Why it's not always best to top up your state pension

Don't rush to join the Government's new scheme to get £25 a week more, says Chiara Cavaglieri

Pensioners will be able to boost their state pension by up to £25 a week after yet another tweak to the pensions system was announced this week. Early indications suggest that this opportunity has generous terms, but what are the likely benefits and what else should you be looking to do?

Right now, the most anyone can get from their basic state pension is £110.15 per week but under new proposals pensioners can use their savings now to make top-up payments to get as much £25 extra per week. The scheme will open in October 2015 when the Government introduces a new class 3A of voluntary national insurance contributions (NICs), available to existing pensioners and anyone due to reach state pension age before April 2016 when the single tier pension is brought in.

"If you have spare cash to devote to increasing state pension entitlement it will almost certainly be a good thing to do that," says Tom McPhail, pensions expert for Hargreaves Lansdown. "In principle the terms offered by the Government for these additional state pension deals look very attractive. Reports suggest an extra £1 a week of class 3A state pension would cost £900 to buy. On the open market, an inflation-linked single life annuity for a 65-year-old currently costs £1,468 for each £1 a week of income."

The finer details of the scheme will follow in the coming weeks but older pensioners can expect to get more generous terms. The extra payment is also linked to inflation, so while £900 might buy £1 per week extra in year one, it will rise with the index year after year. The maximum top-up will be set between £20,000 and £25,000.

This new deal will provide something of a sweetener for people feeling disgruntled that that they will miss out on the higher flat rate pension of £155 a week when it is introduced on April 6, 2016. It is also being pushed as a golden opportunity for women, many of whom often miss out on the "additional pension" which is added to the basic state pension, to get more from the state.

Richard Watkins, from Close Brothers Asset Management, says: "With just over two years to go it is worth taking this opportunity as soon as possible. This is particularly relevant for women, who often live longer than men and who may have taken time out of the workplace to raise a family and not made voluntary contributions during that period. The self-employed may be attracted as well, as they may have made lower contributions in the past and are entitled only to the basic state pension".

With savings interest rates so poor, a product with built-in inflation proofing is an attractive prospect, particularly as there will also be survivor benefits offering protection to spouses. However, if savings rates return to form will this look as generous as it does today?

Craig Palfrey, from pension advice website Increase Your Pension, says: "If income and savings rates escalate in the future, as they are likely to do, this Government pension deal could look decidedly second-rate".

It is also worth noting that in December last year, after the Government first unveiled these plans, a survey of over 1,000 people found that most people were not interested in taking part. Even if it does prove popular there are aspects of this scheme that pensioners should be wary of - for example the pension income will be taxable, which may make pensioners think twice before they choose this over putting the money into a tax-free vehicle such as an ISA (individual savings account).

"Anyone who suffers from ill health could probably secure a better than market pension income – so they should not judge this top-up option against ordinary pension rates. Instead they should examine how much income they could secure from a comparable product where their health is considered," says Mr Palfrey.

The safest way to decide whether this is a good idea for you is to see how it might work in conjunction with any other financial arrangements you have such as private pensions, mortgage debt and any other savings or investments.

Voluntary NICs already exist for people who need to fill any gaps in their national insurance records. The rules state that you need 30 years of contributions to qualify for the full basic state pension but many people can make up for lost years so that they don't miss out. Usually any top-up payments must be made within six years but there are some exceptions, for example people reaching the state pension age before 5 April 2015 may be able to pay voluntary NICs dating as far back as 1975.

If you can, deferring the state pension is currently rewarded fairly handsomely. If you continue to work beyond retirement age, part-time or otherwise, you don't pay national insurance on any income once you're over state pension age. Furthermore, the Government increases the pension by 1 per cent for every five weeks you put off claiming, or 10.4 per cent for every year. To illustrate, if you would be eligible for the basic state pension of £110.15 per week deferring for a full year would get you an extra £595 a year. As an extra incentive, if you defer for 12 consecutive months you can choose to take the extra money as a one-off lump sum, which will include interest at 2 per cent above the Bank of England base rate.

The best place to start is with a state pension forecast which gives you an estimate of the basic and additional state pension you will be entitled to based on your NICs so far. Clearly the further away you are from retirement the more opportunity you have to work and build up qualifying years, but you may also be able to use your partner's contributions to improve your state pension without forking out for voluntary NICs.

Any extra help is worth looking into – one in three people who are entitled to Pension Credit fail to claim it, potentially missing out on hundreds of pounds a year, tax-free. This benefit is means-tested but the first £10,000 of any savings and investments is ignored. It currently comprises two parts - guarantee credit (which tops up your income to £145.40 a week if you're single or £222.05 if you're married or in a civil partnership) and saving credit (up to £18.06 a week for a single person, £22.89 for married couples/civil partners).

Independent Partners: 10 top tips for retirement. Get your free guide here

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