Your IndustryNov 19 2015

Assessing if topping up is appropriate

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Using the state pension top-up is essentially the equivalent of buying an annuity from the government.

As with buying any annuity, Intelligent Pensions’ technical director David Trenner, says it will be good for some and not so good for others.

The decision to use the new state pension top-up is relatively complex and will depend on a host of individual factors.

Unfortunately, he says the government has not made things very clear and if someone only has £25,000 to invest, they may not wish to spend fees for specialist regulated advice to ensure they make the best decision.

But, Mr Trenner added, if they do pay for advice and the adviser gets it wrong they can be compensated; if they just do what the government says and it is wrong, then there is no comeback.

Catrina Ogilvie, senior consultant for executive and retirement services at Broadstone, says advisers should start by getting a statement of state pension entitlement.

Clients can do this by going to https://www.gov.uk/state-pension-statement and requesting one. This statement will let you clients know their accrued state pension entitlement.

If there is a shortfall, Ms Ogilvie says this may be due to them starting their employment later in life, career breaks or periods of overseas employment, which means they may not have accrued sufficient national insurance contributions to reach the maximum entitlement.

Given how valuable the state pension is (it is paid gross but does use up some personal allowance: the income you are able to receive before paying tax), Ms Ogilvie says it is worth everyone considering topping up if they have a shortfall and they can afford to do so.

As the top up is like investing in a ‘government annuity’ scheme, Billy Burrows, director of Retirement Intelligence, says some of the same issues to be considered when purchasing an annuity from any provider should be taken into account.

These include: health and life expectancy including spouse/partner, personal circumstances, future cash/income requirements and attitude to risk.

If you are not in good health, you may not live long enough to get back your investment, warns Steven Cameron, regulatory strategy director at Aegon, who says those struggling with their health may be able to get better terms through an impaired life annuity.

“It might not suit people who think they will require a lot of income flexibility in retirement as you’ll effectively be swapping a lump sum for a regular fixed income which you won’t be able to vary to meet unexpected costs.”

As an add-on to the state pension, Malcolm McLean, senior consultant at Barnett Waddingham, says the extra pension will be subject to income tax and will therefore be less beneficial for higher rate taxpayers than those paying tax at the standard rate, or are otherwise non-taxpayers.

At the other end of the income scale, he says if you get a means tested benefit such as pension credit, council tax support or housing benefit, they will normally be reduced.

So again, in these circumstances, he says it is probably not worth investing in the extra state pension.

John Wilson, head of technical at JLT Employee Benefits, says all of those eligible need to consider whether topping up the state pension is right for them, adding that eligible clients need to consider affordability.

The cost depends on how much someone wants to add to the state pension payment they receive. The more money they put in, the higher the pay-out.

Based on how much lump sum they pay, their week state pension will be increased by an extra £1 to £25 a week.

The cost falls as age increases, so it can make sense for an individual to wait until their next birthday before making the payment, Mr Wilson notes.

For example, to get an extra £1 per week (£52 per year) state pension for life, the lump sum contribution for a 65-year-old would be £890, compared to £674 for someone who is 75.

Tax is another key consideration

The top up is taxable, Mr Wilson points out, so eligible savers should check how much they would receive after tax.

Mr Trenner reckons at first glance the extra income of £1,300 a year in return for an investment of £22,250 for a person of 65 looks attractive, and it will be for someone who does not smoke or drink and who is in good health, or does not want any risk on any return of capital on their death.

Based on current rates (from the Money Advice website) someone of 65 living in a G2 postcode – where Mr Trenner’s office is – who was average height/weight, non-smoker, not a heavy drinker and generally in good health, would get just £794 a year from the best provider.

If they were a heavy smoker, Mr Trenner says the income would increase to £992 a year and if in addition they were overweight and were taking medication for high blood pressure and high cholesterol, it would be £1,121 a year.

Add another unspecified medical condition and the best offer would be £1,281 a year, Mr Trenner notes.

On the face of it, he says these rates suggest that the government offers best value except that the private pension contribution would get tax relief.

Assuming 20 per cent relief and therefore a gross contribution of £28,125, Mr Trenner says the incomes increases to £1,003 a year, £1,254 a year, £1,416 a year and £1,619 a year.

Of course not everyone at the age of 65 will have sufficient earnings in the tax year to qualify for 20 per cent relief, but conversely, Mr Trenner says some people will qualify for relief at 40 per cent or even 45 per cent.