Top-up your pension for half the price of an annuity
A new state pension top-up scheme will allow pensioners to buy an extra £25 a week of state pension from next year, for around half the price of an annuity.
The scheme will be available from October 2015 for existing pensioners and those who reach state pension age before 6 April 2016 - women now aged 61 or over, and men aged 63 or over.
It will help those who would otherwise have been excluded from the £144-a-week single-tier state pension, due to be introduced in April 2016. The single-tier arrangement will join together the existing basic state pension and the Second State Pension into one simple payment.
The pre-April 2016 pension system comprises a basic state pension of around £110 per week, and then an additional state pension is not available to everyone.
"The government recognises that many pensioners feel rather aggrieved about being excluded from the new state pension system and is giving them a chance to achieve higher future state pension payments," says independent pensions expert Ros Altmann.
The top-up scheme was first announced in the chancellor's autumn statement last year, but today the Department for Work and Pension (DWP) has defined the new legislation.
Savers can gain the extra pension by paying 'Class 3A' voluntary national insurance contributions. The maximum amount that contributions can provide will be £25 per week. The scheme will only be available for 18 months from October 2015.
"This is another bold action in how we build a stronger economy through choice in retirement income," says pensions minister Steve Webb.
"The scheme will give [pensioners] a guaranteed, index-linked return and will be particularly attractive for women pensioners who will draw the higher pension for longer [because they have longer life expectancy]. It will also help the self-employed, who currently qualify for only the basic state pension."
How much do you need to contribute?
As an example of the new scheme, the DWP sets out the contribution needed for a top-up of £1 per week. A 65-year-old individual would need to pay £860 as a lump sum to get a £52 a year top-up.
The contribution decreases with age, so for a 70 year old the rate per extra £1 a week reduces to £779, and by age 75 it is down to £674.
The maximum top up for a 65 year old is £22,250, which would provide them with an extra annual income of £1,300 a year for life.
As with the existing additional state pension, these figures will be increased in line with inflation and the top-up payout will be partially inheritable on death.
According to Laith Khalaf, head of corporate research at Hargreaves Lansdown, the scheme looks generous compared to current annuity rates.
"It is an olive branch from the government to those who retire before the new single-tier state pension is introduced in 2016," he says.
Altmann is equally enthusiastic. For a 65 year old, she says, the rate for an inflation-linked joint life annuity is around 2.9 per cent, so buying the equivalent of the maximum £25 a week top-up would cost around £45,000 instead of £22,250.
"Relative to the private annuity market, this seems a very good deal for many people," she says. "The price of buying these extra state pension rights has been set at about half the cost of buying an inflation-linked joint life annuity in the open market."
To help savers work out how much they need to contribute to boost their state pension provision, the government has launched on online calculator.
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This article was written for our sister website Money Observer
A scheme originally established in 1944 to provide protection against sickness and unemployment as well as helping fund the National Health Service (NHS) and state benefits. NI contributions are compulsory and based on a person’s earnings above a certain threshold. There are several classes of NI, but which one an individual pays depends on whether they are employed, self-employed, unemployed or an employer. Payment of Class 1 contributions by employees gives them entitlement to the basic state pension, the additional state pension, jobseeker’s allowance, employment and support allowance, maternity allowance and bereavement benefits. From April 2016, to qualify for the full state pension, individuals will need 35 years’ of NI contributions.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.