Your state pension explained

In previous articles I explained that the current state pension will not be sustainable in the future (due to the population getting older and there being fewer people working to contribute to the pension 'pot'). In future articles I will look at the options for reform and compare experiences from other countries that have already been through the pension reform process.

First, however, it is important to ensure that we understand the current state pension benefits (often referred to as First Pillar Pensions), so that we can appreciate how the changes will affect our entitlement and benefit levels.

Pensions were first introduced in Malta in 1885 when the government sponsored the Malta Police Force Pension Scheme. This was closely followed by a similar scheme for civil servants.

Non-contributory pensions were introduced for widows and orphans of Public Officers in 1927, with a means-tested non-contributory pension available from 1948 for those over the age of 60 (the old age pension).

Contributory pensions were introduced by the National Insurance Act in 1956, and the two-thirds pension was introduced by an amendment to the Act in 1979.

The Social Security Act of 1987 brought all previous pensions legislation together in one place and confirmed the existence of two structures of pension in Malta:

¤ non-contributory pensions - where entitlement is based on means testing (i.e., you only receive it if your income and assets are below a certain level); and

¤ contributory pensions - where entitlement is based on National Insurance contribution records.

The current state pension is commonly referred to as the two-thirds pension, which implies that the maximum pension you will receive is two-thirds of your salary. In reality, however, the majority of pensioners will never receive such an amount.

In 2004, for example, the average state pension was just Lm46 per week, which was only 85% of the national minimum wage (Lm53.88) and only 47% of the national average wage (Lm98.06).

Clearly, most people do not receive a pension equivalent to two-thirds of their salary; but why not?

The two-thirds pension is an income-related pension. What you receive depends not only on your income, but importantly on your National Insurance contribution record.

To receive the full two-thirds pension, you must have paid, or been credited with, an average of at least 50 National Insurance contributions out of a possible 52, each year, over a 30-year period.

If you have an average of less than 50, or have not paid for 30 years, then your pension entitlement is reduced accordingly.

The income used to determine your pension is based on an average of the best three consecutive years in the last 10 (or simply an average of the last 10 if you are self employed).

There is also a maximum pensionable income, which was set in 1990 at Lm6,750 p.a. and hasn't been increased since, meaning the maximum pension payable in 2006 is capped at Lm87.70.

How much money will you need in retirement?

If we assume that by retirement age we hope to have repaid our mortgage and other debts, while our children should hopefully be self-sufficient, then two-thirds of our final income is a reasonable pension to aim for.

However, with more time on our hands for leisure activities we might prefer the same level of income we enjoyed while working.

If we are already earning more than the income cap of Lm6,750 then we know the State will never provide us with the two-thirds income we need in retirement and we will have to make sure our own pension provision is sufficient to bridge the shortfall.

If you have a pensions-related question please e-mail us at pensions@middlesea.com.

Mr Fairbairn is a pensions consultant with Middlesea Valletta Life Assurance Company Ltd (MSV).In a series of fortnightly articles we will explain everything you need to know about pensions. Starting with the demographic influences on future pension provision, we will then investigate the global and local pension time bomb, focusing on different solutions and experiences from other countries. Specifically, we will then focus on the situation here in Malta, looking at current pension levels and the proposed changes to state, personal and corporate pensions. Full explanations will be given of the technical terms you will hear along with an analysis of how the changes will affect different sectors of society. Finally, we will look at some general holistic retirement strategies and focus on building suitable investment portfolios for medium to long-term savings. A 'question and answer' section will also be published with future articles to help unravel the world of pensions. Anyone with questions should e-mail: pensions@middlesea.com

Middlesea Valletta Life Assurance Company Ltd is authorised to carry on long-term business under the Insurance Business Act 1998 and is licensed to provide investment services in terms of the Investment Services Act, 1994 in relation to linked long-term contracts of insurance.