Should you top up your state pension? Act now if you want to buy Class 3A contributions

Individuals can get between £1 and £25 a week extra state pension (men born before 6th April 1951, and women born before 6th April 1953) by applying to make a lump sum payment by 5 April 2017 using the ‘State Top-Up Scheme’. But should they top-up, and by how much?

WEALTH at work, a leading provider of financial education, guidance and advice in the workplace, has created a list of some of the things that individuals need to consider before deciding whether to top-up their pension.

  1. Get a state pension forecast – The state pension is extremely complex and only by getting an up to date state pension forecast from https://www.gov.uk/check-state-pension will someone know what they are likely to get. This will then give them a baseline to work out whether they can, or should, do anything to improve the level of state pension they will get.
  1. Triple lock – The state pension is triple locked until 2020, which means it goes up each year by either the measure of the increase in the consumer price index, average earnings, or 2.5% (whichever is the highest).  Given the current low interest rate, low inflation, and low annuity rates, it would be unlikely that individuals could find a better deal elsewhere for their retirement income.
  1. Guaranteed safe income – The state pension is guaranteed income, meaning it will pay out for as long as someone is alive, even if that is to 100 or older.  Also, no need to worry about being scammed or the annuity provider going bust as it’s provided by the government.
  1. Good genes and health – If you are in good health and have long living genes then the deal is better as you will receive the additional amount for longer. For example, individuals that pay the maximum top-up amount to get an extra £25 a week at age 65, will need to live 17.1 years (if a non-tax payer) to break even. The breakeven point increases if you are a taxpayer and will depend upon whether you are a basic, higher or additional rate tax payer. 
  2. Gender – As there is no difference in the rate of the state pension payments between men and women, it is likely to result in a better deal for women as they tend to live longer.
  1. Impact on means tested benefits – More income from the state pension can mean that any other benefits received, (such as housing benefit or pension credit) may be reduced when assessed against the state pension income. Topping up for lost years might not be worth it, if it means losing benefits that would have ordinarily been received.
  1. Tax – The income being bought for the extra state pension is taxable, so for many the real amount received would not be what they ‘buy’ but the net amount after tax. Individuals should do their sums very carefully before making any top-ups.
  1. How much to contribute? – How much the extra state pension costs depends on how much is wanted in return, and how old someone is when they make the contribution – the cost of buying the additional state pension reduces with age. The government has an online calculator that shows the different options. www.gov.uk/state-pension-topup.
  1. Flexible – It is possible to change your mind within 90 days of receiving the extra pension via the State Top-Up Scheme. This is useful if someone realises that it is going to affect other benefits or if they suddenly get a life shortening health diagnosis.
  1. Timing – As this list demonstrates, it isn’t an easy decision, and ideally financial advice should be taken. The offer closes on April 5th so anyone considering toping up needs to get their skates on to get it.

Jonathan Watts-Lay, Director, WEALTH at work, said: “The State Pension Top-Up, seems like the obvious thing to do when you consider that you are unlikely to get such a good deal elsewhere. However, it can involve hefty lump sum payment for the top-up in the short term, and has a direct impact on things like means tested benefits and taxable income, so isn’t a ‘slam dunk’ for everyone. Ideally financial advice should be taken.”

CashQuestions adds:

Remember that not only is the pension you buy with Class 3A contributions taxed, unlike income purchased with savings in a pension scheme you are possibly buying it with money saved from income that has already been taxed, so the headline figures may need some recalculations.

Deferring – either not taking your state pension as soon as you become entitled to it or pausing taking it – could provide you with a better deal than buying contributions because of the better rate achieved from deferral. The idea is that, while you deferred or pause  your state pension you live off the capital you intend to use to buy Class 3A contributions instead of actually purchasing them.

While extra state pension is a good way of securing guaranteed income, once the capital has gone it has gone and you can’t change your mind (after the cooling off period) and  spend it on anything else or leave it to anyone in your will. You can, under the Class 3A rules, leave 50% pension benefits you have purchased  to a spouse or civil partner, but if you don’t have a partner, or they are unlikely to live longer than you, the deal looks less advantageous.

These contributions will be a good deal for some people , but the low take-up rate indicates scepticism among the general public about exactly how worthwhile they are and whether there are better uses for savings, or a better way of securing guaranteed income – such as deferral. Take professional advice.

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