Alternatives to topping up the state pension

Private pensions, deferring the state pension, voluntary national contributions under the established Class 3 system and extending your working life, are all alternatives to the current state pension-top offer.

Class 3 system

Instead of going down the Class 3A route (which technically tops up the additional state second pension) it may be possible and more beneficial for some people to pay voluntary national insurance contributions under the already established Class 3 system, says Malcolm McLean, senior consultant at Barnett Waddingham.

This would enable those who have a deficient contribution record, and therefore an entitlement to only a reduced rate pension, to plug gaps in their qualifying years and thus increase their main basic state pension up to the full rate.

Whether your clients are eligible to pay into this and how much it will cost them to do so, depends where the gaps are and when they occurred.

Mr McLean says the general rule is you can only fill a gap which is up to six-years-old.

So now, in 2015 to 2016, you can fill gaps back to and including the tax year 2009 to 2010. The cost of those contributions depends on how old the client is.

For 2009 to 2010 to 2012 to 2013 they will cost £733.20 for each year to fill, says Mr McLean.

Filling 2013 to 2014 will cost £704.60 and 2014 to 2015 will be £722.80, he says, adding that those rates will probably change from 6 April 2016.

Another thing to note is that some people are allowed to fill much older gaps going right back to 1975 to 1976. The people who can do this are men born 6 April 1945 to 5 April 1950 and women born 6 April 1950 to 5 October 1952.

They all reached state pension age between 6 April 2010 and 5 April 2015 and must also have at least 20 years national insurance contributions – paid or credited (though at least one must have been actually paid).

They must pay these extra contributions within six years from the date when they reached state pension age. So it is too late for the oldest in this group and there is not long left for some of the slightly younger ones.

Mr McLean says the cost is £733.20 for each year paid. This group can also pay to fill gaps back to 2009 to 2010, but only for years before they reached state pension age.

“You must bear in mind that it is only worth paying enough contributions to ensure you have 30 years. Paying for extra years after that does not increase your pension further. In exchange for the contributions you will get extra pension of around £200 a year from the date you pay.

“So the payback time for the cost of the contributions is less than four years. The pension you buy is basic state pension and will rise by at least 2.5 per cent a year until April 2020 and after that in line with earnings, unless the law is changed.

“I am afraid this is all ridiculously complicated,” commented Mr McLean.

State Pension Deferral

Another alternative to making either type of top-up is to defer (or give up) drawing your state pension in return for a bigger pension later on.

For each five weeks delay, the whole of your state pension currently is increased by 1 per cent, which works out at a 10.4 per cent increase for a year’s delay. So a pension of £120 a week would become £132.

If you delay by five years it will be 52 per cent higher – turning a £120 pension into £182.

Mr McLean says the actual amount you get will be more as the basic state pension rises each year with the so-called ‘triple lock’ of at least 2.5 per cent a year.

During those years of deferring you do not, of course, get your pension. If you defer a year and give up £120 a week you will have lost £6,240 in pension you did not draw.

So you will have to live quite a while to get that amount back from the higher pension – in fact it is about 11 years to show a profit.

But Mr McLean says that as life expectancy at 65 is around 20 years, most people could gain from deferring for a year.

On the surface, for people with an average or above life expectancy who can afford to manage for a time without their state pension, Mr McLean says deferral would appear to be a really good way of increasing their pension.

However, before using this option, it is important to check with the Department for Work and Pensions that you will in fact receive a bigger pension and are not in an excluded category – normally where other benefits such as a widow’s pensioner pension credit are in payment.

Private pension

Steven Cameron, regulatory strategy director at Aegon, says that with a private pension, you can choose the age you start taking an income.

Since April this year, after the age of 55, you have complete freedom over how much to take and when, giving you much more flexibility.

Mr Cameron says: “This makes it much more flexible than the state pension where the government determines the age people can begin drawing an income. Another benefit of private provision over the state pension is that if you instead pay a lump sum into a private pension, the government adds tax relief.

“For a basic rate taxpayer, this would boost how much you have to buy an annuity from £22,250 to £27,800. For a higher rate taxpayer, you’d get an even bigger uplift to over £37,000.

“It is also important to remember whether you buy extra state or private pension, you may have to pay tax on this, although for private pensions, you can take some of the proceeds as a tax free lump sum,” he added.

Given how valuable the state pension is (you would need over £180,000 of your own money to replicate the state pension), Broadstone senior consultant Catrina Ogilvie, says for many the options listed above are probably ‘additions to’ and not ‘alternatives to’ topping up the state pension, if they have a shortfall.

However, she says that for those not wishing to top up, or who simply wish to save more in addition for their retirement, there are many savings products available: from bank/building society accounts, national savings products and Isas, through to more complex products such as pension plans and other forms of investments.

Ms Ogilvie says: “Normal practice would be to have a spread of additional investments, wherever possible, and to ensure you exhaust the relatively low risk options of tax efficient, simple products before contemplating more complicated avenues.”