Pensioners will be able to make 'top up' payments to boost their state pension by up to £25 a week, pensions minister Steve Webb has announced.
The new scheme is aimed at those already drawing a state pension or who will reach state pension age before the new flat rate state pension comes into effect in April 2016. It will allow them to pay in lump sums from as little as £900 to a maximum expected to be around £20,000 to £25,000.
The additional payments will translate into an increase in their weekly state pension of around £1 per £900 added (though the precise return will depend on the age of the retiree making the contribution).
The maximum contribution would amount to an extra £25 a week (or £1,300 a year), index-linked, for life. So someone living 22 years beyond pension age would gain an extra £28,600 of income over that period.
This is an interesting new idea, says Tom McPhail, head of pensions research at Hargreaves Lansdown: "In principle the terms offered by the government for these additional state pension deals look very attractive."
McPhail points out that if the money were used to boost a pension pot and buy an annuity instead, it would be markedly less advantageous. An inflation-linked single life annuity for a 65 year old currently costs £1,468 for each additional £1 a week of income, making the state pension "£900 per extra £1 a week [offer] a very generous" one, he says.
Current annuity rates have improved recently, rising a record 13% over 2013, according to the MGM Advantage Annuity Index.
However, this rise is from a historically low base, coming after several consecutive years of falls, including a 12% fall in 2012. The average conventional annuity rate now stands at around 5.8%, says MGM Advantage.
"The rise in rates has been driven by the market calming after the introduction of gender neutral rates, increased competition among open market providers and the better returns available on underlying investments," says MGM Advantage spokesperson Aston Goodey.
But he points out that rate rises tailed off towards the end of 2013 and "the prospect of further strong rises in annuity rates seems unlikely."
The government's state pension boosting initiative could therefore be all the more attractive to those approaching retirement. It will be available for 18 months from October next year.
This article was written for our sister website Money Observer