Fail to pay enough National Insurance before you retire and you could miss out on the full state pension. But does making up your missed payments make financial sense?
If you don’t pay enough National Insurance over the course of a tax year you’ll receive a letter asking if you’d like to top up your National Insurance contributions.
This usually means sending a cheque to HMRC with the promise of a better return on your state pension in years to come, but is it really worthwhile paying up, or should you just pocket the cash? Here’s what you need to know about National Insurance contributions and how to work out whether to top up if you’ve missed a payment year.
What is National Insurance and what does it pay for?
National Insurance isn’t strictly a tax and while it may certainly feel that way, its aim is to benefit those who contribute to it.
The main areas funded by National Insurance contributions are the NHS, unemployment benefits, sickness and disability allowances and the state pension.
Aside from the NHS, most of these benefits are in some way linked to your National Insurance contributions. However, only your state pension allowance and entitlement to bereavement benefits are impacted when you top up; your entitlement to other benefits won’t change.
How to make National Insurance count
In order to claim the full basic state pension you will need to have paid sufficient National Insurance for a certain number of years.
Each year that counts towards your state pension entitlement is called a qualifying year. The number of qualifying years you need to build up to qualify for the full basic state pension depends when you’ll start to claim it.
• If you reached state pension age before 6th April 2010, then the number of qualifying years you would need would, in most cases, be 44 years for a man or 39 years for a woman.
• If you retire after 6th April 2010, you’ll only need 30 years of National Insurance contributions – both men and women – to be entitled to the full state pension.
For the 2010/11 tax year, the amount of National Insurance you will need to pay for it to count as a qualifying year is £5,044.
If you fail to accrue the full number of qualifying years you need, you will not receive the full basic state pension but a proportion based on your National Insurance contributions.
For example, if you’ve made 20 years contributions you’ll be paid 20/30 of the basic pension.
The full state pension for 2010/2011 is £97.65 per week, meaning you’d be paid £65.10 per week if you had 20 years contributions.
At present each ‘qualifying year’ equates to roughly £3.26 p/week of state pension.
Do you have to top up?
National Insurance itself is compulsory for most people and is usually deducted automatically from your salary.
However, if you get a letter from HMRC asking you to make up your National Insurance contributions you’re not under any obligation to send off a cheque.
Instead this is more an invitation to top up your NI contributions for the previous tax year (letters sent out in 2010/11 will refer to the 08/09 tax year) so that it counts as a qualifying year towards your pension entitlement.
Should you top up?
If your National Insurance contributions don’t meet your annual threshold (this can vary depending on the type of NI you pay) HMRC will write to you between September and January to ask if you’d like to make up the difference. Whether you decide to pay to top up your National Insurance contributions will entirely depend on your circumstances. Here are some of the main points to consider.
Will you reach your target?
How close you are to making 30 years of qualifying National Insurance contributions should have a big influence on whether you opt to top up or not.
If you are in your 20s or 30s for example and expect to be working for the next 20-30 years you may decide your money is better used elsewhere.
Equally, if you’ve already contributed 30 full years of National Insurance or are very close, then you may feel that there is no benefit to topping up.
However, if you are nearing retirement and missing a number of years’ contributions, you may feel that it’s worth your while.
Are you eligible for National insurance credits?
It is possible to make National Insurance contributions without being in work.
Before sending off a cheque, you should check to make sure that you’re not eligible for National Insurance credits. These can replace your National Insurance contributions if you’ve been raising children or caring for someone in need.
If you are claiming child benefit for a child under 12 years of age or are an approved foster carer then you should automatically accrue National Insurance credits, if you don’t you may need to complete an Application for Carers or Parents credits.
National Insurance credits replace annual National Insurance contributions meaning you would not need to top up for any years you receive them.
Do you need the money now?
Whether you can realistically afford the payment is another important consideration when deciding whether to top up your National Insurance contributions.
The amount you might be asked to pay can vary hugely depending on your income and the type of National Insurance you pay and can easily run into the thousands of pounds.
Before you send this money off to HMRC you should consider whether paying will leave you hard up, or if the money might be better used now, be that to pay off debts or add to your savings.
Will you get a better return in a private pension?
Rather than topping up your National Insurance contributions you could opt to invest the money in a private pension instead; especially as the state pension may be so minimal that you’ll need to supplement your retirement income anyhow.
Essentially this would mean sacrificing your missing year’s National Insurance entitlement in exchange for investment in your private pension.
If you are considering this option you will need to weight up the impact on your state pension:
• Will doing this mean you don’t build up enough years of NI contributions to receive the full entitlement?
• Will these losses be offset by the money you’ll get back through your private pension?
It’s always worth consulting an Independent Financial Advisor if you need help.
Will there be a state pension in 20-30-40 years’ time?
The assumption that you will receive a state pension at all when you retire is worth questioning.
As the UK population continues to age many people believe that in the long run the state pension will simply become too big a burden to maintain and that people will eventually be asked to fund their own retirement.
While this is essentially all speculation, if you’re at the start of your working life you may decide that paying your outstanding National Insurance contributions will be wasted and better placed in a private pension plan.
Other points to consider
The government safety net
The government currently guarantees a minimum retirement income of up to £123 per week for everyone in the UK, regardless of their National Insurance contributions.
If you have been unable to reach the necessary full qualifying years before you retire, you may be able to top up your retirement income through these pension credits.
This benefit is means tested so if you have a private pension, savings over £10,000 or another source of income your may not be entitled to assistance.
You can get an estimate of your pension credit entitlement at the Directgov website.
However, if you have several years to wait until retirement you should consider the likelihood that similar minimum income guarantees will still be in place when you stop working.
An extra state pension
If you‘re in full time employment then it’s likely your National Insurance contributions will also be counting towards a second state pension. This could amount to up to £157.74 extra a week (2010/11). However, any top ups that you make don’t add to your second state pension.
For more information on the second state pension read the Second State Pension guide from Moneymadeclear.
It’s likely that a number of different factors will influence your decision as to whether to top up your National Insurance contributions.
To get an idea how much you will receive in retirement from the state pension you can request a State Pension Forecast, which will include both the basic state pension and second state pension.
If you are unsure whether to top up your contributions or to keep the cash yourself, you can seek independent financial advice from your nearest Citizens Advice Bureau.
Alternatively, if you have a personal pension provider you may also want to seek advice from them before making a decision.
Compare Personal Pension Plans now via http://www.money.co.uk
By Martin Lane