In this article we talk about buying added pension, give you the pros and cons, and offer up an example.
Armed Forces Pension Scheme 2015 (AFPS 15) was introduced on 1 April 2015 and the majority of you were transferred to it on that date. As a transferee, you can’t do anything to improve your benefits in your ‘old’ scheme (AFPS 75 or AFPS 05) but, even with only a short period left to serve, you can improve your AFPS 15 pension should you so wish. These pension improvement arrangements we are about to explain are a change for the better for the majority, as very few people serve for a full career, and as both of the ‘old’ schemes had service-related criteria which would prevent personnel approaching discharge from entering into most pension-improving contracts.
Before delving into the subject of AFPS15 Added Pensions it is probably wise to address the successful challenge to the transitional rules which governed the transfer of certain people to the new 2015 pension arrangements. The court found that the transitional rules were discriminatory and all public sector schemes have been working on how to right the wrong. The consultation document makes it clear that, if someone who was transferred to a 2015 scheme (so, AFPS15 for you) decides to transfer back to their ‘old’ scheme, the transfer will include the value of any Added Pension purchased. It is not a given that everyone who was transferred to AFPS15 will want to return to their ‘old’ scheme: some will be better off in AFPS15, but the issue of transferring back to an old scheme could not be ignored.
AFPS15 offers members the opportunity to improve their pension benefits by purchasing Added Pension. The purchase of Added Pension, rather than Added Years, is attractive to the MOD as it allows the scheme to keep a firm control on scheme costs. The beauty of the scheme for the member is that the contracts are for one year only which means that members can buy Added Pension in years when they feel they can afford it and even someone approaching retirement can participate. The scheme year runs from 1 April to 31 March and only one Added Pension contact may be entered into in any scheme year.
There are two types of contract which may be entered into. The first type boosts just the member’s pension and the second boosts both the member’s pension and his or her dependants’ benefits. Members can take out a new contract every year should they so wish and much depends upon how much they choose to contribute and whether the Added Pension is just for the member or is to include dependants. The rules do not include a ‘dependants only’ option.
Currently, the maximum amount of extra annual pension that someone can benefit from is £6,500 per year but this would cost up to £200,000 depending upon the member’s circumstances. We have seen from posts on social media that this £6,500 figure has been misunderstood by a significant number of people – £6,500 is the overall maximum you can improve your pension by NOT the maximum you can pay in to an Added Pension contract in any one year. This maximum level of pension improvement is set by Her Majesty’s Treasury and may alter.
The minimum amount you can pay towards Added Pension is £300 per year as a lump sum or £25 per month. This makes the arrangement flexible for all and affordable for even the most junior serviceman or woman.
Exactly what any given sum will buy is arrived at by employing factors which are produced by the scheme actuary. The factors will cater for many variable which include:
- your age when you start to pay for Added Pension,
- whether you pay monthly or by lump sum,
- whether you take out the contract at the beginning of the contractual year or part way through, and
- whether you buy Added Pension just for yourself or yourself and your dependants.
Your gender makes no difference in terms of the factors and the amount you pay.
To obtain a quote, simply submit an AFPS Form 6 to Defence Business Services (Glasgow) – this does not commit you to anything. It is not until you accept the quote in writing on an AFPS Form 6A that the contract begins. Once you have entered into the contract, if you need for some reason to stop paying the instalments, you do so by submitting a further AFPS Form 6A which cancels all previous instructions. If you do stop paying, the improvement to your pension will reflect only what you have actually paid for, rather than the amount specified in the original Added Years contract. Further, you will not be able to enter into a new contract until on or after 1 April of the next scheme year.
Once Added Pension has been purchased, it increases each year by Consumer Prices Index until it is paid out. It is paid out at the same time as the pension becomes payable and then increases each year as part of that pension.
Obviously, with every financial arrangement you enter into, there are pros and cons.
The pros are:
- Purchasing Added Pension is cost effective.
- Purchasing Added Years is tax efficient as the money you pay into the scheme to improve your pension comes from you pay before tax. For many of you, it will reduce your 40% tax liability.
- The increase in pension will feed through to Early Departure Payment (EDP) lump sum and income stream. This is because EDP benefits are based on the value of the AFPS15 deferred pension. As you know, the EDP lump sum is 2.25 times the AFPS15 pension and the EDP income stream is at least 34% of the pension. So, if you buy £100 Added Pension your EDP lump sum is £225 more than it would otherwise have been!
The cons are:
- AFPS15 is less flexible than many civilian pension schemes in respect of how you take your pension. For example, you cannot take your pension pot in cash.
- You need to be careful not to breach the Annual Allowance (AA). The AA, which is set by HMRC, is currently £40,000 and, if breached, you could be liable for a tax charge.
Many readers will be within two years of retirement at about age 40 (the AFPS 75 immediate pension point or the AFPS 05/15 EDP point) the following will give you some realistic figures to consider. Assuming you joined the Armed Forces at age 20 and were 38 when you elected to buy £100 Added pension you would pay:
Member only: £1,566 as a lump sum or £133 per month for 12 months
Member & dependants: £1,687 as a lump sum or £144 per month for 12 months.
This may appear a lot but, remember it is reducing your income tax liability and improving your income when you need it most!
To finish this article, let’s try an extrapolated example:
Joe joined at age 18 and is leaving a month after his 40th birthday. He transferred to AFPS 15 on 1 April 2015 and has decided to stay in that scheme. His rate of pay is £40K and he is a basic rate tax payer.
He decides to buy £100 Added Pension, by lump sum, on his 40th birthday. He is a single chap, so he decides to pay for the enhancement to apply to his pension only.
The cost of this lump sum purchase is £1,613 but, given that he will not pay tax on that sum, the purchase, effectively, cost him £1,290.40.
He leaves with EDP benefits so he will receive £225 more in his tax-free EDP lump sum than he would have done had he not purchased the Added Pension. So, already, the effective cost is eroded to £1,065.40.
Each year he receives EDP income, he will receive £34 per year more than he would had he not purchased the Added Pension. His State Pension Age is 68, so he will be in receipt of the EDP income for 28 years, which means he will have, over that period (and taking no account of inflation) received £952 more than he otherwise would. After basic tax this £952 would become £761.60, and that would reduce the initial outlay to £303.80.
He would only have to receive his pension (from State Pension Age) for about 4 years to have broken even – and life expectancy for males in the UK is currently about 80 years of age.
Author Mary Petley, written for the February 2021 issue of Pathfinder Magazine
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