to roughly £155.

You will need at least ten "qualifying years" of National Insurance contributions to receive any of this sum, and 35 years to get the full amount. At first glance, that sounds great. Not only will it mean more money, but it will simplify a system that has become mind-blowingly complicated. But many retirees could be in for a nasty surprise, as they will receive much less than the headline figures suggest. The reason for this lies in a now-defunct scheme, known as the state earnings-related pension scheme (Serps).

What is Serps?

Under Serps, there were two classes of employees. Those who were "contracted in" accrued an additional pension linked to each person's contributions and level of earnings. Those who were "contracted out" by virtue of paying into some company, public sector, or personal pension schemes saw the National Insurance contributions that funded Serpsand S2P paid into their pension scheme instead, helping fund an additional pension from these.

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Within many pension schemes, part of their benefits was known as a guaranteed minimum pension (GMP). This was calculated to be broadly in line with the amount they would have received from Serps and was subject to some special rules (for example, it had to increase at a minimum rate in retirement).

Most retirees who have spent time in work will have been both contracted in and contracted out at some stage in their careers. Around 3.7 million people were still contracted out, when the option to contract out was abolished in 2012. So you might expect people in this position to have their entitlement to the new state pension adjusted to reflect the fact that they've paid lower National Insurance contributions for part of their life. For example, if somebody worked for 35 years, but was contracted out for ten years, you'd expect them only to get full credit for 25 years. And that is what's happened but the adjustment is more far complicated than this suggests.

The GMP penalty

For example, their company pension scheme may be underfunded and not paying full benefits, or their personal pension may have performed poorly and be giving them less for their contributions than the state pension would have done.

Nobody should get less from the new pension system than they have already built up (although some may not keep accruing as much in future as they would have done under the old rules). But it's clear that many won't get the full £155 per week and not all of them will see the difference made up from other pensions. So it's important to make sure you have an accurate idea of where you stand. For more details, see below.

How will your state pension be calculated?

For the new rules, it's your number of qualifying years (up to 35) multiplied by 1/35; minus i) any GMP accrued up to 1996/97; minus ii) the value of any notional Serps and S2P that you lost by being contracted out between 1997/98 and 2015/16.

You can see this gets very complicated. So the best way to find out where you stand is to ask for a forecast of your state pension and what the deduction for your contracted-out years will be. You can do this at Gov.uk/state-pension-statement.