From October 2015, some clients will be able to top up their state pension by making the new Class 3 national insurance contributions. The deal will be very good for most people who qualify, so advisers need to make sure that these clients have enough funds to be able to make this investment.
Advisers should plan for this valuable opportunity because ignoring it could open them up to criticism.
The risk committee of the fictitious Smith Jones Financial Planning has been considering how to build this into their advice processes.
The opportunity to make this investment will be given to people who are either existing pensioners, or who will reach state pension age before 6 April 2016, when the single-tier pension is introduced. They must have an entitlement to a UK state pension – either basic or additional.
One of the aims is to give people the opportunity to increase their state pension in retirement. These people are generally those who will not get the new higher flat-rate pension, and who may have lost out because of the structure of the legacy second-tier pension. But the opportunity goes wider and will be a welcome option for self-employed people and others who have never qualified for Serps or S2P.
The Government intends to introduce Class 3A in October 2015. The scheme will be open for a limited period – it expects most people who want to take up their Class 3A entitlement will do so in the first few months, so the money will need to be available pretty promptly.
The Government says rates will be actuarially fair both for the individual contributors and to taxpayers generally but, in practice, they look pretty attractive.
The rates are age-related but are the same for men and women. The maximum income that can be bought per individual is £25 a week – that is £1,300 a year.
As an illustration, the contribution required for an extra £1 pension per week for a person aged 65 is £890, or 5.84 per cent, increased in line with prices and inheritable on death in the same way as existing additional state pension, and with a minimum of 50 per cent for the surviving spouse or civil partner.
The maximum investment for a 65-year-old is therefore about £22,250. The corresponding open market commercial annuity rate for an equivalent return would cost roughly twice that.
For a 70 year-old, the rate reduces to £779 (i.e. a maximum investment of about £19,475).
There is a website where advisers and clients can go to get an exact quotation: www.gov.uk/state-pension-topup
The risk committee want to try and identify those clients who should be reserving funds for this purpose. The key issues are:
- Identifying who qualifies
- Deciding the characteristics of clients for whom this would make a suitable investment and how to prioritise it
- Determining how much clients should aim to invest
- Agreeing the appropriate source of funds for the investment in October 2015 or the suitable interim investment for the holding period
The firm needs to establish who this opportunity is most suitable for.
Clients who are looking for long-term retirement income are the main target. This covers a large number of people but there are be bound to be a few people who do not need any more taxable income now, and almost certainly will not in the future. But even these people may be grateful for such an opportunity and might use it to finance further gifts from income to help with their IHT planning.
State pension top-up
Alternatively, they could save it or make extra pensions contributions (if possible) it they do not need the income initially.
With government backing and full indexation, it is a low-risk investment. The main problems are liquidity –or the lack of it – tax and health.
A priority would be for a client who is likely to be paying basic-rate tax, rather than a spouse or partner who is a higher-rate taxpayer, to invest in a state pension top-up on their future income.
A client with poor health would probably not want to invest in the top up, but it would depend on the degree of their impairment.
A client without someone to whom the dependant’s pension would pass would be less inclined to regard this as a priority investment, although it might still make a lot of sense.
Danby Bloch is editorial director at Taxbriefs