State pension boost: top-up vs deferral

Next month the government will offer the opportunity for savers to 'top-up' their state pension. For men and women of a certain age it will allow them to buy a bigger state pension.

From 12 October the Department of Work and Pensions will allow men born before 6 April 1951, and women born before 6 April 1953, to purchase special Class 3A voluntary national insurance contributions. In return, individuals will receive a higher income in retirement.

The scheme is attracting a lot of interest, and it certainly seems appealing. This is not surprising: if you compare the returns on offer with standard savings account they are very attractive. Some people could "treble their income from savings by buying a state pension top-up instead," says Sylvia Morris in the Daily Mail.

Subscribe to The Week

Escape your echo chamber. Get the facts behind the news, plus analysis from multiple perspectives.

SUBSCRIBE & SAVE

Sign up for The Week's Free Newsletters

From our morning news briefing to a weekly Good News Newsletter, get the best of The Week delivered directly to your inbox.

From our morning news briefing to a weekly Good News Newsletter, get the best of The Week delivered directly to your inbox.

Sign up

If you pay just short of £10,000 you’ll receive an extra £11 a week state pension for the rest of your life. That works out as £572 a year before tax. The same amount of money invested in the average savings bond paying 1.8 per cent would make just £180 a year.

If you put in the sum of £22,250 you would get a top-up of £25 extra a week, or £1,300 a year. In contrast a savings account would make just £400 a year on the same sum.

Of course, if you invested in a savings account you would also have the £22,500 sitting there that you could take as a lump sum whenever you pleased. It's also worth noting a 65-year-old-man would have still to live to at least 82 to make their money back from the pension purchase.

Deferral

This is where the problem lies: in order to get that increased income you have to part with your savings. A better option may be to hold on to your savings and opt to defer payout of your state pension instead.

If you reach state pension age before 6 April 2016, "you get a very generous future pension uplift for every year that you defer your pension," says Richard Dyson in the Daily Telegraph.

It works out as a 10.4 per cent increase in payments for every year that you delay. So, if you wait just one year to start collecting your state pension you’ll get an extra £12.05 a week, or £627 a year.

If you hit pension age after next April then the boost drops from 10.4% per year to around 5.8 per cent, although even this beats standard rates available on annuities.

Figures calculated by The Telegraph show that if you use that £22,250 savings to buy the maximum top up, and the state pension increases by 2.5 per cent each year under the 'triple lock', then in year one you would get £144.40 per week, in year two £147.93 and after year three £151.54.

In contrast if you kept your savings and deferred taking your pension (assuming you hit retirement age before 6 April 2016), you would get £131.21 a week after one year’s deferral, £147.16 after two and £163.82 after three years.

In short, this means deferring the state pension for two years gives you the same pension as if you had spent the £22,250 on top ups - and you'll have whatever of your savings is left to enjoy. After three years you have enhanced your income considerably.

Why is it unknown?

Boosting your state pension without having to spend tens of thousands of pounds is certainly appealing. So, why haven’t more of us heard about deferring state pension?

"It could cost the Government billions if more people chose to defer, which is perhaps why the Department for Work & Pensions rarely highlights the benefits of deferral," says Alan Higham of Pensionschamp.com in the Telegraph.

"This is in contrast to the way it promotes the concept of buying extra state pension through the new top-up."

So, don’t get drawn in by the marketing. Do your sums and work out for yourself whether you are better off spending money on top-ups or simply sitting tight and living off those savings in order to defer taking your pension.