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How to top-up your state pension pot by £25 a week

IF you are due to reach retirement age before April 2016 when the new single tier state pension is introduced, the chances are you are feeling short-changed.

The new flat rate pension will be around £144 a week, replacing the current basic state pension and state second pension.

But many people who retire beforehand will get a lower state pension - for the rest of their retirement.

To appease this group, the Government has announced a new top-up option for the state pension.

This will be open to anybody due to reach retirement age by 2016, including existing pensioners.

The new scheme will allow extra pension of up to £25 a week to be purchased with a lump sum.

The cost of each additional pound of pension will depend on your age.

A 65-year-old will have to pay £890 to get a £52 annual income.

The maximum payment he can make is £22,250 to get an annual income of £1,300. The scheme will be open between October 2015 and April 2017.

Tom McPhail, head of pensions research at financial advisers Hargreaves Lansdown, predicts: "This will be a big story next year as people will only have a limited time to make a decision." He says

"It is a pretty attractive deal.

"The return on your money is around 6 per cent compared to an ordinary annuity where returns are 3 per cent to 4 per cent.

"And it will be inflation linked and state guaranteed. But the payback period is 17 years."

McPhail admits it is not quite the same "no brainer" as the existing pension top-up scheme for people who don't have a complete National Insurance record which hits payback within four years.

In fact no financial adviser appears willing to give a blanket recommendation that the new pension top up scheme will be right for everyone.

David Trenner, technical director at Intelligent Pensions in Glasgow, is cautious about the scheme. He says: "I fear that some people will buy the extra pension who shouldn't because they would be better off keeping the cash available.

"Some will buy it who could get a better deal elsewhere.

"And others won't buy it even though they should."

Mr Trenner lists a number of issues that people need to take into consideration.

He points out that if you are in poor health you may get a better deal from investing the money in an impaired life annuity.

Although even this may not be a good idea if you have a very poor life expectancy.

Other factors that can also boost ordinary annuity rates include your postcode, and whether you smoke or drink.

By adding to a state pension through the new scheme, you will also be creating an entitlement for a spouse.

Mr Trenner points out: "If the partner is significantly younger and in good health the dependent's pension will be very attractive.

But if they are older or in poor health it will not be."

If you do not have a partner then no further payments will be made after your death.

It is also important to remember that extra state pension would be taxable.

Therefore if you have other taxable income, it could tip you into a higher tax bracket.

Hazel Brown, pensions director at advisory firm Carbon Financial in Edinburgh, believes certain people will find the top-up facility particularly useful such as married women. She says: "Married women who have only paid the married woman's stamp may welcome the opportunity to buy extra pension.

"The self-employed, or those with their own companies who have kept their salary to a minimum and so will only receive a minimal state pension under the current rules, may also be interested."

But Ms Brown says: "There is the downside to consider.

"The fact that you have to live for around 17 years to recoup your money.

"If you die earlier you won't get any money back."

Mr Trenner adds: "It is important to consider the rest of your finances.

"Ironically, for the people for whom the extra pension would matter most, it may not be such a great idea.

"Especially if they only have a modest amount of capital.

"They would probably be better advised to keep it as rainy day money so they don't have to take out credit if something unexpected happens."

Since the extra pension will be taxable, Mr McPhail suggests that an ISA may be a more tax efficient and flexible use of money for some people.

Stocks and shares ISAs can invest in funds or investment trusts.

These are currently paying incomes of around 3.5 per cent with no extra tax to pay if they are held within an ISA.

This year the annual ISA investment allowance is being increased to £15,000 (£30,000 for couples).

Besides being able to shelter income from tax, the other advantage of ISAs is that you do not lose access to your capital while you are alive.

It will still be there in your estate when you die. ISAs are not as secure as a Government backed pension but historically income from stocks and shares has also risen with inflation.

Ideally people should take independent financial advice on these decisions.

Independent advice is needed as although the Money Advice Service may be free it cannot offer tailored advice.

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