Class 3 National Insurance contributions are one of the best investments a client could make. the Brand Financial Training team explains.
Most good advisers and paraplanners will have a reasonable understanding of the National Insurance contributions (NICs) system.
After all, those who work on an employed basis will be used to seeing it as a deduction on their payslip on a monthly basis (class 1 NICs). The self-employed, meanwhile, must account for it by means of their tax return, potentially paying class 2 and class 4 contributions depending on their level of profit.
To most people, NICs might just be considered to be another form of tax. It is mostly used to contribute towards the social security system including state pensions, the health service and a number of state benefits. But, did you know that it might also turn out to be one of the best performing investments a client could ever make?
How? you may well ask. Well, the current system requires an individual to have 35 qualifying years in order to benefit from a full flat rate state pension. The flat rate state pension is payable to anyone who reached state pension age on or after 06 April 2016. It is payable at a maximum rate, which is £203.85 per week (£10,600.20 for the full year) for 2023/24.
Under the previous system, 30 qualifying years would get you a full basic state pension entitlement.
Entitlement to the ‘basic’ state pension could be topped up with an additional earnings-related entitlement earned under three predecessor schemes – the graduated state pension, the state earnings related pension scheme (SERPS) and the state second pension. Transitional provisions were therefore in place for those who, as of 5 April 2016, were entitled to a pension higher than the full flat rate one as a result of these entitlements.
A qualifying year is one where the individual had taxable earnings above the lower earnings limit, which for the 2023/24 tax year is £123 per week, or £6,396 per annum. The slightly curious thing about this is that the lower earnings limit is significantly below the primary threshold, the earnings level at which contributions start to become payable. For the current tax year, the primary threshold is equal to the income tax personal allowance threshold, which is £12,570 per annum, or £242 per week.
This is interesting in that those earning between £6,396 and £12,570 per annum effectively have the best of both worlds, i.e. they gain a qualifying year towards the state pension, but don’t have to actually pay the National Insurance contributions towards it.
So how can NICs be considered an investment? Well, for those who don’t have a full 35 years’ entitlement, there is a facility to pay what are known as class 3 contributions. These can be paid regardless of employment status, or even whether the individual is employed at all. Their purposes is to allow the individual to make a one-off lump sum payment in order to effectively ‘purchase’ an additional qualifying year.
The rate payable as of the 2023/24 tax year is £17.45 per week, or £907.40 per annum. Now a one-off lump sum payment of almost £1,000 may seem like a substantial outlay. However, we need to look at what the client gets for this. One qualifying year gets you 1/35 of the state pension, which for the current tax year is £5.82 per week. This equates to £302.86 per annum.
Ignoring, for a moment, the effect of inflation, it would take just three years’ worth of payments to recoup your money. Those who received the pension for six years would benefit from payments worth double their outlay (an effective return of 100%) and those who received it for 9 years would get back triple what they paid (an effective return of 200%). When you consider that the statistical average life expectancy for a 66-year-old is a further 20 years, you can start to see why the option looks so attractive.
If you happen to have a client approaching state pension age with less than 10 qualifying years, perhaps a national of another country who has moved to and settled in the UK, the payoff could be even greater. Ten years is the minimum qualifying period for the state pension. If you have any less qualifying years than that then you will not receive any state pension at all.
So, for example, if your client is due to reach state pension age with 9 qualifying years. Then, the same £907.40 one-off outlay could mean the difference between getting no state pension at all and getting an inflation proofed pension of £3,028.57 (2023/24 figures) per annum for the rest of their life. Provided the client is in good health with a normal life expectancy, it’s almost a no-brainer. The slight caveat is that the flat rate state pension ceases on death and cannot be inherited. Hence for those with serious health conditions and short life expectancies, this course of action may not be appropriate.
Under normal circumstances, class 3 NICs can only be paid for up to six years following the end of the tax year for which they are being made. So contributions for, say, the 2016/17 year would have to be made by the end of fiscal 2022/23. Surprisingly, it is even possible to make class 3 top-up payments after starting to receive the state pension, provided they meet the above criteria, though the increased pension would not be backdated.
However, from 6 April 2016, a little known concession was introduced. This allowed top-up payments to be made all the way back to the 2006/07 tax year for anyone who did not have a full entitlement. This was in recognition of the fact that some people may be disadvantaged by the move to 35 qualifying years for a maximum state pension from the previous figure of 30.
The concession was due to end on 5 April 2023. However, due to unprecedented demand, the government announced that this timescale had been extended until 31 July 2023. In other words, clients without a full entitlement have another 3 months to make up to 17 years’ worth of class 3 contributions. For those with clients meeting the criteria, it might just be the best investment they ever make.
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