Gareth Shaw: Mind the gap for your state pension

There may be less need to raid your piggy bank if you get the full state pension ' but to do that you'll need to have made 35 years' worth of National Insurance contributions. Picture: PA
There may be less need to raid your piggy bank if you get the full state pension ' but to do that you'll need to have made 35 years' worth of National Insurance contributions. Picture: PA
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It makes front page news every few weeks, has politicians falling over themselves committing to it and thousands of people campaigning outside of Westminster about it – yet it’s an investment that takes 35 years to mature and pays out just a few hundred pounds a month.

Amplified by the campaigning frenzy of a General Election, however, the state pension is in the spotlight and the parties vying for power clearly recognise what an important part of people’s financial future this is and how committing to its future could be a vote-winner.

Prospective parliamentarians, campaigners, lobbyists are all paying attention to the state pension, and what you’ll get in the future. The question is, amid the furore, are you?

Let’s start with the basics. The full state pension is £159.55 a week, and in order to get that amount you’ll need 35 years’ worth of National Insurance contributions.

The state pension system has recently changed to pay out a single amount – anyone who reached pension age before April 2016 would have received a combination of the basic state pension (currently £122.30) and the second state pension, which varies depending on your contribution record.

But you may get more or less than the single rate, depending on whether you were ‘contracted in’ or ‘out’ of the second state pension. If you were contracted out, it means that your workplace pension scheme (typically a final salary scheme) had agreed to pay a higher income at retirement in return for paying lower National Insurance contributions. Your state pension may be reduced because you’re getting more from your private pension. If you were contracted into the second state pension, you could get more than £159.55 a week.

I get letters from readers weekly asking why they haven’t got the full amount of state pension. And often it’s because they worked for the public sector or enjoyed being part of a final salary scheme at some point during their working life, and while they took home more pay because they paid less National Insurance, they’ve found their state pension has been reduced as they’ve been contracted out.

But more and more are getting to retirement and finding they haven’t got the 35 years’ worth of National Insurance contributions to get the full state pension amount.

And here lies a smart investment opportunity that could provide you with a double-digit return in retirement.

One reader wrote to me asking why he was only due to get around £141 a week from his state pension, and it transpired he was missing four years’ worth of contributions. Each year is worth £4.55 (£159.55 divided by 35 years), which had knocked £18 a week off his pension. It doesn’t sound like much, but over a year he’d miss out on £936; over a 20-year retirement he’d miss out on more than £23,000, factoring in an annual increase of 2.5 per cent.

The good news is that the Government allows you to fill in gaps in your National Insurance history. Usually from the past six years, but because it wants to ensure that people don’t lose out from the changes to the state pension system, it’s letting people fill in gaps from as far back as 2006 and giving them until 2023 to do so.

Voluntary National Insurance contributions costs £14.25 for one week, or £741 for a full year, although that could be lower depending on when your gaps come from and when you pay – do it before May 2019 and you could pay a lower amount.

For our downtrodden reader, that would mean a maximum outlay of just over £2,900 to boost his weekly state pension to the full amount. But it would deliver him with an additional £23,000 income over a two-decade retirement, which translates to an annual growth rate of ten per cent – a pretty tasty return as well as guaranteed, inflation-linked income for life.

Topping up your state pension might not always be the right step for you. If you’re in good health, the chances are you’ll be able to enjoy the “profits” from this investment through increased state pension after you’ve recouped your initial investment. But if you’re in poor health, you may need to think about whether or not that lump could be better spent elsewhere.

And bear in mind that any increase in the weekly rate would increase your tax bill – and could push you into a higher tax bracket.

But while you’re being bombarded with party plans for the future of this much cherished benefit, pay attention – not necessarily to the noise of the campaign rhetoric but to your own situation. If you’re short a few years, a small outlay could turn out to be one of the smartest investments you make.

Gareth Shaw is head of Which? Money Online