Summary
'State Pension' is treated as a yearly income source in gross terms.
No National Insurance taxes are applied to this income type.
Income tax is calculated based on the most recent tax rates and bands.
State pensions have a 2.5% collar due to the triple lock.
Introduction
State pensions are a cornerstone of retirement planning for many individuals. In Timeline Planning, state pensions are treated in gross terms, allowing for a complete financial overview. This article will explain how National Insurance and Income Taxes are calculated for the 'State Pension' income type and how it appears in cash flow charts.
State Pension Explained
In Timeline Planning, a state pension is considered a yearly income source. Advisors can input the gross annual amount of the pension, which is defaulted to £11,502 for the year 2024 but can be changed to any value.
State pensions can be adjusted for inflation based on the Consumer Price Index (CPI). A 2.5% collar is applied. That means:
If a given year the CPI was less than 2.5%, the state pension will increase by 2.5%.
If the CPI is more than 2.5% in a given year, the state pension will be adjusted for the exact CPI.
Step #1: National Insurance Tax
For income received from a state pension, no National Insurance taxes are applied.
Step #2: Income Tax
Income tax for the 'State Pension' type is computed based on the most recent tax rates and bands. The total tax is then subtracted from the gross income to arrive at the net income value.
Example
Let's consider Joe, who receives an annual state pension of £70,000. Timeline Planning calculates his income tax as follows:
£12,570 * 0% = £0
(£50,270 - £12,570) * 20% = £7,540
(£70,000 - £50,270) * 40% = £7,892
The total income tax Joe has to pay is £15,432, leaving him with a net annual income of £54,568.
How State Pension Appears in the Cashflow chart
Since state pensions have a collar of 2.5%, these investments tend to show up with varying numbers in the cash flow chart in Timeline Planning. The reason for this is because of how Timeline uses the triple lock system.
Imagine it's a new year, inflation is at 2%, and the State Pension is £10,000. First, the State Pension would increase to £10,200, in line with inflation. But wait, there's more! Because the triple lock guarantees a minimum increase of 2.5%, the State Pension would go up to at least £10,250.
When it comes to the cash flow chart, we show real values. This means that we adjust the State Pension increase for inflation. The growth you see in the cash flow chart may be different:
In the case of inflation smaller than 2.5% for a given year, converting to real will cause the State pension to increase in value.
If the inflation for a given year is more than 2.5%, then the value will remain the same in real terms.
So there you have it. The State Pension increase in the cash flow chart may appear higher than expected due to how it's adjusted for inflation due to the triple lock system. By knowing how inflation and the triple lock affect the State Pension increase, you can provide more accurate and reliable advice to your clients.
Conclusion
The 'State Pension' income type in Timeline Planning offers a structured way to plan for a stable income during retirement. Understanding how National Insurance and Income Taxes are calculated, along with the cap and collar system for inflation adjustments, can help advisors and clients make more informed financial decisions.