For most people in the UK, the State Pension will form a substantial portion of their retirement income. On its own, it might not be enough to fund your ideal retirement, but it’s a good start.
However, building up a full State Pension means maintaining your National Insurance record. Normally, this happens automatically if you are working or receiving benefits. But in some situations you might have gaps in your record, which is where voluntary contributions can be useful.
A Short Guide to the State Pension
The State Pension works as follows:
- You build up a portion of the State Pension for every year you make National Insurance contributions or receive credits. You need 35 years’ worth of full contributions for a full State Pension.
- The full State Pension is £9,627 per year.
- It is payable from age 66, although this is rising to age 68 over time.
- The income is taxable, although tax is not deducted directly from your State Pension.
- The State Pension normally increases each year, either in line with inflation, earnings, or 2.5%, whichever is higher. This is known as the triple-lock.
It’s worth building up as much State Pension as you can, given the security of the income and the annual increases.
How Does National Insurance Work?
Most people will have National Insurance contributions deducted from salary or will pay through their tax return. If you are working, your employer will also pay National Insurance contributions on your behalf.
Sole traders also pay National Insurance contributions from their trading income, although the rates are different.
You can find out more about the rates and thresholds here.
In the following situations, you do not pay National Insurance contributions, but will receive credits that allow you to build up a State Pension:
- If your earnings fall between the lower earnings limit (£6,396 per year) and the primary earnings threshold (£12,570 per year).
- If you are receiving Child Benefit.
- If you are receiving Jobseeker’s Allowance you automatically receive credits. If you are looking for work but not receiving this benefit, you can claim credits through the Job Centre.
- If you are in receipt of disability benefits or sick pay.
- If you are on maternity, paternity, or adoption leave.
- If you are a carer.
More information is available here.
You do not qualify for National Insurance credits if:
- You are not working or in receipt of any benefits.
- You are working but earn under the lower earnings limit.
- Your income consists mostly of dividend income. Many company directors take a small salary to maintain their record.
- You are resident overseas during the tax year (although if you pay tax in another country, you may build up benefits there).
- You are in full-time education.
- You are in prison.
A State Pension Forecast can help you establish if you have any gaps in your record. If you do, you may wish to make voluntary (Class 3) contributions.
Final Salary Pensions And The State Pension
Many members of Final Salary or Defined Benefit pensions – such as the Teachers Pension, will have spent time during their working lives contracted out and paid a reduced rate of National Insurance during this time.
Contacting out ended on the 6th of April 2016, if you have service before this date what this means is that although the service during the period will count towards a Basic State Pension, it will not count fully towards the higher Flat Rate State Pension.
Some of the gap between the Basic State Pension and the Flat Rate State Pension can be made up by making voluntary National Insurance contributions
Who is Eligible to Make Voluntary Contributions?
You can make voluntary contributions for any tax year in the last 6 if:
- You have gaps in your record for any of the above reasons.
- You were eligible to pay National Insurance in the given tax years.
- You did not receive credits towards your record in the relevant tax years.
You can still make voluntary contributions if you have already reached State Pension age and you want to fill in the gaps before you claim your pension.
How Do the Numbers Stack Up?
Voluntary contributions are fixed at £15.85 per week. This amounts to £824.20 over a full tax year.
This might seem like a significant expense, but if you have gaps in your record, this will buy an additional £275 per year in index-linked pension income. This is an annual return on your investment of 33%.
To put this in perspective, current annuity rates are around 4% for someone of State Pension age to buy an increasing income for life. This means that to buy an income of £275 per year using a private pension would cost around £6,875.
No other investment provides the same level of guaranteed return as voluntary National Insurance contributions.
What Are the Risks?
As the State Pension is backed by the government, it is not subject to the same risks as a personal pension. However, there are a few risks you need to take into account.
- Your pension cannot be passed on when you die, although in some situations your spouse could receive an extra payment.
- The State Pension rules are in the hands of the government. Providing the State Pension is a significant cost, particularly as life expectancy is increasing. There is no guarantee that it will always be as generous as it is now.
What Should You Do?
It’s a good idea to make sure you build up as much State Pension as possible. If you have exhausted the other options, e.g. working or claiming the relevant benefits, it is well worth looking into voluntary contributions.
Of course, there are some risks, but given the numbers involved, they are worth taking. However, you should not rely on the State Pension alone to fund your retirement. You can mitigate these risks by building up a personal pension (or other investments) in addition to your State Pension.
Please don’t hesitate to contact a member of the team to find out more about retirement planning.