It is often said that the State Pension is the foundation of a solid retirement. It may not be enough to live on alone, but you definitely wouldn’t want to do without it.
However, a Freedom of Information request reveals that one in nine people defer their State Pension, choosing not to take it when they reach the State Pension Age. Whilst this may sound counter-intuitive to living a comfortable retirement, there are situations when deferring could be the right thing to do.
But when exactly is it the best option? And how does it work?
How does deferring your State Pension work?
According to the Department of Work and Pensions (DWP), as of September 2016, 11% of people chose to defer their State Pension. This equates to 1.56 million people out of 12.95 million.
Deferring essentially means that you are choosing not to claim your State Pension, instead delaying it until you decide otherwise. Once you are four months away from the State Pension age you can choose to claim it, or do nothing, which will result in a deferral. There are a number of reasons for deferring, the most common being that payments, once the pension is claimed are higher for every year of deferral.
A reform in April 2016 saw a reduced bonus for deferring, with a 1% increase for every nine weeks deferred (equating to just under 5.8% for each year of deferral. Before the policy change, deferring for one year would take 10 years to be worth it. Deferring for a year now would take 17 years to benefit from the decision (Source: Gov.UK)
For somebody in receipt of the full State Pension, deferring for one year would see their income increasing from £8,296.60 to £8,775.60 (an extra £479).
What other reasons exist for deferring?
Whilst the State Pension is often the foundation for retirement planning, it isn’t always the primary source of income for people. Some choose to defer, essentially treating the State Pension like an investment that is index-linked and yields a 5.8% return.
Of course, this is only sustainable for so long; those with a reduced life expectancy or who are worried about living long enough, may choose to claim their State Pension. Something is better than nothing, after all.
Under the old rules, a condition applied where any deferred pension could be claimed as a lump sum. This came with a guaranteed return of 2% above the Bank of England (BoE) base rate, making it a useful halfway house for those that were suffering from ill health. Unfortunately, this lump-sum option does not apply after the 2016 reform, making it vital to know the implications of deferral.
Another common reason for deferral is taxation. The State Pension is taxable, meaning that it could be efficient to receive that income later in life. For example, a higher-rate taxpayer who has not yet fully retired may find themselves paying a 40% tax on their State Pension income. That same person may be earning significantly less when they fully retire. It could then be beneficial to defer their State Pension, where they will pay either 20% or no tax depending on their level of income.
So, is deferring a good idea?
As with the majority of questions that affect your personal finance, the answer completely depends on your personal situation. It is dictated by your general level of health, life expectancy, your taxation position (now and in retirement), and the amount of money you need to meet your cost of living in retirement.
If you cannot afford to live without an income from the State Pension, then it’s safe to say that deferring isn’t the best of ideas.
However, it goes beyond that.
It is important to look ahead in both the long term and the short. Not receiving the State Pension may be sustainable at present, but it is important to know how your financial stability would be affected if:
- Your other sources of income stopped
- Your level of health changed for the worst
- You needed money for an emergency
Nobody has an identical situation, so there is no one-size-fits-all answer. Taking professional financial advice can ensure that you are making the best decisions for the right reasons.
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