A guide to the new State Pension top up

Oct 19, 2015 | Tony Byrne's View

For a long time now, many people have believed final salary pension schemes are sacrosanct and should not be touched. However, since the new Pensions Freedom rules were introduced by the Government on 6th April the whole ball game has changed significantly! One of the many pensions changes introduced was the ability to not only leave your money purchase pension to your spouse, but also to other members of your family such as children and grandchildren. This means that if you want your pension to survive you and benefit your family you can now do so, because your pension does not need to die with you. The big problem with final salary pensions is that like annuities they die with you. Pretty much the best you can hope for is that your final salary pension scheme will provide a 50% widow’s / widower’s pension on your death. On the second of your deaths it dies with you. We have a male client who is in his fifties with a wife and children. He has a company final salary pension scheme worth around £900,000. In the last year he has been diagnosed with cancer and although he has recently been given the all clear, his life expectancy will probably be much reduced. He is quite wealthy and has other large pensions so retirement income is going to be plentiful. We did a cashflow forecast comparing the income from his final salary scheme with that from a personal pension based on the pension transfer value offered by his previous employer’s pension scheme. We assumed investment growth of just 5% p.a. in a new personal pension. Staggeringly for all time periods up to and way past retirement his and his widow’s personal pension income was no worse than the income from his final salary pension scheme would have been. More importantly the value of his personal pension fund did not fall much at all in value! This means that his family in this situation would have been substantially better off to the tune of nearly £900,000! Not surprisingly, he decided to transfer his pension preferring the “bird in the hand” approach. Please do bear in mind this is just one isolated case. Every client’s situation is different. Professional advice is essential and should always be taken. To find out more we are offering a free end of tax year review worth £470 to the first 10 people who contact us before 25 November 2015. This offer is subject to qualifying conditions. We offer a great cup of coffee too! Ring us on 01908 523740 or email wealth@wealthandtax.co.uk.

 

What is it?

For a limited period only (12th October 2015 – 5th April 2017) the government is giving pensioners and people approaching retirement the opportunity to increase the amount of State Pension they receive for life.

 

Who does it apply to?

To be eligible to make a State Pension top up you need to be entitled to a UK State Pension and either already be in receipt of this or due to receive it before 6th April 2016. This includes men born before 6th April 1951 and women born before 6th April 1953.

 

How does it work?

State Pension top up could give you an extra £1 – £25 per week (up to £1,300 per year) for life in exchange for a one-off lump sum payment. The lump sum cost will vary depending on your age and how much you want to top up. The cost decreases as your age increases so in some circumstances it may make sense to hang on for a while. The government have created an online calculator that tells you how much each pound of State Pension top up will cost. You can find this here → www.gov.uk/state-pension-topup .  As an example, a man born 1st January 1951 would need to pay a lump sum at age 65 of £22,250 in order to receive an extra £25 per week State Pension for the rest of his life or wait until 66 and only have to pay £21,775.  Any extra top up is on top of the amount of State Pension you would normally receive based on your national insurance contribution record. As with your normal State Pension, the top up will be payable for life, is protected against inflation (under current rules but the government could always change their mind!) and your spouse will likely inherit between 50% and 100% of your top up after your death once they reach their State Pension age. But remember your children get nothing!

 

Is it right for me?

Whether it is right to top up your State Pension will depend on your own circumstances and in particular how much you value the security of an income for life rather than investing the lump sum. Your tax position will also be a big factor. Example 1 – Basic Rate Taxpayer A woman born 4th May 1950 pays a lump sum of £22,250 to increase her State Pension by £25 per week. The extra annual pension is £1,300 however as she is subject to basic rate tax the extra amount she receives after tax is £1,040.  To receive the same level of income if the women had instead invested the money in an investment not subject to tax the investment would need to pay an interest/yield of 4.7%. Example 2 – Higher Rate Taxpayer A woman born 23rd September 1949 pays a lump sum of £21,775 to increase her State Pension by £25 per week. The extra annual pension is £1,300 however as she is subject to higher rate tax the extra amount she receives after tax is £780.  To receive the same level of income if the women had instead invested the money in an investment not subject to tax the investment would need to pay an interest/yield of 3.6%.  However in both examples remember the income from the State Pension top up will increase with inflation. On the other hand the investment could benefit from capital growth although this would not be guaranteed and your investment could go down.

 

Pros and Cons

In summary the pros and cons of the new State Pension top up are as follows:

Pros:

  • Guaranteed income for life.
  • Increases with inflation (unless government changes its mind!).
  • Don’t have to worry about investment market fluctuations.
  • Peace of mind.

Cons:

  • Subject to Income Tax.
  • No chance of investment growth.
  • Irreversible decision.
  • Your Pension will likely reduce for your spouse on your death and your children will inherit nothing.

To find out more information visit www.gov.uk/statepensiontopup. This guide is not advice and we recommend that you take independent financial advice before making a payment.

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