When the new state pension was introduced in 2016, the goal was to create a much simpler system. Once the new scheme is fully up and running, people who have a combination of paid National Insurance contributions and/or NI credits for 35 years of their working life will get the full flat rate pension, currently worth a little over £8,500 per year. However, in moving from an old to a new system there’s inevitably a transitional period which adds to the complexity and this is particularly true of the new state pension. Some of those transitional rules provide opportunities for clients to substantially boost their state pension at a relatively modest cost.
Who might want to top up their state pension?
There are two main transitional features of the new state pension system. Firstly, people who had already built up a pension in excess of the full flat rate by 2016 will get the full amount they had accrued by 2016, though they will be unable to add to this amount. So, for example, someone who had a basic pension plus a SERPS pension totalling £180 per week as at April 2016 will get an up-rated version of the full £180 and not the current flat rate.
The second transitional feature relates to clients who have contracted out, and it is here that the opportunity arises for state pension boosts.
Many millions of people will at some point have been members of a contracted out pension scheme. Where people were contracted out into an occupational pension scheme, they and their employer will have paid a reduced rate of National Insurance Contributions. In exchange they will have built up a smaller state pension than someone who was not contracted out.
The new state pension takes account of this by making a one-off deduction to pension rights built up as at April 2016 to reflect past contracting out. This can mean that many people will not qualify for the full flat rate pension, especially in the early years of the new arrangements.
However, once that adjustment has been made, contributions for 2016/17 and succeeding years can add to that 2016 ‘starting amount’ and enable people to build up a bigger state pension, including those who have already made 35 or more years of contributions into the scheme.
For those who stop work before state pension age but don’t have a full entitlement, this presents a golden opportunity to consider paying voluntary (‘Class 3’) NI contributions for years from 2016/17 onwards. The rate of Class 3 contributions is set by government at a subsidised rate which means that it does not cost much to generate a significant boost to the state pension. If they continue working to state pension age they would still be paying NI and building up credits for the full state pension.
The rate of Class 3 contributions for the year just ended, 2017/18 was £14.25 per week or £741 for a full year. Someone whose 2016 starting amount is well short of the full flat rate would gain an extra 1/35 of the state pension in return for a year of voluntary NICs. So, someone filling a gap for 2017/18 could see their annual state pension rise by around £244 each year through the whole of their retirement. Allowing for income tax on the state pension, they would probably only need to draw a state pension for around four years to recoup their initial outlay and everything thereafter would be pure profit.
Consider the details
There are various detailed things to think about when deciding whether or not it is worth topping up your state pension. For example, some men close to pension age in 2016/17 or 2017/18 might get ‘automatic’ NI credits and therefore wouldn’t benefit from making voluntary contributions for those years. There are also some cases where it makes sense to pay voluntary contributions for years before 2016/17, but this needs to be done with care because in some cases this will not boost your clients' state pension.
We’ve recently updated our step-by-step guide to topping up your state pension. We hope that it will be useful to you and clients who are considering boosting their state pension in a cost-effective manner.