Friday 23 October 2015

State Pension Top-up; A Cheap Annuity?


Millions of pensioners and those approaching retirement will now have the chance to raise their state pension income by up to £25 a week with the launch of a new scheme.

From 12 October 2015 to 5 April 2017, you are able to apply to make a ‘Class 3A voluntary contribution’ to top up your State Pension by up to £25 per week.

Under the deal, you can choose to top up your weekly basic state pension by between £1 and £25 a week. 

How much you need to contribute will depend on:

* How much extra pension you want to get each week

* How old you are when you make the contribution

If you are 65 now and you want to buy an additional £1 a week for life it will cost you £890. If you want to buy the full £25 (or £1,300 a year) it will cost you £22,250.

Cheap Annuity?

The reaction to this has been generally good, with a string of experts pointing out that this is effectively a very cheap annuity. 

For example, if you had wanted an annuity that provided you with £1,300 per year, on the open market you would pay around £35,000, rather a lot more than the £22,500 that the Government are asking for.








Effectively, you’re getting an annuity rate of 6%, far better than the 3% available on the open market. 

On top of that, factor in that your spouse can inherit 50% of your State Pension on your death and it looks like a bargain, doesn't it?

Double Taxation

In many ways the scheme - known as Class 3A - looks generous, but it may not necessarily be the best way to boost your pension. 


The state pension top up is likely to be paid with money that has already been taxed, and will have tax applied a second time when taking the income from your topped up state pension. 

This is in contrast to an annuity purchased via your pension where the contributions are exempt from tax, the growth of the funds are exempt and tax is only applied when taken as an income.

All of this will reduce the net amount of income that you receive.

Payback Period 

So how long would you have to live for you to get your money back?

Lets say that you hand over the £22,250 for the extra £25 a week. 

* If you are likely to fall below the personal allowance tax threshold of £10,600 and will not pay tax on the income, it will take 17 years for the state to return to you the money that was yours anyway (£22,250/£1,300). You’ll need to live to 82 to break even.

* For those who will be basic rate taxpayers, you can expect 21 years before you break even at age 86. 

Given that the average life expectancy in the UK is 81.5 years, it may not seem like such a good deal after all. 

Other Options 

To receive the full state pension, you are required to have 30 qualifying years of national insurance contributions. 

For those who don’t, luckily you can pay to plug the gaps. Each year costs you £733.20 and will get you an extra £200 a year. 

That’s a payback of less than four years for non-taxpayers and just over four years for 20 per cent payers. That’s got to be better than 17 and 21 years with the State Pension top-up.

Alternatively, you could consider deferring your pension. Each year that you defer your pension, you will receive a 10.4% increase in your annual payment. The payback on this would equal 9.6 years, not quite as good as 4 years but certainly a lot better than 17 years! 

As always, the devil is in the detail. Despite the headline cheap annuity, it pays to consider the opportunity cost.

 

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