Should I top up my state pension

[richfool]

I am in receipt of the UK state pension and an occupational pension which together make me a basic rate taxpayer. Because of my age (and the fact I just missed out on the new increased state pension), I have the opportunity to purchase additional state pension. If I choose to do so, it would cost me £8270 to purchase an additional £10 per week state pension (i.e. £520 per year). That additional pension would then be eligible for the usual cost of living increases (including the triple lock guarantee, for as long as it lasts!)

Noting that I am a basic rate taxpayer, I would of course lose 20% of the additional amount in income tax.

I realise I would be giving up my access to the capital involved and that depending on longevity I may or may not recover that in the fullness of time. If inflation ran at a higher figure, the triple lock or any successor to it would enhance the return. On the other hand, if I directed that same amount of capital into my ISA (invested it in the stock market), I ought to be able to earn c 4.00% on it, whilst still maintaining access to the capital for myself or my estate, although the capital and return would of course be at risk.

Can anyone see any reasons that I might have overlooked as to why I should or should not take up the offer (before it ceases next month). Currently I think the fact that I would lose 20% of the income in tax is just tipping the scales against the idea.

Thanks

[flint]

richfool

My wife ( 71 ) is in the same boat as you and recently paid £19k to purchase £25 pw additional pension.
A key point is assessing the return on investment is that the additional pension increases every year.
As we made the purchase about 4 months ago, she has recently been notified by the Pensions Service that it will be increased effective 10/4/17.
I think it is better value for my wife than myself as her life expectancy is greater than mine.
Another reason that she liked the idea, was that she prefers certainty, even if there is a small price to be paid for it.

Edit : I should have added that she does not pay tax, her only taxable income is her OAP.

[AJC5001]

That additional pension would then be eligible for the usual cost of living increases (including the triple lock guarantee, for as long as it lasts!)

Are you sure? I was under the impression that the additional pension was not protected by the triple lock and only increased by CPI. See https://www.gov.uk/statepensiontopup

If you do want to do this, you've only got until 5th April!

Adrian

[flint]

richfool

I think that Adrian is right in saying that increases are in line with CPI and that the scheme ends shortly.
CPI is good enough for us.
It can all be done online - however, I would leave it until the last minute.

[BarrenWuffett]

Yep, assuming you are happy on longevity, the state pension deal with auto cost of living increases would be the smart option compared to the uncertainties of the market.

[richfool]

Yes, just checked, you are both correct. It is only subject to increases at CPI. I thought I had read otherwise in the past, but that is from the horse's mouth.

I don't suppose IF I did it now, before the pension payment due on 27th March, that I might get an increase wef the April payment!

[flint]

If this helps, my wife received her first payment 10 days after paying over the £19K.
She receives her state pension weekly. We were happy with this.

[richfool]

I tried doing a few calculations to see if they help point the best way forward.

1. Starting with the outlay of £8270 buying an extra £520 pa in (taxable) state pension income (+ index-linking @CPI).
So currently £416 net of tax (£520 x 80%).

2. If on the other hand I invested the £8270 and obtained a return of 4% that would produce £330 pa (no tax)
...or even @ 3.5% would produce £289 pa.
... I would however still have my capital and the prospect of it growing, plus the ability to pass it on to my beneficiaries.

3. Another variation calculation, if I invested the £8270 and took income at 3.5% giving me the additional : £289pa., and then .....
withdrew 1/20th of the capital each year for the ensuing 20 years, that would substantially increase the overall income, adding £413 pa (making a total of £702 pa), BUT as it would be consuming the capital, the dividend income/interest component would quickly fall, ultimately to nothing. The only justification in the latter that I can see would be if I wanted to boost my income for the earlier part of my retirement and allow it to fall back later. Doing the latter would minimise any income tax liabilities, as I would be drawing down my own capital.

As said earlier above, if I invested the capital amount I would hope to have some growth of that, as well as some growth of the income arising. Though that is where we come down to the vaguaries of the stock market, particularly with regard to the capital growth aspect. I would also anticipate that that would not create tax liabilities, whereas buying extra state pension would incur basic rate income tax..

I realise this is bit of a HYP'ers dilemna, though the return offered by (buying) the extra state pension is significantly higher than would be obtainable buying a standard annuity and would be index-linked (to CPI).

[Gengulphus]

I tried doing a few calculations to see if they help point the best way forward.

1. Starting with the outlay of £8270 buying an extra £520 pa in (taxable) state pension income (+ index-linking @CPI).
So currently £416 net of tax (£520 x 80%).

I would look at it this way: that means that it's producing £416 per year in real (i.e. inflation-adjusted) money, that ceases on your death. At a cost of £8270 now, that means you have to live very nearly another 20 years to come out ahead in real terms. Assuming you're around state pension age (which it sounds like on the basis that this offer is being made to you, but I haven't and am not going to dig into the exact details of who it gets made to!), that's probably somewhat more than your remaining life expectancy (*). I.e. the odds are that it is going to have a slightly negative real rate of return. In contrast, long-term stockmarket studies indicate that share investments are expected to have a positive real rate of return of a few percent (**), making stockmarket investments pretty clearly the better bet for that sort of timespan (and they're clearly the better bet if you're unlucky and don't live that long, at least in total return terms).

The trouble is of course that word "bet". The real return of the additional state pension may be low, but it is about as certain as anything can be, whereas any stockmarket investments have a distinct chance of doing quite a bit worse than expected (and equally, a distinct chance of doing quite a bit better than expected - but unpleasant surprises tend to be more shocking and have more practical consequences than pleasant ones!)

In other words, it's a classic risk vs reward trade-off - the stockmarket investment has greater potential and expected reward but at the cost of higher risk. And it looks a reasonably balanced one to me - governments have been known to present people with such trade-offs that should pretty obviously be made one direction rather than the other, but this looks like one that could go either way, depending on the investor.

So I can't really say what to do. But three key questions I would ask myself if I had to make the decision are:

* How essential is the extra income to me? (The more essential, the better the low risk / low reward option of the additional state pension looks.)

* Is my personal life expectancy significantly lower or higher than that of people of my age generally? (If I reckoned it was lower, due e.g. to coming from a generally short-lived family and/or a poor state of health, that makes the additional state pension particularly low-reward and so favours the stockmarket investment. If I reckoned it was higher, the opposite, though for various reasons I think that would be a much smaller effect.)

* How important is it to me to leave capital to my heirs? (If married, split into the cases of leaving it to your spouse if still alive and the case of leaving it to others if not, and check up on whether the additional state pension has any consequences for your spouse's state pension after your death.)

Then it's basically a matter of weighing those factors and any others I haven't thought of against each other - and only you can really do that weighing up...

(*) I'm basing that on https://www.ons.gov.uk/peoplepopulationandcommunity/birthsdeathsandmarriages/lifeexpectancies/bulletins/lifeexpectancyatbirthandatage65bylocalareasintheunitedkingdom/2014-04-16 and the fact that I believe you're a man. If you are a woman, the same source suggests that it's probably equal to or very slightly above your remaining life expectancy.

(**) Assuming the stockmarket concerned continues to exist! The pre-Revolution Russian stockmarket is an obvious counterexample... However, if that sort of thing were to happen, I reckon all bets would be off for both the purchase of additional state pension and the HYP investment - so we might as well assume that it doesn't when we try to compare the two...

Gengulphus

[Lootman]

I tried doing a few calculations to see if they help point the best way forward.

1. Starting with the outlay of £8270 buying an extra £520 pa in (taxable) state pension income (+ index-linking @CPI).
So currently £416 net of tax (£520 x 80%).

I would look at it this way: that means that it's producing £416 per year in real (i.e. inflation-adjusted) money, that ceases on your death. At a cost of £8270 now, that means you have to live very nearly another 20 years to come out ahead in real terms.
(*) I'm basing that on

In Rich's example that makes sense. But when I inquired about repurchasing extra NI years, the sums came out very differently. A payment of about £700 for an extra year got me an extra £4 a week. Call that £200 a year and the break-even point is about 3.5 years. That is good odds especially given the near-zero credit risk that you mentioned.

So I'm not sure why Rich's numbers are so unfavourable.

There is a similar computation needed when it comes to decide when to start taking a state pension. If you defer then it goes up about 6% a year for each deferred year. That's under the new scheme - the old scheme was much more generous with an accrual rate of 10%. A back of envelope calculation indicated that it might take 20 years for deferral to pay off.

So in my case there is an argument to buy as many years as I can, up to the point where it adds nothing, but not a good argument to defer getting the pension.

[richfool]

Thank you for your thoughts Gengulphus.

The rate is only as favourable as it is, because my age falls just short of qualifying for the new higher basic pension. Therefore the offer was made to those who reached pension age before 6th April 2016, which I did. I am currently aged 68.

I did in fact defer taking my state pension for exactly one year, which gave me an enhancement of 10.4%. Deferring has been/was the best way to go. The return for deferring has or is about to reduce to about half that figure. The offer (of buying extra state pension) I am referring to will no longer be available after 5th April 2017.

I believe the break even point would come around the 18 year point, dependent on the actual CPI increases along the way. Thus life expectancy and the return one could achieve investing in the stock market are key to the decision. The fact that I have other pension income and thus any extra pension I purchase would be subject to income tax tends to me to take the edge off the appeal of the proposition. It's also not likely that the personal tax allowance will increase soon enough to overtake my cumulative pension income to remove the income tax implication.

[beeswax]

I looked at this a couple of weeks ago for me and my wife who is 70 and me 72 and they also wanted about 19K each for the max 25 quid per week. I decided it was not a good deal when in both cases you would need to live 20 years just to get the capital back. It may make sense for someone who is a non taxpayer but not for someone who is imo. Also life expectancy is mid eighties if you are lucky. You also lose the capital which can be reinvested elsewhere as stated and think interest rates will start to rise to more traditional levels and wrt to the triple lock? I think that will go after the next general election when the Tories are expected to have a huge majority and so no need to bribe the grey vote. I think the old terms were better and may have been more worthwhile.

[richfool]

Here are 3 articles about the subject:

http://www.telegraph.co.uk/finance/pers ... nsion.html

https://www.theguardian.com/money/2016/ ... -one-wants

http://www.bbc.co.uk/news/business-34474028

They make the point that the return is significantly better than a commercially available joint life annuity, but as with an annuity one loses access to the capital.

If I was a non-tax paying female in perfect health I think it would be a clearer decision!

[beeswax]

Thanks for those links and makes the same point that you need to hope if that is the right word that you will get to live to circa 87 years of age to break even and to me that represents a very poor deal, why? Two reasons. As someone who visits my MIL in a care home for the last two years, the majority in them are between 80 and 90, some older and some younger than that. Secondly there are state benefits like disability living allowance or its new title now and other benefits that dwarf the 25 quid a week IF your health deteriorates in or out of the care homes, which leads to my second point. 20 grand in the bank now allows you to go and buy something worthwhile in the years when you benefit from them now, eg a new Kitchen or a new car or any number of things that may not appeal when you get to say 80 plus and will you be able to drive a car then?

Its fine saying people are living to these ages but how does it affect your mental and physical health as one may get the impression that we are all going to be fit as fiddles and still riding our bikes then. Keep the money and spend it now and btw the things you can buy now will also cost more probably in ten to twenty years too.

Also people forget that a single person is guaranteed to be paid 155 pounds per week if they have no other means of income or a low state pension. A lot higher if its a couple. Its why some people won't pay into a pension fund at young ages too. The State Pension is £113 per week now which that too is rising and so why top that up when the State will give you the difference FREE of charge?

I suspect most readers here will be on pensions a lot higher and so what real difference does 25 quid a week make anyway to your quality of life? 20 grand is a lot of money to part with imo anyway.

[Gengulphus]

In Rich's example that makes sense. But when I inquired about repurchasing extra NI years, the sums came out very differently. A payment of about £700 for an extra year got me an extra £4 a week. Call that £200 a year and the break-even point is about 3.5 years. That is good odds especially given the near-zero credit risk that you mentioned.

So I'm not sure why Rich's numbers are so unfavourable.

Because Rich is talking about "State Pension top up", described in the link https://www.gov.uk/statepensiontopup given earlier in the thread, and you're talking about buying extra NI years, which I think is the "Voluntary National Insurance" contributions described in https://www.gov.uk/voluntary-national-insurance-contributions. They're not the same thing! And as I said:

... governments have been known to present people with such trade-offs that should pretty obviously be made one direction rather than the other, but this looks like one that could go either way, depending on the investor.

On your figures, which look correct to me on a quick skim, buying extra NI years looks like one of those pretty obvious decisions, whereas State Pension top up doesn't. That's governments for you...

And indeed, the first link actually admits that "If you have gaps in your National Insurance record, it may be more cost effective to make voluntary contributions first"!

Gengulphus

[Steveam]

There may be other considerations.

I'm very happy with my retirement income arrangements which are almost entirely provided by large equity holdings (including ITs and ETFs) but I have almost no inflation protection other than dividends rising over the years. I do have a considerable safety margin which just gets reinvested. For me it will be a comfort to add £25 per week of inflation protected income.

The situation can be even better than it looks as you can defer taking the state pension (including the newly bought £25) and, as I'm old enough I get this whole sum increased by 10.4% per annum. It is even better if you have a spouse or civil partner as they inherit some of this inflation proofed pension.

I do not have dependants or heirs to worry about so my main concerns are inflation risk and longevity risk both of which might have been addressed at some time in the future by buying an inflation proofed annuity.

A further consideration is that my estate is likely to be paying 40% so I'm beginning to look at expenditures like this as only costing 60%!

In summary, there may be individual circumstances when it is worth seeing this lump sum expenditure as an insurance premium to protect against serious inflation or longevity. It is particularly attractive if you are on the old scheme so that deferral is at 10.4%/annum.

Best wishes,

Steve (the same Steve from the MF with the same username but I've only now decided to join you here)

[Kantwebefriends]

I did in fact defer taking my state pension for exactly one year, which gave me an enhancement of 10.4%. Deferring has been/was the best way to go. The return for deferring has or is about to reduce to about half that figure.

It's not about to reduce for you. if you deferred again you'd get another 10.4% boost per annum. That's better value that the top-up if you wish to view them as either/or. If both interest you buy the top-up and then defer; that way you'll get the extra 10.4% on the bigger pension.

Most people reckon vaguely that their retirement portfolios should combine bonds and equities. But bonds are currently distinctly unattractive so to replace them by good-value annuities is appealing. That's what HMG is offering you. Take it or leave it.


P.S. If IHT is a worry for you remember that you can make regular gifts of surplus income without being liable to IHT whether you survive seven years or not.

[richfool]

Kantwebefriends and Steveam, Thank you. Deferring (again) is a very good point. I was aware of it, but had pushed the idea to the back of my thinking, partly because I don't want to distrupt/reduce my income stream over this coming year. (I have to show evidence of income for my wife's visa).

Thinking it all through again, I think I will either defer, as you suggest, but for a short period, or do nothing and keep the flexibility of cash liquidity over forthcoming months. If Mr Market provides any "bargain sales", I could then at least take advantage of those. There is also the increased ISA limit this coming year.

[richfool]

It's not about to reduce for you. if you deferred again you'd get another 10.4% boost per annum. That's better value that the top-up if you wish to view them as either/or. If both interest you buy the top-up and then defer; that way you'll get the extra 10.4% on the bigger pension.

Kantewebefriends, I note that deferring would be the better option, but are you sure I can do both? If so I might buy a smaller top up AND defer for say 6 months.

I take the view that by deferring and using my savings to support living expenses, I will in effect be reducing my income and thus income tax liability during this (coming) year, albeit increasing it slightly in subsequent years, though PA's would then be higher.)

[Steveam]

I’m reviving a very old thread because I think it is salutary to recognise that just six and a half years ago we were having conversations in the context of low inflation and low interest rates and a steadily rising equities market.

We talked about how many years it would take to recover the cost but, of course, it all changes with a few years of 5-10% inflation.

Best wishes,

Steve