The problem stems from the government decision to simplify the state pension system from April 2016. As part of reform, the second state pension will officially be abolished at that time. This poses a problem for a certain segment of workers who have opted out of the second state pension in the past and, due to additional circumstances, will not be eligible to receive the full basic state pension of £155 per week.
The writer of The Week article went on to present three options for affected workers: spend a minimum of £10,000 to purchase extra National Insurance credits between now and October of 2017, take that same £10,000 and put it into a savings account, or simply defer the state pension for a few years in order to increase payments. The writer went on to do the maths for all three options.
The first option is not even close to being acceptable. Spending £10,000 on additional National Insurance credits only amounts to an extra £572 annually. A pensioner who lived for ten years beyond retirement age would receive a total of £5,720 in extra payments after spending £10,000 to get them. It is an obvious loss.
The second option, taking the £10,000 and placing it in a savings account instead, is better – but not by much. The writer assumes the best savings rates of 1.8% on a two-year bond. Such a return would yield an additional £180 per year. After ten years the pensioner with have earned £1,800 in interest, considerably less than he/she would have received in extra state pension payments. BUT he/she would also still have the original £10,000. Under the first option, that £10,000 would be gone.
The third option is to defer the state pension for one year. Doing so would generate an additional £627 per year in state pension payments for someone who retired before 6 April 2016. Over ten years, that's an additional £6,270. Combining options two and three means the pensioner can take advantage of the best savings rates possible while at the same time increasing state pension payments to a higher level than would have been received had he/she purchased additional National Insurance contributions.
We said we were going to demonstrate how property beats all three options, so here we go. Buy-to-let property has consistently averaged a 6% annual return since the mid-1990s. Let us take that £10,000 and combine it with an additional £10,000 from a private pension pot to generate a £20,000 deposit on an £80,000 investment property. Despite mortgaging £60,000, the total investment made is still £80,000. At 6% annually, that works out to £4,800 before expenses. Even if you assume half that revenue to cover expenses, you're looking at £2,000 annually. Over ten years, that same £10,000 will have earned you £20,000.
Of course, most buy-to-let landlords earn closer to the full 6% even after expenses. It is clear that property is better than the best savings rates on the market, better than deferring your state pension, and certainly better than spending money to top up your National Insurance contributions.
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