Does it make sense to defer my state pension?

You’re entitled to start claiming your state pension as soon as you reach state pension age, which is currently 66 for both men and women.

You don’t however, have to claim it, and the government is prepared to incentivise those who don’t have an urgent need for the cash, with a higher weekly payment when they do eventually claim.

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Under the current rules, if you reach state pension age after April 2016, you will get a top up worth 1% of your state pension for every nine weeks that you delay taking it, which works out at a rate of just under 5.8% over the course of a year.

This means that if you defer your pension for 12 months, you will get an extra £12.82 a week, taking the current weekly payment of £221.20 up to £234.02.

Or, if you prefer an annual picture, your annual pension of £11,502.40 will be boosted by £666.64 to £12,169.04 a year.

You don’t need to do anything to defer your state pension, you just don’t claim it. And, even if you’ve already started claiming your pension you can still defer it – perhaps if you’ve started working again – but you will need to request that payments are stopped.

However, it’s important to note that if you or your partner claim certain benefits, you won’t be able to get increases from deferring your state pension. This includes benefits such as Pensions Credit, Income Support and Universal Credit as well as the Carer’s Allowance and Widows Pension.

You will still be eligible for the Winter Fuel Payment if you defer your state pension. However, you’ll need to submit a claim – it won’t be paid automatically.

Does the maths add up?

As tempting as an extra £666 a year might sound, it isn’t unfortunately as good a deal as the one offered to those who reached state pension age before April 2016. They get a 1% uplift for every five weeks that they defer, which works out at 10.4% a year.

In addition to the extra cash, they also get the option to take the money as a lump sum (if they defer for more than a year) instead of taking higher weekly payments.

If you don’t need your state pension – perhaps because you’re still earning in some capacity or you have sufficient income from other pots – deferring is always worth considering. But it’s important to do the maths before you just let your state pension drift.

The most obvious starting point is to think about how long it will take for you to recoup the income you miss out on – roughly £11,500 over the course of a year.

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While those who reached state pension age before April 2016 – who benefit from a larger top-up – would only need to live between nine and 10 years to recoup that money, claimants of the new state pension would need live between 15 and 17 years (depending on the rate of pension increases).

To put that into perspective, the average 66-year-old man is likely to live for 19 years, according to the Office for National Statistics (ONS), while a woman can expect another 21 years.

This means state pension deferral should normally only be considered by those in ruder health.

If you already have health problems and suspect you might have below-average life expectancy, you’ll likely be better off taking your state pension as soon as you can. However, if you are in good health and end up being a lucky recipient of a letter from the king on your 100th birthday, it could be a canny move.

(If you like your life expectancy stats, the ONS reckons 3.1% of 66-year-old men will make it to triple figures, compared to 5.5% of women.)

The bigger picture

While your state of health is an important consideration, it’s not the only one.

You’ll also need to think of your tax position. For example, if you are still working – and expect to pay a lower rate of tax once you’ve retired – deferring your state pension can also offer an income tax saving. By deferring your state pension, you’ll not only get an enhanced weekly payment, you will also pay less of it back to the government in tax.

This is perhaps the major benefit of state pension deferral. However, if you’re in the fortunate position of not needing your state pension just yet, it isn’t the only option. There are other ways to feather your retirement nest, without needing to make predictions about your life expectancy.

Alternatives to state pension deferral

It feels a bit sneaky perhaps, but there’s nothing to stop you taking the state pension and paying that money into a personal pension, such as a self-invested personal pension (SIPP).

There can be several benefits to this approach. By ploughing more money into your retirement pot, you’ll still be boosting your future financial security, just as you would with state pension deferral, but there could be more to gain.

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Furthermore, not only will you get the benefit of investment growth over the years, you will also get the instant hit of tax relief on contributions – equivalent to the rate of income tax you pay.

This means that every £1,000 contributed by a basic-rate taxpayer would be worth £1,250, once tax relief has been added.

The longer you live, the more your money should grow. However, with this approach, you don’t need to worry about life expectancy and whether you will recoup the income you gave up. That’s because when you die, any money that is left in your personal pension can be passed on – inheritance tax (IHT) free – to your chosen loved ones. Your state pension, by contrast, will just stop once you’ve died.

You can pay 100% of your income (up to £60,000 a year) into your pension up until the age of 75 and still get tax relief on contributions. However, you just need to be aware that if you have already made a taxable withdrawal from your pension, the amount you can pay in will be limited to £10,000 a year due to the money purchase annual allowance (MPAA).

Another option is to pay the money into an individual savings account (ISA). Each year you can invest up to £20,000 in ISAs and there will be no tax to pay when you take it out (unlike pensions), enabling you to boost your tax-free income in retirement.

Finally, if IHT is a concern and you’re confident that you will have enough income in retirement, you could also think about giving your state pension income away and using it to help younger generations.

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You could perhaps pay into a Junior ISA for your grandchildren and help them build their own nest egg, or chip in with school or university expenses.

Each year you can give away up to £3,000 tax free and most gifts in excess of that will be considered potentially exempt transfers, meaning you will need to live for seven years after the gift is made for it to become totally free of IHT.

However, a lesser-known rule means you can give away as much income as you like, free of IHT, so long as you can demonstrate that making the gift doesn’t impact your lifestyle.

It does take a bit of paperwork, but where you have money to spare, it can be a very effective way of getting money out of your estate and reducing a potential IHT bill.