On Monday 12th October the government launches its state pension top up scheme, known as ‘Class 3A National Insurance contributions’. By Hargreaves Lansdown comment: Tom McPhail, Head of Retirement Policy.

The scheme allows individuals to increase their state pension entitlement above the maximum of £115.95 a week, by up to an additional £25 a week. They ‘buy’ this additional guaranteed income from the government by making a one-off lump sum payment. The actual cost varies depending on the individual’s age. It is open to anyone who reaches state pension age before 6 April 2016, in recognition of the fact that they will be ineligible for the New State Pension which launches on that date.

According to DWP estimates, 265,000 people are likely to take up the scheme. Hargreaves Lansdown comment: Tom McPhail, Head of Retirement Policy: “No private pension company can offer such an attractive deal; so if you are eligible and you want to buy yourself some inflation-linked guaranteed income for life, with death benefits for your spouse thrown in too, then this is the scheme for you.”

“Whilst the scheme is a good one, we find it ironic that a government which has done so much to undermine the annuity market, is now launching a scheme which looks remarkably like a nationalised annuity business. We are also disappointed that the government hasn’t done more to help individuals to access state pension data and projection tools online.”

Costs vs annuity
The additional state pension purchase scheme costs are age-dependent, with the price falling for higher ages. A full table of costs is appended to this document, however here are some sample prices, together with comparisons of buying the same income via an annuity.

Prices are based on buying a full £25 a week top up – the equivalent of £1,300 a year.

Here is the same data, presented in yield terms

Source: Hargreaves Lansdown annuity service & DWP

For further details on the annuity assumptions used, see notes below. A key question in assessing value for money of this scheme is how long the investor might live for. The better your health and the longer you expect to live, the better your eventual return will be.

Cost vs cash in a deposit account
For comparison we looked at a 65 year old and a 70 year old holding an equivalent sum in a deposit account and simply drawing an inflation-linked income of £1300 a year. The bank account would be likely to run out of money at or before average life expectancy – at age 82 for the 65 year old and 85 for the 70 year old. The state pension offer comes with guaranteed inflation proofing plus a 50 percent spouse’s income, whereas the bank account option means you retain control of the capital but you don’t get the guarantees.

A calculator has been placed on the Gov.co.uk website to help retirees to assess the cost of buying additional state pension. It can be accessed here https://www.gov.uk/state-pension-topup

Availability
The scheme is available for 18 months from 12 October 2015. There will be a 90 day cooling off period for anyone who wants to reverse the transaction after it has been set up.

Class 3 National Insurance
Separately there is the Class 3 NICs scheme which allows anyone with gaps in their National Insurance record to buy additional years to fill in the gaps. This scheme is far more generous costing just £733.20 to buy an additional year of state pension, which would be worth £3.86 a week or £200 a year, meaning it would deliver pay-back on your investment within around 4 years.

Tom McPhail: “Anyone looking at buying some additional state pension should make sure they have filled in any gaps in their standard record using the Class 3 scheme before looking at the Class 3A additional pension top-up scheme.”

New State Pension announcement?
As an outside bet, it is just possible the government will use the launch of this scheme on Monday as an opportunity to announce the rate of the new state pension which will launch in April next year. We expect this to be set at around £155 a week. Alternatively, they may wait until the Spending Review on 25 November to make the New State Pension announcement.

Annuity data
Annuity comparisons are based on an indexed annuity at 3 percent per annum (The top up state pension will actually increase in line with CPI however no CPI-linked annuities are available) with a 50 percent spouse’s pension. Enhanced annuities are based on a heavy smoker with high blood pressure and high cholesterol; the severely enhance annuity also assumes a history of pancreatic cancer. All annuity quotes are based on a PE29 post code.