In this week's millennial money episode, I ask financial expert Damien Fahy how state pensions work and the chances of millennials ever having one.
How do state pensions work?
A lot of people don't realise that a state pension is not something that has got your name on it or is guaranteed. When you pay your national insurance contributions, some of that goes towards funding the people who are receiving a state pension today. People wrongly assume that when you pay your National Insurance contributions you are contributing to a little pot with your name on it and it will sit there until it is time to retire.
The reality is very different, the National Insurance Contributions you pay are simply used to formulate your record and ensure that you have paid enough to qualify for a state pension (or how much you qualify for) You can check this online by going to the governments 'check your state pension' site.
Try and think of a state pension as bit like a cash machine, the workers paying national insurance contributions are filling up the machine and then on the other side of the machine are the older generation drawing out their pensions. That's how it works, our contributions that we pay today are paying for the current wave of retired people. So as we pay taxes it goes through the 'cash machine' and they are queuing up and taking the money we pay in. When it is time for you to retire, you walk from one side of the cash machine to the other and instead of paying in, it will be you drawing it out.
This current method however starts to highlight a problem that is emerging due to our ageing population. The workers that are paying national insurance contributions have to realise that there are more and more people reaching the state pension age and so as more people join the other side of the queue, naturally there are less people paying the money in.
How will the state pension work going forward and will I qualify?
At some point there will not be enough people paying national insurance to fund the state pension and so we will probably see increased taxes, followed by a reduced state pension and at some point it is likely that it will be removed altogether.
What is auto-enrolment
The auto-enrolment pension scheme was introduced by the government as a way to get more people paying into pensions. Instead of having to opt into a pension (which is the way a pension scheme used to work) you now have to actively opt out. Employers have to auto-enrol new employees within 3 months of starting a new job.
Auto-enrolment is a good thing but there is no denying that the government are preparing us for a world without state pensions (or at the very least a reduced benefit). If you are lucky enough to get one you're going to get it later than your parents did and the reality is you're probably going to pay more tax along the way to support our ageing population.
Check out our podcast (Episode 212) where we cover auto-enrolment in more detail.
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