Topping Up Class 3 NICs
State pensions are a crucial aspect of financial planning because they are secure sources of income guaranteed by the State and paid until death. State pensions are funded on a ‘pay-as-you-go’ basis which means that there is no underlying fund from which to provide retirement benefits and the National Insurance Contributions (NICs) of the current working population are used to pay the State Pensions of those who have reached State Pension Age (SPA).
Entitlement to the new State Pension is accumulated through Class 1 NICs (for employees) or Class 2 NICs (for the self-employed). Class 4 NICs (paid by the self-employed) do not contribute towards an entitlement to the new State Pension. Entitlement is based on ‘qualifying years’ and 35 years of NICs are required to gain the full State Pension.
If an individual has gaps in their contribution record they can pay Class 3 NICs. They are voluntary and can be paid by individuals with an inadequate NIC record, allowing them to increase their entitlement to the new State Pension. Generally, if an individual wishes to pay Class 3 NICs, they should ensure they are paid within six years of the end of the tax year in which the contribution shortfall occurred.
The Class 3 NIC rate for 2022/23 is £15.85 per week, so it would cost £824.20 to purchase a full year of State Pension entitlement. If you make payment in respect of a gap in contributions that occurred in the previous two tax years, then you will pay the rate that applied for the tax year in which the gap occurred. If the payment is in respect of a tax year more than two years previously, the rate will be the one applicable in the tax year of payment.
Warning! The current arrangement of being able to pay class 3 NICs to fill gaps in your NIC record going back to the 6th of April 2006 ends on the 5th of April 2023, after which you can only fill gaps going back six tax years. It is crucial to ensure that gaps prior to the 6th of April 2017 are filled in because topping up your State Pension is a very worthwhile exercise – each additional year of State Pension purchased provides an extra pension of £5.29 per week (£275.08 a year). Looking at this from another perspective, it effectively represents an annuity rate of 33.37%(!), meaning the payback period on your initial capital is only 3 years. This represents excellent value for every taxpayer to obtain secure income for life guaranteed by the State.
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