£205K to replace -- why clients really need a full State Pension

There can be lots of reasons why clients might not get the maximum State Pension.

If they’ve taken time out of work to raise kids or care for elderly parents, if their earnings have been very low or they’ve worked for themselves, or if they’ve spent time living and working abroad - all can be reasons why they may not get the full State Pension.

If that’s the case, it could cost them dearly in retirement. As you’ll appreciate, that’s because the State Pension is extremely valuable income - and very expensive to replace.

How expensive? According to the latest market prices, replacing the current maximum State Pension (available to those retiring after 5 April 2016) would cost slightly more than £205,430. That’s based on buying an annuity to replace the income provided by the State Pension.

The reason it costs so much to replace is obvious - the State Pension is both guaranteed and protected against inflation, two things that are precious and difficult to replicate any other way.

The rates on annuities paid to a healthy 65-year-old at the moment is around 5.16%. That’s with income payments escalating by 3% a year to combat rises in prices – not the full protection against inflation that the State Pension enjoys thanks to the ‘triple lock’ (the promise to raise the payment by the greater of inflation, wage rises or 2.5%) but still very valuable.

On the basis of that rate, it would require £205,430 of pension savings to replace the current full State Pension of £203.85 a week.

As you’ll know, annuities are not the only way to get an income from retirement savings. Income drawdown is another option. A rule of thumb is that someone can withdraw around 4% a year from their drawdown pot and still have a good chance that their savings will last for 30 years.

Based on that, an individual would need £265,005 of pension savings in drawdown to recreate State Pension income - more than an annuity and without the guarantee that income will last until they die, but with the benefit that the money remains theirs.

Why the State Pension is so valuable

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Given the high cost of getting it any other way, it makes sense for most clients to maximise the income they get from the State Pension. Their entitlement to the State Pension is, of course, based on their National Insurance (NI) contributions. To get the full State Pension a client needs to have made NI contributions for 35 complete years by the time they retire.

The government has an online service that lets individuals check their NI record for any gaps and to see whether they’ll get the full amount. They’ll need a government Gateway account, which they can sign-up for using details from their passport, payslips or P60. If they have gaps in their record, they may be able to pay voluntary NI contributions to fill them, or else fill them with NI credits that apply in some circumstances.

As you’re probably aware, the government has just extended the window to fill in missing years of NI from 2006 to 2017. Usually, it’s only possible to pay for gaps for the previous six years. However, men born after 5 April 1951 and women born after 5 April 1953 now have until 31 July 2023 to pay for any eligible gaps between the tax years April 2006 and April 2017. This effectively creates a window of just over 17 years. After 31 July 2023, this will revert to the usual six-year period.

The new State Pension – special offer now extended