Extra! Extra! Read all about it! Topping up your State Pension: is it worth it?

Financial planning and retirement planning can get complicated when coming to the right solution for each individual. The new flexibility introduced in the Budget 2014 is very welcome, however it is very important not to forget the basics, such as the State Pension available to each individual.

Normally, as part of our standard process, we ask individuals to check their State Pension benefit accumulation to ensure that the correct value is being achieved. This may not always be the case and it is important that allowances, such as the Home Responsibilities Allowance, are accounted for. This can be achieved by using a BR19 State Pension Forecast form, which may be found here: https://www.gov.uk/government/publications/application-for-a-state-pension-statement-form-br19-interactive-pdf or by going online to check the value of future benefits here: https://www.gov.uk/calculate-state-pension

It should be clear that in most cases there is real value in maximising the index-linked income from the State Pension, and reviewing the benefits, in our opinion is usually worthwhile (not in all cases), especially if you have the opportunity to increase their value.

Extra! Extra! Read all about it!

From October 2015, pensioners will be able to ‘buy’ up to £25 a week of extra State Pension. This option will be open to anyone who reaches State Pension Age before April 2016 – in other words, women born before 6 April 1953 and men born before 6 April 1951. The scheme aims to compensate the millions of pensioners who will miss out on the new flat-rate State Pension, which will come into effect from April 2016 and will pay around £155 a week.

If you qualify, there is only a short window of opportunity to increase your State Pension under this new top-up scheme: the scheme will run for 18 months, from 12 October 2015 to 1 April 2017.

Is this a new top-up scheme?

Yes, although there’s already a system whereby you can top up your basic State Pension. You currently need 30 years of full National Insurance contributions to qualify for the full basic State Pension. If you’ve accrued fewer years, you can make a lump-sum payment to increase the amount of basic State Pension you will receive on retirement.

The new scheme doesn’t replace this system and it’s important that you check that you have full entitlement to the full basic State Pension before you subscribe to the new top-up scheme. This is because your money will buy you significantly greater benefits under the existing scheme – for example, a sum of £890 would currently buy a 65 year old £4.64 a week of extra basic State Pension, whereas under the new scheme the same sum would boost your income by just £1.

What benefits can I ‘buy’ extra?

You can choose to top up your State Pension by between £1 and a maximum of £25 per week. How much you’ll need to contribute depends on how much extra pension you want to get each week and how old you are when you make the contribution.

For example, you are 68 years old in October 2015. You decide that you want an extra £5 per week (£260 a year) on top of your pension. The cost of an extra £1 per week for a 68 year old is £827, so you multiply £827 by 5. Therefore, you’ll make a lump sum payment of £4,135.

An online calculator is available at https://www.gov.uk/state-pension-topup . This will give you an idea of the cost and value of buying extra State Pension income at your current age.

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Does the new scheme offer value for money?

It could, for many people. The scheme works like an annuity, in that you are buying a guaranteed (and index-linked) income for life with a lump sum payment. Thus, your investment will only pay off if you live long enough to recoup the cost of buying the income and subsequently start earning a ‘return’. So those in good health should benefit from topping up their State Pension.

The maximum additional benefit of £25 a week costs £22,250 for a 65 year old. This is equivalent to an annuity rate of 5.84% - significantly higher than the current market rate of just over 3%. The return is higher still for older pensioners – a 70 year old will pay £19,475 for an additional income of £25, which is equivalent to an annuity rate of 6.67%.

Spouses and civil partners will also be able to inherit 50% of the top-up on the death of the pensioner, and the resulting income payments will remain index-linked.

The scheme may offer poorer value for money for a range of individuals:

• Single pensioners – as they have no spouse/civil partner to inherit 50% of their top-up
• Those with shorter life expectancies – as they may not live long enough to benefit from their investment
• Those who need access to their capital in retirement – rather than committing their lump sum to buying an income

What are the alternatives?

There are alternatives and each individual case is different. This is where high quality financial planning advice can help you understand the options and to allow appropriate decisions to be made as to the ways clients and enquirers use their capital to gain income.

The Chapters teams in Guildford and Woking are well placed to advise you on the impact of current and future changes to pensions legislation on your finances. No individual advice is provided during the course of this Blog. If you would like to receive further information regarding your own individual situation and circumstances, please contact the Chapters team in either Guildford or Woking.

Vicky Fulcher

Trainee Financial planner

 
Chapters Financial Limited is authorised and regulated by the Financial Conduct Authority, number 402899.