What are the benefits of deferring my state pension?
The age at which we can begin receiving state pension payments is going up. And for most of us it just makes us roll our eyes. But for some of us, it may make sense to put off receiving your state pension until you really need it.
Let’s recap the basics of deferring your State Pension.
State Pension Deferral is the official term for telling the government that you’re happy for them to keep hold of your pension for the time being.
Everybody has a State Pension Age at which you become eligible to receive your State Pension. The government will send you a letter two months before, asking you to confirm if you want to start accepting payments. By failing to accept it, your State Pension will automatically be deferred.
Choosing to defer your payments means that you’ll receive higher weekly sums in the future. There may be benefits to deferring your state pension, but it’s not without risk.
How much is the State Pension?
The maximum weekly State Pension you can receive is currently £181.15. This amount usually rises annually based on what’s known as “the triple lock” – the higher figure of inflation, earnings growth and 2.5%. However, from April 2022-2023, inflationary linked rises have been scrapped because inflation is so high.
Does a deferred State Pension increase in value?
Yes, the longer you defer your State Pension, the higher your weekly payments to live on as you get older, but the higher the risk that you might not live long enough to see the benefits.
How much will I get when I claim my deferred State Pension?
For every nine weeks that you defer claiming your pension, your weekly payments will increase by 1% to make up for the money that you’ve missed out on.
If you defer payments for a year then once you start taking your State Pension, it will be nearly 5.8% higher for the rest of your life.
Did you reach State Pension age before April 2016?
The terms for deferring your State Pension changed on 6 April 2016, so anyone who reached retirement age before that date could gain a lot more from deferral than under the current scheme.
This is because the ongoing increase to your pension from deferring taking it for a year, was 10.4% under the old scheme, compared to just under 5.8% under the current scheme. This difference is pretty big - a one-year deferral for your State Pension will take you only 10 years to pay back, rather than just over 17 years under the new scheme (ignoring inflation).
Will it benefit me to defer my State Pension?
On the face of it, sacrificing a year of payments to get a larger payment every year for the rest of your life might sound worth it. But to decide if it will really benefit you, there are some factors you need to consider.
1) Life expectancy
Remember – the State Pension is guaranteed income until you die. Whether that’s the day after you start receiving payments or 40 years later.
Somebody eligible for the maximum State Pension this current tax year (2022-23) would receive £9,627.80. So, if you deferred your State Pension for a year, you’d effectively be postponing that amount of cash.
If you then started taking your State Pension after one year of deferral, it would take you just over 17 years to earn back £9,627.80 through increased weekly payments. This does not factor in inflation.
Will you live longer than 17 years?
According to the Office of National Statistics (ONS), current average life expectancy in the UK from the age of 65 is around 19 years for a man and 21 years for a woman.
So, on average, most people will slightly benefit from deferring their State Pension by at least one year. If you have a history of family illness, you smoke or you suffer from ill health, then you may think it’s too risky to defer and would prefer the State Pension payments sooner.
2) State Pension payments and income tax
As I explain in my other article about pension payments and tax, income you receive in retirement stacks up like pancakes. And this can carry a tax burden.
For most of us, our State Pension will be tax-free as it will be less than the annual Personal Allowance for income tax. But anything you earn on top of your State Pension that pushes you above the income tax free annual allowance will be taxed according to which tax band it falls into.
For example, if you defer your pension and you’re still working when you start to receive payments, you may end up paying some tax on your State Pension payments.
The same could apply with pension payments from any private/workplace pensions you start taking payments from. With private pensions, 25% can be taken tax free and the rest is subject to income tax and will be added up with your State Pension payments to work out just how much tax you will pay.
The right decision on deferring your State Pension for you will depend on your individual circumstances and how much you are earning.
The tax considerations can get complicated if you do have multiple income sources at State Pension age, so I recommend speaking to a qualified financial adviser who will be able to look at your individual circumstances and help you make the right decision.
3) Impact on other Government benefits
If you’re in receipt of other Government benefits, the rules on State Pension deferral can get complicated.
If you get:
Pension Credit, or
you will typically find that you can’t build up additional State Pension funds through deferral.
Your ability to delay taking your pension and boost your future pension payments can also be impacted if your partner receives certain benefits.
Also, when you start receiving a higher State Pension from deferral, the extra amount you receive in future years will count as income, and therefore will count against any state benefits you receive in future. For example, if you receive Pension Credit, Housing Benefit or Council Tax support then these may be reduced due to the extra income you are getting.
Unfortunately, the benefit system is complicated. Think very carefully whether deferring your State Pension will benefit you. You can find more information on how deferring your State Pension impacts other Government benefits on the Government’s website here.
What if I just take the payments now and invest them somewhere else?
As explained, deferring your State Pension effectively gives you nearly a 5.8% return in a year.
If you don’t need the income right now, there’s nothing stopping you from taking the payments and putting them in an ISA…but can you be sure you’ll make a return higher than 5.8%?
This sort of strategy is high risk and not something I come across often or noticed any success with.
Can I defer my State Pension if I’ve already taken payments?
If you’ve started taking your State Pension but have decided you would like to defer it, then you can. The same terms will be applied as if you had never taken your State Pension in the first place.
The key benefit to deferring your State Pension is increased income when you really need it.
There are several factors to consider thoroughly, so don’t make the decision lightly just based on a few numbers.
Many of us will rely on our State Pension as soon as we are eligible for it. If you’re in the very fortunate position to not require your State Pension as soon as you reach retirement age and think are in good health, then you could benefit from a higher State Pension later in life.
For more information on deferring your State Pension, you can visit the government website here.