If you don’t qualify for the new flat rate State Pension, to be introduced in 2016, you are about to be offered a one-off chance to top up your State Pension by up to £25 per week.
The move will give people, particularly those who have paid insufficient National Insurance contributions, the opportunity to increase the income they get from the state.
“How will the State Pension top-up scheme work?”
The scheme was announced by George Osborne in his recent Budget, but full details have only now been revealed.
- The scheme will be available from 12th October 2015 and will close on 1st April 2017
- It will be available to anyone reaching their State Pension age before 6th April 2016
- For men this means being born before 6th April 1951 and for women before 6th April 1953
- Top-ups of up to £25 per week (£1,300 per year) will be allowed
- Should you die after making additional contributions, 50% of the extra income will be paid to your surviving spouse or civil partner
Anyone topping up their State Pension will have to pay a lump sum to do so.
“How much will it cost me? Is it a good deal?”
The cost is based on age and life expectancy; if you qualify you can calculate the exact cost for your age and the top-up required, by using the online calculator.
The top-up State Pension is a guaranteed income for life, will currently rise each year in line with the Consumer Prices Index (CPI) and 50% will be paid to your spouse or civil partner if you die before they do.
Let’s start by comparing the cost of State Pension top-ups with the amount you would need to contribute to a pension, which could then be used to buy an Annuity, to get the extra £25 per week.
We’ve crunched the numbers and the following table shows the results:
|Age on 12th October 2105||Cost of £25 per week State Pension top-up||Net cost of a lump sum pension contribution used to purchase an Annuity|
|Male age 64 (the youngest age at which you can buy top-ups)||£22,825||£34,448|
|Male age 65||£22,250||£33,144|
|Female age 62 (the youngest age at which you can buy top-ups)||£23,350||£36,670|
|Female age 65||£22,250||£33,144|
The results in this instance would seem to show that the State Pension top-ups are cheaper than a pension contribution but you would need to look at your specific circumstance and as ever, seek advice.
The State Pension top-ups are aimed at people who will not qualify for the flat rate State Pension, due to be introduced from 2016 and who have incomplete National Insurance records. These people are often women who have stayed at home to look after their children as well as other groups such as carers.
It is possible that such groups will have insufficient earnings in a single tax-year to make a large lump sum pension contribution, such as that shown in the previous table. The alternative therefore, to produce a guaranteed income for life, would be a Purchase Life Annuity or PLA for short.
Now, it should be noted that this is not a perfect, like for like comparison. Whilst a PLA will provide a guaranteed income for life and a 50% spouse’s pension, the annual rises are set at 3% in our example as it is not possible to buy a PLA with annual increases linked to CPI.
However, for people who cannot make a large pension contribution, because they have insufficient earnings, it is a valid comparison.
Here’s how the numbers work out:
|Age on 12th October 2015||Cost of £25 per week State Pension top-up||Cost of a Purchase Life Annuity|
|Male age 64 (the youngest age at which you can buy top-ups)||£22,825||£34,858|
|Male age 65||£22,250||£33,818|
|Female age 62 (the youngest age at which you can buy top-ups)||£23,350||£36,942|
|Female age 65||£22,250||£33,818|
Again, the State Pension top-ups would seem to work out to be cheaper than the alternative but as before, you would need to look at your specific circumstance.
Our research shows that compared to either Annuity option, it’s pretty clear that the State Pension top-ups offer excellent value. Although it is worth remembering that the income from the Purchase Life Annuity and Annuity could be improved upon if it can be ‘enhanced’ due to medical or lifestyle factors.
Furthermore, less tax will be paid on the Purchase Life Annuity than either the State Pension top-up or the Lifetime Annuity, it is therefore important to calculate the net income each option provides. This can only be done when your other income is known
“But, what are the downsides of topping up my State Pension?”
Whilst the income is guaranteed, index-linked and a proportion will be paid to your spouse or civil partner, there are downsides to topping up your State Pension, these include:
- Once you have contributed the lump sum necessary to top-up your State Pension you cannot reclaim the money
- If your spouse or civil partner dies before you do, they will not benefit from the top-up to your State Pension
- If you and your spouse die sooner than expected, you might receive less back in income than you paid as a lump sum
- If your health deteriorates in the future, you may have been better off buying an Enhanced Annuity, which will provide a higher income based on your illness or lifestyle. The State Pension top-ups take no account of health or lifestyle factors
- Some people may prefer to buy a level Annuity, rather than an index-linked top-up to their State Pension, which will provide a higher starting income, but will be eroded by the effects of inflation
It’s also worth remembering that whilst not actually a ‘downside’, the maximum top-up which can be bought is just £1,300 per year.
“What should I do if I’m thinking of toping up my State Pension?”
You need to ensure that topping up your State Pension is the most cost-effective use of your capital. This means calculating the cost of both Purchase Life Annuity and Lifetime Annuity and then comparing that to the capital needed to top-up your State Pension.
You then need to decide whether you can afford to commit a lump sum of capital from your savings or investments.
This is a complex decision and there’s plenty of time to decide what’s best for you, we are of course here to help.