COMMENT
The Cheapest Way To Top Up Your Pension

By Alison Hunt (TMFAlly)
February 9, 2005

Are you one of the millions of people who may be entitled to a larger weekly pension, in return for a one-off National Insurance back payment?

The basic State Pension is calculated from the number of qualifying years during which you have paid National Insurance contributions. As long as you have made at least ten years' contributions (women) and eleven years (men), you will be entitled to the minimum basic State pension (currently £19.90 per week). The more contributions you have made, the larger your pension.

Missed contributions (within the last six financial years) can also be back paid to make up any shortfall. To receive the full basic pension (currently £79.60 a week) you need to have qualifying years covering 90% of your working life.

However, a problem occurred during the six tax years from 1996/7 to 2001/2. People were not informed about any years they had missed, and as a result now have gaps in their contribution record. As a result, a large number will only be entitled to a reduced pension with some not eligible for a pension at all, as their number of years falls below the minimum.

The Government has written to about 10.5m people, some of whom are already retired, to inform them of the situation and provide them with the opportunity to pay for their missing years, should they wish to.

In many cases, making the payment will be extremely worthwhile, as they'll recoup the money in just a few months of pension payments.

What should I do if I've been sent a letter?

First, read it thoroughly. The letter will tell you:

• Whether or not you have a gap in your National Insurance record, which you can fill by paying voluntary contributions
• How the payment of these voluntary contributions will affect your State Pension
• How you can pay these voluntary contributions
• How much you can pay and when you need to pay by.

Back payments are made using what are called 'voluntary class 3 contributions'. In the 1996/7 tax year, for example these contributions were £5.95 a week, so you would need to pay £309.40 if you missed the entire year. In 2001/2 they were £6.75 a week or £351 a year. To pay for all six of the missing financial years, you would need to make a one-off payment of £1,976.

You will have until 5th April 2008 if you wish to make this payment, which can be paid in instalments.

Should you make the payment?

This depends on how much it would cost and how close you are to retirement. The closer you are, the more you are likely to benefit.

For example, the mother of someone in our office is 57, and has found she has missed 3 years' payments. She has the option of paying £824 to increase her weekly pension by £12.74 to £60.03 (an extra £662 a year). It's a no-brainer in this instance – she'll recover her outlay in just 15 months after she turns 60, and receive the extra £662 a year for life.                                                                       

If you haven't received a letter but would like to know more, you can obtain a Pension forecast by filling out form BR19, available at the Pension Service website. I recently did this and have found I am missing two years' worth of payments. I can make a one-off payment of £624 to increase my forecasted basic State Pension from £76.42 to £79.60 per week (as long as I continue working and paying until state retirement age, which is over thirty years away in my case). That's an extra £165 a year. If I were to take inflation (at 3%) into account, this sum would increase to £425.

If, however,  I were to put this sum into my stakeholder pension and it grew at 9%, I could potentially have a fund of around £9,800 when I retire. If I were to use this to buy an annuity at 5%, it would generate £490 of extra income each year, slightly more than my estimated pension.

However, if my pension only grew at 8%, I would earn slightly less.

Clearly, there isn't much in it - it's certainly not as cut and dried as seen in the previous case. No one knows what will happen in the next 30 years so to some extent I will have to decide to whom I trust my money the most!

Deciding whether to make the payment can get quite complex. Additional points to consider are whether it may affect means-tested benefits you might get when you retire (such as the Pension Credit or Council Tax Benefit). Of course, these benefits could change by the time you retire and if plans for a Citizen's Pension come to fruition, which would be based on residence rather than your National Insurance record, it would negate the need to make extra payments like this to cover any missing years.

If you need assistance in making a decision on this, you can find out more by calling the Pension Service Helpline on 0845 6006669.

You can find out more about pensions, including stakeholders, in our Pension Centre.