The terrible news for your pension

The budget wasn't particularly kind to pensioners or those saving for retirement. Find out how spending cuts will affect you.

The tax rises and spending cuts announced in the Budget were never going to be particularly easy for anyone to swallow. But it looks like pensioners and those of you who are saving for retirement are definitely going to feel the pinch with this huge shake up of the UK pension system. Here’s how the new measures will affect you:

State pension

Changes to the way the basic state pension will be uprated were reiterated in the Budget. At present, that state pension increases by the higher of prices as measured by the retail prices index (RPI) or 2.5%. From April 2011 a ‘triple guarantee’ will apply where the state pension will rise by the higher of earnings, prices - this time measured by the consumer prices index (CPI) - or 2.5%.

On the face of it, given that the CPI is usually lower than the RPI, it looks like this change could have a negative impact on the value of the state pension in the future. Think about it this way: If May’s inflation figures had been used to uprate the state pension, the rise would have been 5.1% using the RPI, but only 3.4% using the CPI - no contest there.

On the other hand, bringing the rise in earnings into the equation is seen a positive move since earnings normally rise faster than prices. But there are no guarantees of this in a tough economic climate.

The one piece of definite good news here is that the state pension will increase by at least the RPI one last time in April 2011. This will ensure it is as generous as it would have been under the previous rules.

Related how-to guide

Get ready to retire

There are a lot of things to think about as you get closer to your retirement. But the early you start to prepare, the better.

See the guide

State pension age

The government will review when the rise in the state pension age to 66 will be put in place. (This will be reviewed soon to reflect the urgency of firming up the rules in this area.)

State retirement age was always going to increase, but this will happen much more quickly under the coalition. In fact, it could occur as soon as 2016 - eight years earlier than it would have done under Labour plans.

On one hand, with increasing longevity, delaying state pension age is inevitable to prevent the spiraling cost of providing a state pension. But, on the other hand, many workers will have no choice but to continue working for longer before hanging up their boots.  

Pension credit

Pension credit is a means-tested benefit which ensures everyone receives a minimum level of income on top of the basic state pension. From April 2011, it will increase by the cash rise in the state pension, rather than the RPI. Quite simply, this will render pension credit less generous over time.

On the plus side, all the other pensioner benefits have been left unchanged including the winter fuel allowance, free bus travel, eye tests, prescriptions and TV licenses for those over 75.

Recent question on this topic

• raydibble asks:

  how much do i need to live

  • 
    SoftwareBear answered "what do you want to do..."
  • 
    manzanilla answered "how old are you? what is your health like? do you own a house, mortgage frre? mortgage remaining?..."
  • Read more answers

Default retirement age

The government will consult on how the default retirement age will be phased out from 2011. Under current rules, employers are able to dismiss employees once they reach 65 even if they are perfectly capable of continuing to work. Ideally, this rule should be abolished now, but it looks like it may take some time before this is actually achieved.

We are all living longer, and therefore the right to work beyond state pension age is crucial in giving us more time to plan for the financial side of retirement. Let’s hope the government sees sense on this issue sooner rather than later.

Personal pensions

Before the election, each of the main political parties put forward their pension manifestos (take a look at Which political party will save your pension?). Back then both the Tories and Lib Dems stated an intention to look at the possibility of granting early access to our pension pots. Sadly, the Budget revealed no further details on if or when this would happen.

The fact that pensions tie money up over many decades tends to put some savers off. I think an early access option in certain circumstances - such as using pension money for buying a home - could be a valuable incentive.

Public sector pensions

Public sector pensions will now only rise each year in line with the CPI, rather than the RPI, which means they will most likely become less generous over time. This is hardly surprising given the expense of these pension schemes to the government, but that’s of little comfort to the retired public sector workers affected by this change.

In addition, an independent commission will be chaired by John Hutton, the former Secretary of State for Work and Pensions. The commission will review public service pension provision by Budget 2011. The inevitable dilution of benefits available under public sector pensions is bound to cause a major backlash.

Tax relief

Like Labour before it, the coalition plans to continue to raise revenue by restricting tax relief on pension contributions. Under the current plan (that was proposed by Labour), higher rate tax relief is due to be restricted for very high earners - those earning over £150,000 - from April 2011, but (surprise, surprise) Tory voters weren't too keen on this idea.

The Chancellor has attempted a compromise for high earners who aren't saving vast sums each year. He announced in the Budget that an alternative approach of significantly limiting the annual contribution allowance on which tax relief applies will be considered. The government’s provisional analysis suggests that restricting tax relief for the highest earners to maximum pension contributions of £30,000 or £45,000 a year, would be sufficient to raise the revenue required.

This will be more than sufficient for most pension savers to enjoy the same levels of tax relief they do now, but it will disappoint the highest earners who can afford to put hundreds of thousands of pounds into their pension each year.

And finally a bit of good news!

As you are no doubt already aware, an annuity converts your pension fund into an income. Current legislation dictates that you must buy an annuity by the age of 75, but under the coalition this obligation will be removed from April 2011. The Chancellor also announced transitional measures will be introduced for people who haven’t yet purchased an annuity but will reach the age of 75 before the new tax year.

This is the single really positive change for pensions and pensioners. After all, annuity rates have recently reached record lows, which lock pensioners into a dramatically reduced level of pension income. Take a look at Great news for your pension to find out more.

More: Boost your pension by £130,000 before you retire | What the BP oil spill means for your pension