It’s not often that you get a great deal from the UK Government, but Class 3 National Insurance really is a bit of a bargain for those in my situation.
HMRC (the UK equivalent of the IRS in the USA) don’t go out of their way to bring people’s attention to Class 3 National Insurance, and it can be fiendishly complicated for individuals to work out whether it’d be worthwhile given their individual contributions history. It doesn’t work for everyone (for some people, voluntary contributions won’t increase their state pension at all), but for Dossers like me, it’s a steal. I’m regularly surprised when others in a similar position drop into conversation that they won’t receive a full state pension when they hit the appropriate age. Are they mad? I’ve topped up my National Insurance contributions today, so thought I’d post a note whilst my mind is on the subject.
Under the new UK state pension scheme (from 2016), you get 1/35 of a full state pension, currently £164.35 per week, in respect of each year for which you made the necessary contributions. Being a Dosser, with no intention of entering employment or self-employment again in the future, the way for me to make sure I get my 35 ticks in the boxes is by paying Class 3 (also referred to as Voluntary) National Insurance.
CAVEATS: Things can get very complicated due to the interaction of the old (pre-2016) and the new (2016 onwards) systems. For me, it’s clear that it’s only the new system I need to look at here and everything in this post is specific to that. The situation for other people could be very different. Also, people in their 40s like me considering making voluntary contributions do have to be pretty certain that they’re not going to get the contributions in the future anyway through employment or self-employment – in which case any voluntary contribution now will have been money wasted. It goes without saying, but please don’t take any action based on this post without knowing exactly what you’re doing (the place to go for free expert advice is the Pensions Advisory Service).
I’ve paid a total of £2189.20 today in respect of three tax years (2014-15, 2015-16, and 2016-17). That’ll add £164.35 ✕ 3/35 ✕ 52 ≅ £732 per annum to my state pension entitlement. I should receive my state pension from age 68 (or possibly a bit later if the Government keeps moving the goalposts as it has in recent years).
It’ll take three to five years for me to get my money back (depending on the tax rate applied to my £732 – three years if there’s no tax payable, five years if it’s 40% tax), but according to the Office for National Statistics, my life expectancy is 88 – so the chances are I’ll be drawing that £732 a year for a lot longer than that…. If I did receive the state pension from age 68 and died at just turned 88, the extra gross pension I’d receive from today’s contribution would be £732 ✕ 20 = £14,640. That’s not too shabby for a contribution of £2189. If I live longer (apparently I have an 11.9% chance of reaching 100), the numbers get even better; if I don’t, well, my wasted Class 3 National Insurance Contributions will be the least of my worries.
You can check out the ONS Life Expectancy Calculator here
Now, I know that there will be cries of “What about the Time Value of Money?” from certain quarters at this point. Ahhhhh, you academic types……. The issue here is that I’ve paid the £2189 now at age 46, but I won’t start to get £732 a year back for another 22 years, at age 68. That’s a bit of a wait. So maybe the deal isn’t as good as it seems?
Not exactly…. The thing is that £732 I’m promised at today’s prices will increase each year. In the UK, state pensions currently increase annually according to a “triple lock”: the higher of inflation, average earnings, or 2.5%. So long as the estimated pension growth rate exceeds the discount rate (as a guide, current 20 and 25 year gilt yields are around 1.86%) then taking into account the Time Value of Money would make the deal look better than it does already, not worse. Honest. In simple terms, the very generous “triple lock” growth in my £732 each year outweighs the cost of waiting.
The main negative I can see is that there’s plenty of time left for successive governments to mess around with the pension rules before I reach retirement. The triple lock might be scrapped, my state retirement date might be pushed back even further, they might increase the number of years’ contributions needed for the full pension, or they could just increase the cost of “buying” a year’s contributions. Will things change sufficiently to make Class 3 contributions at today’s prices a bad deal? Personally, I don’t expect so. I’m getting my ticks in the boxes sooner rather than later before some cash-strapped Government jacks up the cost……