State pension shake-up - what should you do?
The state pension is in the midst of a radical shake-up. As part of that, today a new scheme launches allowing some people to buy a top up to boost their pension by up to £25 a week. Our Money Saving Expert, Martin Lewis, is here to explain whether it’s worth it, and other key news for the over-55s.
1. New state pension top up.
If you’re a woman born before 6 April 1953 (so 62 or more) or a man born before 6 April 1951 (so 64 or more), that means you’re either drawing your state pension or are eligible to do so before 6 April 2016 when the new ‘flat rate system’ launches. As that means you’ll be missing out on the new system, the Government has tried to launch a sop to allow you to top up your current pension.
Here are the key facts (for a full rundown see Martin’s ‘Should I top up my state pension’ guide):
- You need to be getting the full state pension. You need to get (or be due to get) the full £115.95 current maximum state pension. If you’re getting less, you would be far better off buying extra National Insurance years first than doing this.
- You can buy £1 to £25 a week. In other words, an increase of £52 to £1,300 a year to your pension, which lasts for the rest of your life until you die.
- The younger you are the more it costs. The amount it costs you depends on how old you are when you do it. Eg, at 65 it’s £890 per extra pound a week, at 85 it’s £394 per pound.
- What you receive will rise with inflation. The amount you get will go up each year in line with the Consumer Price Index (CPI) inflation (which is less than the normal pension itself will).
- The payout is taxed. The cash is taxed at your normal rate, so if you are a 20% taxpayer, you'll lose 20% of it.
So who is it best for?
- Lower-rate tax payers. If you’re at the higher rate a lot of the gain is eaten up in tax, even at the basic rate a chunk is. Yet if you're a non-taxpayer (likely to be living only off the state pension), then the gain here can work.
- In good health or good family health. How good value for money this is all depends on how long you are likely to live. For a basic rate taxpayer, for every scenario, barring a woman aged 62, you have to live longer than the typical life expectancy for this to pay out. You would have to live even longer to get the money back if you paid higher rate tax.
For example, for someone doing this at 65, as a non-taxpayer you'd have to live until age 82 until you got back what you paid in, as a basic rate taxpayer you’d have to live until age 86, and as a higher rate taxpayer you’d have to live until age 94. Contrast that to average life expectancies for someone at that age of 83 for a man and 86 for a woman. Therefore for most people the gamble is against them.
- If you’re married or in a civil partnership. If you die, your spouse can inherit at least 50% of your top up payment until they die. So if you paid to get an extra £10 a week and you die, your partner will be able to get £5 a week until they die. If you have no partner, nobody will inherit your weekly payment.
In that case is it worth it for anyone?
Well it can be for those on the state pension, with little other income, who don’t pay tax. Yet perversely they are the ones least likely to have the funds to be able to do this. For those who do pay tax, I struggle somewhat to come up with scenarios where this is a great deal - even compared to putting cash in a savings account at a decent rate of interest.
Yet there are some positives. Firstly there’s what I call ‘the Peter Stringfellow rule’ - if you have a substantially younger spouse, then provided they don’t remarry once you die, they’re entitled to half of it once they’re of pension age. So if you’re 65 and they’re 45, and you both live till 85, you’d get 20 years of it, then when you die they’d get 20 years (assuming they retired at 65).
However, more important is the idea that this gives you a security of income no matter how long you live, and for many people that is attractive. Annuity products have always worked the same way, so this is in effect a Government annuity, but at better rates.
While on paper putting money in a savings account is likely to win for most, to do that you’d need to be prepared to spend the capital as well as the income and psychologically many people hate that, so this, while not text book good, could appeal to those who just want to bag safety for a long term.
2. Equity release can cost you a fortune. Beware.
Equity release is a product a bit like a mortgage, where companies offer to loan money to older people who have property but limited income. In effect you get a loan based on your home, which isn’t repaid until you move or you die.
The problem with it is that interest rates are higher than mortgages – typically between 5% to 7% - and unlike a mortgage you are never paying any of it off, so the interest compounds. For example, borrow £20,000 aged 65 at 6.5% on a £120,000 home and live 25 years, and when you die, £100,000 needs repaying from your estate. Of course house price rises can cover some of this, but when it goes wrong it can cost a fortune as this Daily Mail article shows.
Of course if you have no-one to leave your property to, then it isn’t an issue (unless you need to move home or sell it as then there can be penalties), just ensure the company you’re doing it through, is one where the debt can never exceed the house value (which all that are members of the Equity Release Council do), and get yourself independent financial advice. Plus, if you need money, borrowing £10,000 at 65 and then another £10,000 at 75 is better than £20,000 at 65 as it has less time to compound.