Due to retire in 2016? Pay £1,300 to secure extra £52 worth of state pension a year for life (or a maximum £22,250 for £1,300 a year)

2nd April 2014

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People nearing retirement in 2016 will be able to pay £890 to receive an annual state pension top up of £52 up to a maximum of £22,250 to secure £1,300

The Department for Work and Pensions have released a ministerial statement outlining the new state pension top-up scheme, which will allow retiring savers to pay a lump sum to boost their state pension entitlement.

The scheme looks generous compared to current annuity rates, but not as good a deal as the existing Class 3 state pension top up scheme says pensions firm Hargreaves Lansdown.

Laith Khalaf, head of corporate research with Hargreaves Lansdown says: “This top-up scheme looks pretty generous compared to buying an annuity from an insurance company. It is an olive branch from the government to those who retire before the new single tier state pension is introduced in 2016.

“The scheme offers pensioners another option for putting their savings to work, which will be particularly welcome given today’s low interest rates on cash held in the bank. For some, the secure inflation-linked income will be attractive. However the income is taxable, which means some savers should pause to consider whether an ISA may be a better, more flexible home for their money, if they are willing to take more risk.”

Details of the scheme

A 65 year old* can pay £890 as a lump sum to get a £52 annual income

This is equivalent to an annuity rate of 5.8%

A comparable market annuity rate is just 3.5%

Available to all pensioners who hit state pension age by April 2016 (including existing pensioners)

The maximum top up for a 65 year old man is £22,250, to get an annual income of £1,300

It will be possible to top up between October 2015 and April 2017

*Different rates apply depending on your age

Class 3 v Class 3A

This new top up scheme is called ‘Class 3A’ National Insurance Contributions. It adds to an existing top up scheme in place called ‘Class 3’ National Insurance Contributions.

There are significant differences between the two schemes, the main ones are detailed below. Broadly speaking the Class 3 scheme applies to fewer people, but is a much better deal if it applies to you.

Class 3

Class 3A

Lump sum payment

£705

£890

Annual income

£191

£52

Payback period

3.7 years

17 years

Top up to

Basic State Pension

Additional State Pension

Inflation linking

Triple lock- highest of earnings, CPI or 2.5% (for now)

CPI only

Who can use it

It’s a long story- please ask us

Anyone who reaches state pension age by April 2016

Example based on a 65 year old man who qualifies for these schemes and buys one year of extra state pension.

Class 3A v ISA

Class 3A offers retiring a new option to lock into a secure, inflation-linked income for life, which should not be underestimated. However the income is taxable, and the capital is not accessible once paid across to the government.

Hargreaves says an alternative would be to invest the money in an equity income fund within a stocks and shares ISA. This would be a riskier option, but you would not lose access to your capital, and your income would be free from UK income tax- particularly important for higher rate taxpayers.

Investors can currently get around a 3.5% yield on an equity income fund within an ISA- with no further tax to pay. This is variable and may go down, but over the long term it has the potential to rise too. This compares with an after-tax yield on Class 3A contributions (for a 65 year old man) of 4.7% for a basic rate taxpayer and 3.5% for a higher rate taxpayer.

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