The state pension is in the midst of a radical shake up – on Monday, as part of that, a scheme launches allowing millions of people who already get it (or are about to) to buy a top up to boost their pension by up to £25 a week. Today, MoneySavingExpert.com founder and editor, Martin Lewis, gives his three-minute briefing.
For more information, see our fully updated, detailed, step-by-step state pension top up guide.
Only women born before 6 April 1953 (so 62 or more) or men before 6 April 1951 (so 64 or more) can do this. In other words, this top up is only for those who are already drawing their state pension or who are eligible to do so before 6 April 2016 – this date is crucial.
It's when the new 'flat rate system' launches, and this scheme is about allowing you to pay a lump sum to get a guaranteed increase in your pension, meaning existing retirees can pay to have a pension nearing similar levels to the new system. Here are the five key facts on it:
- If you don't get the full state pension, look at other options first. If you don't get (or aren't due to get) the full £115.95 current maximum state pension, there are other options to look at before doing this. If eligible, you should consider buying extra national insurance years or possibly deferring your pension as more lucrative methods.
- You can add £1 to £25 a week. In other words, an increase of £52 to £1,300 a year, which lasts for the rest of your life until you die.
- The younger you are the more it costs. The amount it costs you depends on how old you are when you do it eg, at 65 its £890 per pound, at 85 it's £394 per pound.
- What you receive will rise with inflation. The amount you get will go up with CPI inflation. It is worth noting though that the state pension itself has a 'triple lock' meaning it rises with the higher of inflation, average earnings or 2.5%. So this payment could fall behind inflation.
- The payout is taxed. The cash is taxed at your normal rate, so if you are a 20% taxpayer, you'll lose 20% of it.
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So who does this scheme work out best for?
When you play out various scenarios it's very clear who this scheme is designed to benefit.
- Lower-rate taxpayers. If you're at the higher rate, a lot of the gain is eaten up in tax, even at the basic rate a chunk is. Yet if you're a non-taxpayer (likely to be living only off the state pension), then the gain here can work.
- Those in good health and with a family history of longevity. How good value for money this is all depends on how long you're likely to live. For a basic rate taxpayer, for every scenario, barring a woman aged 62, you have to live longer than the typical life expectancy for this to pay out.
For example, for someone doing this at 65, as a non-taxpayer you'd have to live until age 82 until you got back what you paid in, as a basic rate taxpayer you'd have to live until age 86, and as a higher rate taxpayer you'd have to live until age 94. Contrast that to average life expectancies for someone at that age of 83 for a man and 86 for a woman. Therefore for most people the gamble is against them.
- If you're married or in a civil partnership. If you die, your spouse can inherit at least 50% of your top up payment until they die (they only get it if they're of state pension age). So if you paid to get an extra £10 a week and you die, your partner will be able to get £5 a week until they die. If you have no partner, nobody will inherit your weekly payment.
Is it worth it for anyone?
Certainly for married people on the state pension with little other income who don't pay tax – this looks a reasonable bet. Yet perversely they are the ones least likely to have the funds to be able to do this.
For those who do pay tax, unless you live for a very long time, there are only a few scenarios where this is a great deal compared to just shoving your money in a savings account. Especially because from next April the new personal savings allowance means basic-rate taxpayers can earn £1,000 of savings interest a year without tax (higher rate £500). Yet they do exist and should be considered:
- High inflation. The top-up payments are inflation proofed, your savings aren't, though interest from savings should go a decent way to covering much of an inflationary hit.
- The 'Peter Stringfellow rule'. If you have a substantially younger spouse, then provided they don't remarry once you die, they're entitled to half of it once they're of pension age. So if your 65 and they're 45, and you both live until 85, you'd get 20 years of it, then when you die they'd get 20 years (assuming they retired at 65).
Where this really comes into its own is if you think of it as an annuity
However, where this really comes into its own is if we think of it an annuity rather than comparing it to savings. An annuity is a product that gives you a payment each year for the rest of your life until you die, no matter how long you live. The aim is to give you lifelong security of income, regardless of any other factors.
In effect, this top-up scheme is a Government annuity that's inflation proofed, and the effective rate is far better than you could get commercially. So if surety of income in case you outlive traditional life expectancies is your key concern, this can look like an attractive deal, especially if you are, or will become a lower-rate taxpayer.
There is an irony that the Government has launched this scheme in the same year it allowed so called pension freedom, which was all about freeing people from buying an annuity, but don't let the disjointed nature of that policy cloud your decision.
In summary – while on paper putting money in a savings account is likely to win for most – that only works if you're prepared to spend the capital as well as the income and psychologically many people hate that – plus if you live much longer than expected there's a risk you'll run out of cash. So the top up can be a winner for those who want to bag safety for a long term.
Your thoughts welcome below. See our full state pension top up step-by-step guide for those interested in doing it, which has much more analysis in it.