Reaching state pension age before 6 April 2016?

July 15th, 2014

From October 2015 some individuals will be able to top up their state pension by making the new Class 3A voluntary National Insurance contributions which will be made available from that date for a limited time only. The aim of introducing this facility is to enable people who will not get the new flat rate pension (and who may have lost out because of the structure of the current second-tier pension) to top up their state pension entitlements.

Although It may seem preposterous to voluntarily contribute more into the system by way of additional national insurance contributions, for those who are eligible to make the class 3A contributions it is worth serious consideration as this may actually offer real value for money. The contribution rates are age related and qualifying individuals will be able to purchase up to a maximum £25 of additional weekly state pension (or £1,300 p.a) and for a 65 year old, for example, the cost will be £890 for each additional £1 of weekly pension, translating into a maximum cost of £22,250 (£890 x £25). The annual pension is also increased in line with the consumer prices index (CPI) and provides a 50% spouses pension in the event of death. The initial outlay may seem large but when you consider that this equates to a rate of 5.84% this is significantly better than annuity rates available on the open market. For example, the same amount would buy an RPI (retail prices index) linked annuity with a 50% spouses pension of just £724.62* (an effective annuity rate of just 3.25%) so class 3A contributions start to look like a good deal. The table below highlights the cost per £1 of additional pension purchased which will depend on the individual’s age attained at the time they make the class 3A contribution.

 

Age                    Cost of max £25 per week                       Equivalent Annuity Rate

65                                    £22,250                                                       5.84%

66                                    £21,775                                                       5.97%

67                                    £21,175                                                       6.14%

68                                    £20,675                                                       6.29%

69                                    £20,025                                                       6.49%

70                                    £19,475                                                       6.68%

71                                    £19,025                                                       6.83%

72                                    £18,450                                                       7.05%

72                                    £17,975                                                       7.23%

74                                    £17,350                                                       7.49%

75                                    £16,850                                                       7.72%

 

Who can make class 3A contributions?

Two conditions need to be met – You must be entitled to the Basic State Pension or Additional State Pension before 6 April 2016 and the additional contribution must be made between 12 October 2015 and 1 April 2017.

Should everyone who is eligible to do so make these additional contributions?

Not necessarily as, whilst the rates look attractive, there are still other considerations. For example, those individuals in poor health may not want to hand over a significant lump sum for which they may not receive value for money over the long-term. Likewise, individuals wanting a higher level of initial income and who are less concerned about the impact of inflation may decide that annuity rates on the open market would offer better value for their money. As always, it is important to seek advice based on your individual circumstances. That said, however, making class 3A contributions may appeal to individuals looking for a long-term retirement income and who expect to live a long time. Just like considering retirement income options when crystallising a pension though, it will be important to consider what is right for you, particularly as you cannot get your lump sum back once you have made the class 3A contribution. If you would like further information on this topic or wish to discuss whether this is relevant to you please do not hesitate to contact us and we will be happy to offer further guidance.