We like to call it the National Insurance (NI) state pension lottery. Not everyone’s a winner, but those who are, scoop the chance to buy the best pensions bargain around. To benefit, it helps to understand some basic principles. Most of us must pay ten qualifying years worth of NI contributions to get a state pension of any sort. To qualify for the full state pension – currently worth just under £9,500 a year – we must pay contributions for 35 years.
Your State Pension is a valuable prize
The state pension may feel paltry to some, but it’s incredibly valuable. Remember, the triple lock means it is (currently) guaranteed to go up in line with inflation, earnings growth or by 2.5% a year, whichever is highest. So to buy that level of income at a typical annuity rate of about 3.3%, you’d need to spend £285,000.
If you are working, the government will calculate if you have paid sufficient NI contributions to bank a qualifying year, and you can get NI credits if you cannot work in some circumstances. Each qualifying year adds nearly £267 to what you’ll get from your state pension. If you have fallen short of the 35-year target or are likely to, there may be the chance to buy back missing years. Hence, your NI is the biggest pensions bargain available. Those eligible may have to pay £880, but they’ll get that back in three years of retirement. It’s the equivalent of an annuity of 33%.
Better still, buying back those years may cost less than £880. Take, for example, someone we recently advised who was made redundant a few years ago, and in that year, her NI contributions fell slightly short. She plans to retire early and needs to have as many years as possible on her record to maximise her state pension. Making that single year count for her will cost just £90. So she’ll get nearly three times that back in the first year alone when she retires.
In it to win it
To calculate where you stand with your state pension, whether you can or should buy back some years or top-up contributions, and how much to pay, go to the government’s website and check your state pension forecast.
Put in your details, and it will tell you how many qualifying years you have, how many years you may be able to buy back, and what it will cost you to top up your state pension. Trying to work this out for yourself is almost impossible, with the legacy rules that have to be factored in and wrapped around this are a whole package of different conditions depending on whether you are self-employed, employed, a carer or on benefits.
How much you pay will depend on which year you are buying; £800.80 is this year’s cost. If you’re paying voluntary contributions for the previous two tax years (2020-21 or 2019-20), you’ll pay the actual rates for those years (£795.60 and £780). But for earlier years it goes back up to £800.80. Don’t ask why.
Window of opportunity
How far you can go back in paying these contributions depends on how old you are. Usually, you can only buy back the past six years, but there are some additional opportunities. For example, if you’re a man born after 5th April 1951 or a woman born after 5th April 1953, you have until 5th April 2023 to pay voluntary contributions to make up for gaps between 2006 – April 2016.
Nearly 400,000 people have made additional voluntary contributions since the current single-tier state pension system was introduced in 2016. However, many of them may have done so needlessly. You may get your 35 years in without having to top up years, and therefore that money will be wasted.
Making the call on whether to pay is particularly hard for younger people – those in their 20s and 30s taking parental leave, for instance.
But there are many thousands, especially older people, who can benefit, like those going part-time who’ve slipped under the NIC threshold, the self-employed on low incomes, those living abroad for a while, and those laid off during Covid, perhaps. In these circumstances, buying back eight years might be a struggle – but paying the top-up costs could make a fantastic gift from parents and grandparents who have the resources and may result in a full state pension entitlement when needed most.
To check if you could be a winner, visit the government website and if there is an opportunity to pay extra NI and gain additional state pension, talk to your financial planner about whether it’s worth it.
If you have any questions or would like to discuss your finances or your state pension entitlement, please don’t hesitate to get in touch and speak to one of our independent financial planners.
This article also features in What Investment, the premier magazine in the UK for private investors, looking at the latest trends in wealth management and tax planning.
