In a competitive field, ‘National Insurance’ might be the single most unhelpful example of money-related terminology.
The name evokes the early days of the welfare state in Britain, although it existed in a different form before that, and unlike other money we pay to the government - income tax, for example - it gives the strong impression that if you pay National Insurance, you’ll get something definite back in return when you need it - just like other types of insurance.
In particular, you’ll get your state pension when you retire, as though the NI money you’ve seen disappearing from your wages all these years has been set aside in a pot with your name on it, ready for when you quit work.
In reality, National Insurance does not work like this. Rather, the money paid in National Insurance by both individuals and employers goes into a fund from which most of it is immediately paid out to pay the pensions, and some other benefits, of those who presently need it.
If more money is being contributed than is being paid out the fund runs a surplus, but there are times when this dwindles and the government of the day has to pump in more. In the past, the trigger for this cash injection has been when the NI surplus falls to below 1/6 of its annual expenditure. At that point, the government can pay in an amount worth up to 17% of the benefits paid to top it up.
These numbers are kept track of by the Government Actuary’s Department (GAD), which this week gave a gloomy update on the state of the fund’s finances. The fund is currently in surplus of about a 1/5 of expenditure, the GAD said, and this surplus will keep growing until about 2025.
At that point, however, the surplus slams into reverse and is eaten away completely by around 2032, meaning anyone under about 50 years old now could face a serious squeeze on their state pension. What’s more, even if the government were to make the maximum cash injections allowed, they would be insufficient to keep the fund above the 1/6-of-expenditure danger level in most years from 2040 onwards.
The story these figures tell is of a system struggling to keep pace with demographic changes to our society. There is an unusually populous generation that is reaching the end of their working lives - the baby boomers. The NI contributions of this large group have easily covered the benefits paid to the less populous generations that preceded them. Soon, however, they themselves will have to be paid for.
On top of that, life expectancy continues to rise so these people will need a state pension for longer, adding even more strain to the system.
It all means that something has to give. Either the government will have to change the rules and pay in more to the fund, or else the benefits paid out by the fund will have to be reduced from what’s currently planned.
It underlines how, in general, tomorrow’s retirees will not be able to rely on help from the state that today’s retirees have enjoyed. Either they’ll get less, or they’ll have to pay in more to get the same.
Providing your own retirement income will become increasingly important and saving inside a pension is how to do it. Make the most of any employer pension scheme you have access to and start your own pension saving inside a self-invested personal pension (SIPP), where you contributions still benefit from tax relief.
The Government’s Pension Wise service offers free, impartial guidance to help you understand your options at retirement. You can access the guidance online at https://www.pensionwise.gov.uk/ or over the telephone on 0800 138 3944.
Fidelity’s Retirement Service also has a team of specialists who can provide you with free guidance to help you with your decisions. They can also provide advice and help you select products though this will have a charge.
The value of investments and the income from them can go down as well as up, so you may not get back what you invest. Eligibility to invest into a SIPP and the value of tax savings depends on personal circumstances and all tax rules may change. As this is a pension product you will not be able to withdraw money until you reach the age of 55. This information does not constitute investment advice and should not be used as the basis for any investment decision nor should it be treated as a recommendation for any investment. Investors should also note that the views expressed may no longer be current and may have already been acted upon by Fidelity. Fidelity Personal Investing does not give personal recommendations. If you are unsure about the suitability of an investment, you should speak to an authorised financial adviser.