Deferring Your State Pension – A No-Brainer or a Gamble?

Financial Planner Simon Hartley breaks down what deferment could mean for you.

You may have heard that it’s possible to defer your State Pension; either before you receive a penny of it, or, even if you’ve been receiving it for years.

“Why would anyone turn down free money?” I hear you scream…

Well, that’s because having a little patience could save you paying a significant chunk of it back into Boris’ coffers!

“Ahhhhh…” Indeed; but it’s not necessarily the right option for everyone. Confused yet?

Let’s take John as an example: he’s 66 and earns £50,000 a year but doesn’t want to retire until he’s 70. At this point he is still a Basic Rate Taxpayer, but if he were to start taking his full ‘new’ State Pension of just over £9,100 a year, this would push him into 40% Income Tax and he would therefore net just £5,460 p.a. of his State Pension; losing him £4,550. John may well be considering putting his State Pension on hold until his income drops.

By deferring, John would avoid creeping into the Higher Rate tax bracket and increase his future government-backed pension by 5.8% a year for every 12 months’ deferred (or 1% p.a. for every 9 weeks deferred).

Assuming that John defers for four years until he retires at age 70, his State Pension would have increased to £11,400 (£9,120 p.a. after tax). In theory, he would be £3,660 p.a. better off; not only has his pension increased, but by waiting until he’s stopped working to draw it, he’s also saved himself £1,820 each year in Higher Rate Income Tax.

Is John actually better off though? After all, he’s missed out on four years of State Pension payments which, even after Higher Rate Tax, would have totalled £21,840. Based on John drawing his increased pension from age 70, it would take him nearly six years to get this back and it would actually be 12 years before he broke even compared to drawing the pension from age 66 when it fell due. This would take him all the way to age 82. Of course, we have to factor in our own longevity. John’s Life Expectancy at age 66, according to the Office of National Statistics, would be 85 (19 years). We need to live long enough to see the benefit as our State Pension unfortunately dies with us. The old adage ‘a bird in the hand…’ springs to mind here.

Since we never know what’s around the corner, it might appear to John that he is better off simply taking the State Pension and incurring the Higher Rate tax bill, even though he doesn’t need the income yet. Before deciding, John consults with Rachel – his Financial Planner – who agrees with John, but discusses a subtle but significant tweak to his plan. Rachel recommends that John draws the State Pension when due but re-invests the net amount into a Personal Pension until he retires.

Personal pension contributions attract tax relief at your marginal rate, and so not only could the 40% tax be reclaimed, the funds would also immediately fall outside of your estate for Inheritance Tax purposes. You would then have the chance to take the funds back out at a more tax-efficient point in time, with the potential to have achieved some investment growth in the meantime. Food for thought.

It’s worth pointing out that if you reached State Pension Age before April 2016 then the deferral rates are more favourable – 1% p.a. for every five weeks deferred rather than nine. You also have the option of taking the increase as a lump sum when you start/restart drawing your pension. This opens up a whole new world of financial planning opportunities (but that’s for another article…).

State Pension Deferral can be an invaluable financial planning tool when utilised correctly, but be aware that there are restrictions and limitations. Obviously not everyone would be better off deferring the State Pension and we strongly suggest seeking independent advice before taking any action.

Simon Hartley BA(Hons) DipPFS
Financial Planner