Reaching the State Pension age is often a seminal moment and many of us still retire when we reach this milestone.
However, more and more people are continuing to work past their State Pension age and defer taking their State Pension until they actually retire.
Increasing numbers of people are looking for more flexibility in their retirement planning, so we thought we’d take a look at some of the questions we regularly get asked about deferring the State Pension, starting with the basics:
“How does deferring my State Pension work?”
There are a few rules to follow:
- The minimum period of time you can defer your State Pension for is five weeks, there is no limit on the length of time you can defer for
- People who defer their State Pension will receive a higher pension, when it is finally claimed, than if they had taken it at their State Pension age
- Alternatively, if you defer your State Pension by 12 months or more, a lump sum can be paid instead of a higher income
- You can defer your State Pension even if you have started taking it, providing you are resident in the UK
- It isn’t just the Basic State Pension you can defer either, if you haven’t opted out of SERPS (State Earnings Related Pension) or S2P (State 2nd Pension), which followed on from SERPS, you can defer that too
- A word of warning though, any extra pension you receive, by electing to defer, will only increase in line with CPI (Consumer Prices Index) and will not benefit from the ‘triple lock’ which applies to your State Pension and means an annual rise in line with wages or inflation, whichever is higher and subject to a minimum increase of 2.5%
“How much extra will I get if I defer my State Pension?”
For every five weeks you defer your State Pension it will be increased by 1% when you come to claim it; that equates to an extra 10.4% every year. The higher pension is paid for every year of your life, no matter how long you live.
For example, not taking into account the annual inflationary increases, a person delaying the current State Pension for two years would receive £110.48 per week when the pension comes into payment, rather than the £102.15 they would have been entitled to without deferring.
Update: 23rd June 2014 Anyone deferring their State Pension after April 2016 will receive a lower annual increase of 5.8%. However, people who have deferred before this date will be unaffected and will continue to get the higher rate of 10.4%.
If you defer your State Pension for a year or more, you will have the option of a lump sum payment instead of an increased income. The lump sum will be equal to the amount you would have received plus interest, at 2% above the Bank of England base rate, currently 0.50%.
Any lump sum payable to you would be added to your other income and subject to income tax, although the rate of tax you pay will not be higher than your current tax rate of 0%, 20%, or 40%.
If you take the lump sum option your State Pension will be paid at the normal level, with no increase.
“How do I defer my State Pension?”
It really is very easy; in fact you don’t have to do anything!
By not claiming your State Pension it will automatically be deferred and when you decide to claim you will need to complete a BR1 Claim Form.
“Which is best? Extra income or a lump sum?”
This is a tough one to answer and really depends on your own individual circumstances.
The first thing to make clear is that you don’t have to make this decision until you finally decide to take your State Pension, you therefore have plenty of time to weigh up your options.
Whether you are financially better off taking the lump sum, or the higher income, depends on a number of factors, principally your life expectancy and the Bank of England base rate, which the interest on the lump sum is pegged to.
As a rule of thumb the longer you live the more attractive the higher pension is, however you need to make sure you live sufficiently long to clawback any income you have missed. For example if you defer your State Pension for a year you will have to live to 10 years to make up for the year you have missed out on, clearly from the 10 year point onwards, you will be in ‘profit’.
It’s also worth noting that the interest rate on the lump sum is set at 2% above Bank of England base rate, currently 0.50%. A gross interest rate of 2.50% will hardly set the world alight, although compared to some best buy savings accounts it is actually quite attractive.
The taxation argument is interesting too, if you take the lump sum it will all be taxed at the rate you are paying when you finally take your State Pension, it cannot push you into a higher rate of tax, nor does it affect your age allowance.
The decision will ultimately come down to your own personal circumstances. For example, if falling Annuity rates will mean a lower income in retirement then deferring the State Pension for a couple of years, and taking an increased pension, when you finally retire, might help to offset the effects of lower Annuity rates.
Conversely you might have sufficient income for your needs, but no spare capital. Deferring the State Pension and taking a lump sum could therefore be one way of creating a small nest egg or emergency fund.
“When is it right to defer my State Pension?”
Some examples of when it might be right to defer your State Pension:
- If you are voluntarily not retiring yet and do not need the income
- If you can’t afford to retire at the moment and need a higher State Pension in the future to enable you to retire in years to come
- If you believe the additional return, either in the form of a higher State Pension or the interest on a lump sum, is better than the return you can make by taking the pension
- If taking the State Pension would push you into a higher rate of tax, possibly because you are still working, then you may prefer to defer it until you have retired when your tax rate may be lower
“When is it wrong to defer my State Pension?”
- The most obvious answer to this question is “when you need the money”! If you need the income from the State Pension to retire you will probably have little choice but to take it as soon as it is available
- If leaving a larger estate on your death is important to you, deferring your State Pension might not be right for you. If you have taken the State Pension as scheduled and saved it, or indeed deferred the State Pension and then taken a lump sum, this money will then be available for you to leave in your will. However, the situation during deferral is hugely complicated, with any lump sum only paid out to your spouse or civil partner when they reach State Pension age and questions over whether the additional income would ever be paid
- Some people may simply wish to take the State Pension because it is available and their ‘right’ having paid National Insurance for their entire working life. Whilst this is certainly a valid view, it may not be the most lucrative financially
Deciding whether to defer your State Pension is a complex decision and cannot be taken without considering your other pensions and options for creating an income.
Our team of Independent Financial Advisers in Nottingham are experienced in developing retirement income strategies for clients the length and breadth of the UK. If you are approaching retirement and would like advice on your options call one of our IFAs today on 0115 933 8433, alternatively enquire online or email firstname.lastname@example.org