25th February 2015
Government plans to allow some older people to top-up their state pension could provide a unique opportunity those with low savings to boost their income in retirement.
For certain retirees, this opportunity to boost their state pension could be worth twice as much as they would be likely to receive by investing an equivalent sum in an annuity, according to analysis by Tilney Bestinvest, the financial adviser.
Men born before 6 April 1951 and women born before April 1953 are set to be given an 18 month window to top-up their state pension between October 2015 and April 2017. This provides a unique opportunity for retirees with small pension pots to get a better deal than they are likely to be able find in the annuities market.
During this window, the maximum additional state pension that can be is £25 per week, equivalent to £1,300 per year. The cost of purchasing this depends on whether the individual is male or female and their age at the time they purchase the benefits.
According to figures from the Association of British Insurers, the median size of annuity purchase in the UK is around £20,000 and 29% of annuities are purchased with pension pots of less than £10,000.
At the small end of the market, research also suggests there is a much less propensity to shop around, meaning many retirees are simply not getting as good a deal as they might. But even then, small pots provide only modest levels of annuity income of around 2.86%. Some retirees could achieve an income that is roughly double this rate by boosting their state pension instead.
The costs associated with buying the maximum additional State pension of £25 per week for a 65-year old male are:
|Age||Cost||Equivalent annuity rate|
David Smith, director of Financial Planning at Tilney Bestinvest, said: “If the same 65-year old male were to use a comparable £22,250 pension pot to purchase an annuity, then this would currently purchase an income of just £637.20 per annum rather than £1,300 available through this top-up scheme. Therefore this window of opportunity to acquire additional State Pensions seemingly provides an incredibly attractive option for those with small pension pots of less than £30,000 and who are not subject to the higher rates of tax.
“Under the new pension freedoms coming into place from the next tax year, those with small pots will be able to cash in their pensions with 25% tax free and the remainder will be subject to their marginal rate of income tax. The proceeds can then be used to purchase an additional State Pension rather than a traditional annuity. In essence, the Government is effectively willing to absorb the smaller end of the annuity market for a limited window of time – you could argue this is de facto nationalisation – but the main challenge is going to be lack of awareness of just how attractive this could be.”
Smith added: “Retirees have suffered greatly in recent years, in part due to monetary policies that have kept interest rates and bond yields low in order to keep the financial system afloat. These, alongside increased life expectancy, have had a very negative knock-on effect to annuity rates which has had disastrous consequences for those with little pension provision.”