While some people are counting down the days until they reach state pension age, others do not feel an urgent need to draw on retirement funds.
However, when it comes to the state pension, there are both pros and cons to putting it off. We spoke to financial experts about how it works, and whether it’s right for you.
How to defer your state pension and how much it increases
As you approach state pension age, you will receive a letter from the Government providing information on how to claim. If you choose not to claim, the pension will be automatically deferred. After a certain amount of time, this can actually increase the future weekly pension payouts you are entitled to, as Dawn Mealing, head of advice policy and development at Fidelity International, explains.
“For those who reached state pension age before 6 April 2016, and chose to defer for more than five weeks, they would be allocated a higher weekly pension provision,” she says. “This is increased by 1 per cent for every five weeks of delay. So, for example, if it is deferred for 12 months, the effective rate of return is 10.4 per cent.”
The return is lower for those who reached, or are due to reach state pension age, after 6 April 2016.
Though there is another regular 1 per cent increase, it is applied for every nine weeks of deferral, leaving an effective rate of 5.8 per cent for 12 months. This works out at an extra £614 at current levels.
What are the upsides of deferring my pension?
The current financial landscape also makes deferment an appealing option for some. Ms Mealing says: “If you have sufficient income from other sources, deferring state pension could be beneficial because the rate of return on the deferred amount is currently better than cash savings rates and the amounts are guaranteed.”
“If you are in good health and have enough other income to support your lifestyle then deferring the state pension could make sense,” says Rob Morgan, chief investment analyst at wealth manager Charles Stanley. “In particular, if you are still working beyond retirement age it can be worthwhile.”
There are also tax considerations that could work as either a pro or con when it comes to deferring the state pension. For example, if you are still working but you start taking the pension on top of your earnings, this could push you into a higher band. Therefore in some cases, it is better to wait until the end of the tax year in which you stopped working before you being drawing on the pension.
What are the downsides of deferring my pension?
While it is not something anyone likes to think about, the value of deferring your pension depends a lot on when you might die. You will get more value out of deferring if you think you will live a reasonably long life, but if you don’t live long enough, you won’t recoup what you deferred.
The double-edged sword of taxes also comes into play here. “Income tax is payable on state pension, but the amount of state pension received is usually below the personal allowance of £12,570 per annum – and so is effectively tax-free,” explains Ms Mealing. “However, income tax will be payable on any increased amount that is in excess of the personal allowance.”
So, pushing your future income above the standard level might mean it attracts taxes. It can also affect your ability to claim certain means-tested state benefits.
Should I defer my state pension?
The decision to claim or defer is a highly personal one, dependent on your circumstances. If you can save tax by doing so, then it might be worth investigating. However, you should always bear in mind that the longer you put it off, the less time you will have to benefit from those higher payments later. It is therefore generally not viewed as something you should do long term.
“If you don’t need the extra income now, and you know you’ll drop a tax bracket within a few years, it’s worth considering deferring your state pension, and starting to claim it once you’re at that lower threshold,” Mr Morgan advises.
“If you have sufficient longevity, the tax saving can outweigh the short-term income forgone from deferring at an earlier point in your lifetime, though if you are unfortunate enough to die early in retirement it won’t. That’s why it can be a reasonable option for some and much less desirable for others, for instance those in poor health.”
Mr Morgan adds: “In theory, you can keep deferring the state pension for as long as you want, but it is generally unwise to do so beyond a few years as you are increasingly less likely to recoup the money given up during the years of deferral.” Broadly, he says, you’d need to live for at least 17 years after taking up your state pension to be better off deferring.
Seeking advice from a financial planner can be useful if you need help working out what your income will look like in your retirement years. They can also make recommendations based on your particular situation.
