Why top-ups could leave you down

New rules for pensions could leave many savers out of pocket, says Toby Walne

Warnings are being sent out in tax letters to 3.5 million savers telling them that voluntary top-ups towards their basic state pensions (BSP) may be a waste of money. These so-called "deficiency" letters are sent out every year to people who have not made sufficient National Insurance (NI) contributions to receive the full BSP. The letters explain how much extra money people need to pay.

Full-time carers, women who have taken career breaks to look after children, and people who have worked abroad are among those who could be most affected.

Men currently need to have made NI contributions for 44 years and women for 39 years to qualify for the full BSP. But proposed new rules would mean that after 2010, both sexes will have had to make NI contributions for only 30 years.

"People being encouraged to top up their pension may simply be throwing their money away," says John Lawson, head of pensions at Standard Life. "It seems totally ludicrous: there should be recompense or a bigger state pension if it turns out that many people are putting in more than they should."

Any shortfall is paid as voluntary Class 3 contributions, which typically works out at £7.55 a week for missed NI payments when people are not in work. Currently, only 49 per cent of women qualify for the full BSP compared to about 91 per cent of men. Lawson is particularly concerned that hard- up mums may be salting away vital money to boost their retirement.

He criticises the Inland Revenue for not making the position clearer in the letters (the impending change is only pointed out at the end).

The confusion has arisen from new pension proposals in a Government White Paper, which is to be voted on by Parliament later this year. If successful, as expected, it will mean that anyone reaching state-pension age after April 6, 2010, will have had to pay NI contributions for 30 years.

"It may be construed as a warning, but that is not our aim," says an Inland Revenue spokesman. "Our job is to inform, not advise, and all we work on is facts. People will have to make their own decisions on what is best for their particular circumstances. All we can do is keep them as best informed as we can."

People missing contributions can make voluntary top-ups to plug gaps in their NI payments stretching back to 1996, but from 2009 they will only be able to backdate six years. Recipients are encouraged to contact the Department for Work and Pensions for a pensions forecast to help them decide whether or not to pay any extra.

More than 3.5 million letters are sent out every year, but only about 260,000 people respond, and less than half of these try to plug the gap.

Although the rules on how much people need to contribute to be entitled to the full BSP may soon be changed, the existing benefits of topping up are huge. The full BSP of £84.25 a week is worth as much as £125,000 as an annuity purchase for a woman retiring at 60.

If this woman were to receive this pension on the open market, she would have to contribute more than double the existing level of £7.55 a week.

"Right now, we don't know what will happen, so it may be worth erring on the side of caution," says Stewart Ritchie, director of pensions at Aegon. "Those who are close to the threshold for NI contributions should top up, as the state-pension benefits are worth the extra money."

"However, hindsight is a great thing. You need to be aware that you could be wasting your money if you have already contributed for 30 years."

Parents with children under 16 and people looking after disabled or elderly friends or relatives for more than 35 hours a week will also be affected by the changes. They currently get help towards their state pensions through home responsibilities protection, but they still have to make limited NI contributions, typically requiring up to 20 years of payments, for the full BSP.

Married partners who have not worked may also be affected. They can currently top up for the full BSP or opt to be assessed based on their spouse's contribution, in which case they only get 60 per cent of the full BSP.

NI contributions are automatically taken from employees and the self-employed, but anyone who is concerned that they may have missed payments should make enquiries even if they have not received a letter.

Information about pensions

* A pensions forecast can be obtained by completing form BR19, which is available from the Pension Service at www.pensionservice.gov.uk.

* Alternatively, you can call the State Pension Forecasting Team on 08453 000 168 or call HM Revenue & Customs National Insurance hotline on 08453 021 479.

* Information on voluntary contributions is also available from the Citizens Advice Bureau. Visit its website at www.adviceguide.org.uk or contact your local Citizens Advice Bureau office.