Class 3A National Insurance pension contributions – good value?
Government announces its terms for buying extra state pension – Class 3A National Insurance
by Dr. Ros Altmann
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This looks like a good deal – about half the cost of buying an equivalent annuity
Designed for those who reach pension age before April 2016
Will help people who are not included in flat-rate state pension to boost their income
The Government has just announced how much it will cost people to buy extra state pension rights under the proposed new ‘Class 3A’ National Insurance contributions.
The cost of buying extra state pension is around half the cost of securing this extra income in the private annuity market. The DWP statement can be linked to here: http://www.parliament.uk/documents/commons-vote-office/April%202014/2%20April/5.DWP-State-pension.pdf
Summary:
- Class 3A National Insurance will give rights to additional state pension
- The extra state pension will be increased by cpi inflation each year
- Half the pension can pass to a partner on death
- Men aged 63 and over, women age 61 and over in April 2014 are eligible
- Cost of buying extra state pension will be £890 for an extra £1 a week at age 65
- Maximum extra pension you can buy is £25 a week
- Equivalent to an annuity rate of 5.8%, when market rate is around 2.9%
- Maximum cost at age 65 will be £22,250 but would cost around £45,000 in the open annuity market
- Best for people in good health and who have a partner, especially self-employed or women with low state pensions
- Not so good for people in poor health or who believe they can invest their money and make strong returns
Who is eligible for this Class 3A?
Anyone who reaches state pension age before April 2016 – including all current pensioners – can buy extra state pension rights. This means women who are now age 61 or older (as of April 2014) or men who now age 63 and over will be eligible (as long as they are already entitled to the state pension).
Why is the Government doing this?
The new arrangement is aimed at helping people who reach state pension age before April 2016, who will be excluded from the flat-rate new state pension As the new system could give some pensioners – especially the self employed and some women –higher state pensions, the Government will allow them to pay extra National Insurance, even if they are already retired, to buy a higher state pension. The new state pension plans to join together the existing Basic State Pension and Second State Pension into one simple payment, that will be worth around £150 in today’s money, whereas the pre-April 2016 system has a Basic State Pension of around £110 per week and then additional state pension which not everyone has been entitled to and which was related to previous earnings, so the lowest paid had the lowest entitlements. The Government recognises that many pensioners feel rather aggrieved about being excluded from the new state pension system and is giving them a chance to achieve higher future state pension payments.
Why might someone need to buy extra state pension?
This will help people who are excluded from the new state pension system starting in April 2016. Anyone who reaches state pension age before April 2016, will not be entitled to the new system. Many of those pensioners will have far less than the £150 a week, either because they had interrupted careers and did not pay National Insurance for the full number of years, or because they have not been living in the UK all their life, or because they were not entitled to the additional state pension (for example many women were not fully credited into the additional state system while bringing up their children and have much lower pension entitlements).
What are the benefits of buying extra state pension?
The cost of buying the extra state pension is very low, compared with buying this kind of income on the private annuity market – about half the cost. The state pension will provide an inflation-linked income, which can also pass onto a partner after the person dies.
When can the new rights be purchased?
The Government says that between October 2015 and April 2017 – an 18month window – those eligible can buy these extra state pension rights by paying the Class 3A national insurance contributions.
How much will they cost?
The cost of the extra years will depend on the age of the person buying. Obviously, if someone is older, they will be expected to live for a shorter time and therefore the cost would be lower. This is the same principle as in the private annuity market, where the cost of the pension income bought depends on the expected lifespan of the buyer. The table below shows what the implications of this are at different ages.
|
Cost of buying a £1 a week inflation linked joint life annuity |
Cost of buying maximum extra £25 a week state pension |
Equivalent annuity rate at age 65 for state pension |
|
|
Age 65 |
£890 |
£22,250 |
5.8% |
|
Age 70 |
£779 |
£19,475 |
6.7% |
|
Age 75 |
£674 |
£16,850 |
7.7% |
Is there a limit on how much you can buy?
Yes, the maximum extra state pension you can buy is £25 a week. For someone aged 65, this means they could pay £22,250 to buy an extra £25 a week. At age 70, the additional state pension of £25 would cost £19,475 and for someone aged 75 the cost would be £16,850.
Is this a good deal?
Relative to the private annuity market, this seems a very good deal for many people. The price of buying these extra state pension rights has been set at about half the cost of buying an inflation-linked joint-life annuity in the open market. For a 65-year old, the annuity rate for an inflation-linked annuity is around 2.9%, so buying the equivalent of £25 a week pension would cost around £45,000, instead of £22,250 (although this does give rpi-linking, rather than cpi), whereas the cost of buying the extra state pension under Class 3A works out at an annuity rate of around 5.8%. About twice as good as the market rate. If you are 65 now and live beyond age 80 or so, assuming inflation is quite low, you will probably get a good deal and the higher inflation is, the better the deal. Of course, you could invest in the markets and do much better, but that entails risk.
Who is this best for?
Anyone reaching state pension age before April 2016, who has a shortfall in their state pension and has some money that they might consider using for extra retirement income could consider buying extra additional state pension. This will be good for women who did not manage to accrue rights to the additional state pension while they were working. It will be good for the self-employed who were excluded from the additional state pension system altogether and paid lower national insurance as a result. It will be good for lower earners who lost out because the additional state pension was earnings-related, so lower earners were entitled to lower state pensions.
Who might this not be good for?
Someone with a short life-expectancy, who might already be ill, would not necessarily benefit so much from this arrangement, because they will not receive the additional income for very long.
Someone who is single and does not need provision for a partner might not find this such an attractive deal, since the state pension automatically includes partner’s pension rights which they do not need.
How many people might buy more state pension?
The DWP estimates that more than a quarter of a million older people might buy extra state pension, concentrated particularly among those in their 60s. Older pensioners are already probably used to living on the current state pension entitlement, so might be less likely to want to spend money topping it up.
What about the public finance impact?
Of course it is impossible to know what impact this will have on Government spending, because we do not know how many pensioners will take up the offer, how much extra state pension they will buy and how long they will live and how much inflation will be. What is clear, however, is that this will have a positive cash flow impact, since the money will come into the DWP immediately, while the obligations to pay out more state pension will spread over many years.
ENDS
Notes:
Here are links to further details if you need them
The attached link to the GOV.UK State Pension top up provides further information about the scheme. https://www.gov.uk/government/publications/additional-state-pension-top-up
Dr. Ros Altmann