With the decline in active membership of final salary pension schemes and with its inflation-based increases, the state pension is becoming a more important part of retirement income for many clients reaching retirement.
Of course, some clients have stopped working some years before state pension age (SPA) and here our planning work is often concentrated on using up available personal allowances from other sources before the state pension kicks in. But what about those situations where someone expects to still have significant taxable income, perhaps for a short time or an extended period, after state pension age? Is it worth deferring the state pension?
How does Deferral work?
State pension can be deferred in return for a higher benefit. The rate pension will be increased by 1% for every 9 weeks of deferral, which works out at just under 5.8% a year. This is less generous than the previous 10.4% rate (a 1% increase for every 5 weeks’ deferral) for those reaching SPA before 6 April 2016.
For those who qualify for the new state pension (reaching SPA from 6 April 2016) it is no longer possible to receive the benefit of deferring state pension in the form of a taxable lump sum but instead it must take the form of a higher weekly amount once it is claimed.
So, using the government’s own example: you get £159.55 a week (the full new State Pension). This works out as £8,296.60 a year. By deferring for one year, you’ll get an extra £479 a year (just under 5.8% of £8,296.60).
The crux of the matter is how long it takes you to get back that £8,296 once the pension does start at the higher rate. Here, deferring for only one year, ignoring inflation, it takes “only” 17 years to recoup the amount foregone (15 years if we allow for inflation).
What if you die whilst deferring?
At the risk of gross understatement, this is not a great result… although a spouse/partner may be able to inherit the deferred pension there is no back-payment made to your estate of the amount you deferred.
And so, leaving aside the perfectly understandable, “bird in the hand” mentality, what about the maths?
As with so many financial planning issues, life expectancy is a key factor.
According to Just (an annuity provider) with average health, three in four men aged 65 today will live to 83. For women, again assuming average health, three in four will make it to 86. So most people will gain from deferring for a year.
Deferring for five years until age 70 will still probably pay off. A five year delay on the full new state pension will mean a starting pension of about £10,700 a year. But it will still take 17 years before the total pension income received is more than if it started at normal pension age (15 if we factor in inflation).
So on average men and women will live long enough to get back what they lose from deferring for five years.
Already claimed the State Pension? You can still defer it
It’s not widely known that if you claimed your state pension when it became due, you are still allowed an opportunity to turn it off.
You can only do this once. The pension will roll-up at the same rate of 1% for every 9 weeks deferral and when you resume taking it, you’ll get a higher amount every week. But if you reached normal state pension age before 6 April 2016, the rate of increase for this deferral will be at the older, more generous 10.4% rate outlined above.
It’s hard to think of many situations where someone would choose to do this but perhaps where there is a temporary return to work or an unexpected one-off taxable income payment this might make sense.
Autonomy Wealth View: No one is going to defer the state pension if they need the money but where that’s not the case, and you’re bullish about living a long time, it’s worth looking at. If you expect to pay a lower rate of tax when you do draw the state pension, so much the better.