The state pension is something that a lot of retirees depend upon, either as an extra source of income in retirement or, in some cases, the only source. The news that the state pension can be increased by up to £25 per week – or £1,300 per year – will therefore be welcomed, but will you be topping up?
Let's take a look at the changes. Yesterday the Government confirmed plans that will mean pensioners (and those reaching state pension age in the next two years) are able to increase their pension by up to £25 per week, by allowing them to make what's known as Class 3A Voluntary National Insurance Contributions. In essence, you'd need to make a lump sum contribution that would be turned into additional income for the rest of your life, providing extra financial security during retirement.
The cost of this top-up, or the amount an individual would need to contribute, will vary according to a person's age and how much they want to increase their state pension by. The Department for Work and Pensions (DWP) has estimated that a 65-year-old seeking an extra £1 a week (or £52 per year) would need to make Class 3A contributions of £890, but this contribution can rise to a maximum of £22,500 to give an extra income of £25 per week (£1,300/year).
That one-off contribution might sound like a significant sum, but a lot of pensioners would welcome the security of getting that extra income guaranteed – something which can't always be said if that money was invested elsewhere – while industry experts are hailing it as a competitive trade-off.
"This top-up scheme looks pretty generous compared to buying an annuity from an insurance company," said Laith Khalaf of Hargreaves Lansdown. "It is an olive branch from the government to those who retire before the new single tier state pension is introduced in 2016.
"The scheme offers pensioners another option for putting their savings to work, which will be particularly welcome given today's low interest rates on cash held in the bank. For some, the secure inflation-linked income will be attractive."
It hasn't come without its criticisms, however. The income gained is still taxable, which means some savers might like to consider ISAs as an alternative to help generate income, albeit with the extra risk involved. It's also widely felt that the new Class 3A scheme isn't as generous as the existing Class 3 state pension top-up scheme already available – fewer people will qualify, but if they do they can generate much better returns.
Hargraves Lansdown calculates that a lump sum of £705 in Class 3 National Insurance Contributions will result in an additional income of £191 per year, a far better deal than the Class 3A system where a bigger lump sum (£890) will result in less income (£52 per year).
Nonetheless, the fact that it's more generous than annuities – the returns of the Class 3A scheme is equivalent to an annuity rate of 5.8%, whereas the comparable market rate is just 3.5% – and that it provides guaranteed income could still appeal, and those that can't take advantage of the current Class 3 system would do well to consider topping up.
The DWP has launched an online calculator that can help retirees work out how much their contribution would need to be, based on age and how much they want to increase their state pension by. Qualifying savers – those who have already reached state pension age or will do so by 6 April 2016 – will be able to top up between October 2015 and April 2017, so it could be time to see what your finances are like.
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