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.
Part two of our helpful pensions glossary covers everything from L – Z. If you haven’t had a chance to take a look at part one, click here to brush up on your pensions terms from A-J, then get to grips with the second part in this Jones Hill double bill.
Lower Earnings Limit – This is the point at which your earnings will build up the right to state pension benefits.
Member – Different from an ‘active member’ of a plan, who is actively making payments, a ‘member’ is someone who is still entitled to benefits under their pension plan.
NIC – National Insurance Contributions are deducted from the income of all employees on a scale which is linked with income levels. You need 30 years of National Insurance Contributions in order to get a full State Pension on retirement.
Open Market Option – Buying an annuity from their own pension provider is not the only option for the retired, and more often that not it’s not the best option – we can compare rates and arrangements for other insurance providers and purchase the one that suits you best.
Preserved Benefits – These are classed as the benefits a pension scheme member has already earned when they stop making payments, or when their scheme closes. They are also known as frozen benefits, and they will be paid when the individual takes their benefits.
Redirecting payments – You can change the funds that future payments are invested in by redirecting your future payments. It won’t affect any payments that have already been invested, and many providers don’t charge for this service.
SIPPs – A self-invested personal pension gives the planholder maximum flexibility and choice with regards to their investments. It is best for those who are more comfortable with investment risk and they can be more expensive to run. SIPPs are also used for pension income drawdown contracts. Alternatives to SIPPs are SSAS – Small Self Adminstered Schemes. If you’re considering either, take professional, independent advice.
Tax Relief – Tax relief means that some of the money that would have been paid to HMRC will be paid into your pension plan instead, encouraging those saving for their retirement.
Upper Accrual Point – This is the maximum earnings that are used to build up the right to state pension benefits.
With-Profits Fund – If your pension plan contains this type of fund, your fund manager retains a percentage of the profits to supplement your investment earnings in the case of a bad year for returns. It helps to smooth out the instability of the stock market, but it can incur heavy penalties for those that cash in early., usually called a Market Value Reduction.
At Jones Hill, we know that pensions terminology can be confusing for those thinking about their retirement for the first time. We’ve put together a handy glossary of the most important terms you’ll ever need to know when it comes to understanding your pension.
Annuity – This is a type of financial contract that guarantees a fixed or variable payment of income. It can be monthly, quarterly, biannually or annually, and it can last for the life of the annuitant, called a lifetime annuity, or for a previously specified period of time, often called a term annuity or temporary annuity. Those diagnosed with health problems or other issues can qualify for what’s known as ‘enhanced annuity’, where they are entitled to receive more, and these are always lifetime annuities.
Basic State Pension – The flat rate for a State Pension is paid to everyone who has met the minimum contribution requirements for National Insurance. It currently stands at £110.15 per week for a single person, but changes come into play each year to keep the basic pension rate in line with inflation. Bear in mind that even with the proposed new flat rate of £140 per week, this is just £20 per day – the poverty level in the UK is, apparently, £17.50 per day!
Contribution – This is an alternative term for the word ‘payment’. Your pension contributions are essentially what you or your employer have pay into your pension scheme.
Drawdown Pension – This allows you to keep your savings for retirement invested and draw an income directly from your plan, instead of buying an annuity. Drawdown pensions come with a number of stipulations, one of them being regular reviews and preferably on-going financial advice from an impartial expert.
Early Retirement – This hardly needs any explaining – it’s what we’re all aiming for! This is when someone takes their pension benefits before the ‘normal’ retirement date stated in their pension plan documentation.
FCA – This stands for the Financial Conduct Authority, and it helps to regulate the financial services in the UK. It was formed as a successor to the FSA (Financial Services Authority).
GPP – A GPP (or Group Personal Pension) is set up by an employer on behalf of their employees. All of the pension contracts are arranged by the employer, but are between the pension provider and the employee.
Higher Rate Tax – The dreaded phrase ‘higher rate tax’ is 40% for those with a taxable income above £32,010 for 2013/14 (plus their personal allowance).
It is a question that sits at the back of many people’s minds. It doesn’t hold much weight during your 20s and 30s, but by the time you reach your 40s, retirement will be on the horizon and you’ll be wondering when you should start putting real, concrete plans into place.
So when should you start thinking about retirement? The answer, according to many experts, is as early as possible. The earlier you start making plans and paying into a pension (this will soon become compulsory thanks to auto-enrolment), the better quality of life you will have when you retire. Thinking you’re ‘too young’ to start thinking about pensions is one of the biggest mistakes many savers make, purely because every year you work without paying into a pension, you are essentially losing money.
People live longer nowadays than they ever have done before, which can often mean that retirement stretches out for longer than you think. In order to avoid living off a pittance when you retire, it’s important to put away some savings early on. It’s better to save smaller amounts over a longer period of time, than to rush paying into your pension in the last five years before you retire.
Savings need time to grow, and the longer you give them, the better they will look when you finally receive those projected pension figures. Would your income now be enough to live on in 20 or 30 years? Think of how much you would need to save in order to achieve that figure when you retire. You are the only person who can save for your future.
If you are rapidly approaching retirement age and still worried about how much you’ll be able to draw when you retire, get some advice. Independent financial advisers are often full of tips that can help you to boost your income close to retirement, and you can be sure that they are impartial, with only your wellbeing and financial status in mind. Just as it’s never too early to think about your retirement, it’s also never too late to boost your retirement income and ensure you are set up for your life post-work.
If you have worries about your pension plan or you simply want to reassure yourself that you’re on the right track, speak to Jones Hill independent financial advisers today.
It’s never too early to start thinking about your pension, and putting away funds that can be used as your income later in life. At Jones Hill we have put together a helpful timeline that will help guide you through the pensions process – starting ten years in advance, so you have plenty of time to perfect your policy and your plan.
10 Years Away
With retirement ten years away, it’s time to take a step back and review all of your current savings and investments. Be sure to take into account any pensions that you may have lost track of from years gone by. There is a Pension Tracing Service that can help you to calculate these figures, as well as a predicted figure of your state pension from the Pension Service. With ten years to go, you’ll be able to work out if you’re on course for the pension you want, and you’ll have plenty of time to make up the difference if your projected income is less than you’d hoped.
Five Years Away
Conduct another review of your finances, and assess how much risk there is involved with your investments. Around five years before retirement is the perfect opportunity to begin reducing your involvement with investments that have a higher risk status, turning to those that have a more steady flow of income. At this point, a sizeable loss would be hard to recover so close to the date of your retirement. Reduce risk five years from retirement to ensure your income becomes more steady and reliable.
One Year Away
This is where things start to get serious. Get an up-to-date overview of your state pension, and put together detailed plans for your predicted income expenditure in the run up to your retirement, and the first few years afterwards. This is the point when independent financial advice is highly recommended, to ensure that you are fully prepared for retirement, and to help make any small adjustments that might be necessary.
Six Months Away
Your pension provider will send you a letter confirming your date of retirement and the current value of your fund. For those who have saved with different providers over this year, this may result in multiple letters and a few quick sums to figure out what this means for your total income.
Three Months Away
Again, you’ll receive a letter from your pension provider, this time outlining the annuity they are prepared to pay you for your pension. In certain cases, it is sometimes worth consolidating your various pension pots (if you have more than one) in order to receive a more competitive annuity arrangement. Shop around, seek some independent advice, and find the best rate for you.
Retirement Day
By the time your retirement arrives, you should feel happy and comfortable with the decisions you made in the years leading up to drawing your pension, whether you received independent pensions advice or whether you did your own research and figured out your own best policy. You should have enough to enjoy a happy and fruitful retirement.
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