Retirement planning can be a complex puzzle, and one piece of that puzzle in the UK is deciding whether to defer your state pension. It’s a question that many Britons face as they approach their retirement age. In this friendly journalistic-style blog, we’ll break down the factors you should consider when contemplating the idea of deferring your state pension in the UK.

UNDERSTANDING THE UK STATE PENSION

First things first, let’s get on the same page about the UK State Pension. It’s a regular payment from the UK government that you become eligible for once you reach the State Pension Age, which is currently undergoing changes, but it’s between 66 and 68 years old. The exact age varies depending on when you were born. The State Pension provides a financial safety net during your retirement years.

 

 

PROS OF DEFERRING YOUR STATE PENSION IN THE UK

• Bigger Monthly Payments: The most significant advantage of deferring your UK State Pension is that it could lead to higher monthly payments when you eventually decide to claim it. For every nine weeks you defer, your pension could increase by 1%, which works out to be around 5.8% for every full year you defer.
• Enhanced Financial Security: By deferring, you can potentially build a more robust financial safety net for your later years. This can be especially beneficial if you expect to have more significant expenses later in retirement, like healthcare costs.
• Tax Efficiency: In the UK, deferred State Pension income isn’t taxed as earned income until such time as it is put into payment, which could result in tax savings. This can be particularly useful if you have other sources of income that are taxed at a higher rate.

CONS OF DEFERRING YOUR STATE PENSION IN THE UK

• Delayed Income: The most obvious drawback is that you’ll have to wait to start receiving your State Pension. If you need the money to cover living expenses immediately upon reaching State Pension Age, deferral may not be practical.
• Uncertainty: None of us can predict the future, and deferring your pension means taking a gamble that you’ll live long enough to reap the benefits of the higher payouts. It’s a risk, as there are no guarantees in life.
• Potential Lost Income: While your State Pension sits in limbo, you’re potentially missing out on investment opportunities. If you can earn more from investing the money elsewhere, the benefit of deferring might diminish.
• Changes in Legislation: Government policies can change, including pension rules. What’s advantageous today may not be in the future if the rules get a makeover.

 

INHERITING A DEFERRED STATE PENSION

I have an acquaintance, let’s call him Joe, who is aged 76 and is ten years older than his wife, let’s call her Sarah.  They’re not clients.  He has deferred his state pension for 11 years so far.  He is planning to retire near the end of the current tax year probably in March 2024.  He is entitled to a deferred state pension lump sum of £120,000.

Two main questions sprung to mind.  Is his wife entitled to a widow’s state pension and how much tax will he pay on his lump sum?

The following link takes you to the state widow/er’s section of the HMRC website on deferred state pensions:

https://www.gov.uk/deferring-state-pension/tax-and-inheritance

The challenge is in understanding the government’s website and then making the right decision as to what to do with your deferred state pension.

 

 

I then decided to ask a series of questions to a pensions expert I know.  The questions are below in blue and the answers are in red.

Do widows/er’s still receive a state widow’s pension and, if so, how much is it these days?  I understand it depends on when the state pensioner became of state retirement age, doesn’t it? Yes, it does Tony. It also varies on other elements such as the different parts that can make up the ‘old’ state pension, i.e. basic state pension, additional state pension and the age/circumstances/marital status of the surviving spouse. Section 8 of the attached Fidelity guide, pages 17 to 19, explains the position well.

I’ve checked on government websites but it is not at all clear.  Even when it refers to an individual reaching state pension age before 6.4.16 it doesn’t categorically state whether the widow’s pension is 50% or 100%. These are areas where it isn’t always possible to be definitive as there are different variables that will affect the outcome so, although the information can be taken as a general guide, it’s always best for the client to confirm their own position with the Pension Service.

As for state pensioners who reach state pension age after 5.4.16 it doesn’t appear there is any form of state widow/er’s pension at all.  Other than where the deceased had a ‘protected payment’ (assuming the surviving spouse doesn’t remarry before they reach their own state pension age – always conditions attached!) – see page 18 of the guide.

For this category of state pensioner isn’t it better to not defer the state pension because otherwise the individual could die and leave no state widow/er’s pension to their spouse? They could. Only up to three months’ worth of backdated state pension is paid to the deceased’s estate.

I have an acquaintance who has deferred his state pension until now, aged 76, as he will retire in the next 6 months.  If he takes the lump sum option he will receive £120K but it will be fully taxable. He will pay income tax on it at the highest rate he pays on his other income in the tax year in which he starts to take his state pension (or the following tax year if he chooses to have the lump sum payment made then) but it isn’t added on top of his other income and taxed in that way. So if he is currently a higher rate taxpayer on his normal income he would pay 40% tax on the state pension lump sum.

What can he do to mitigate this tax charge if anything? The article below describes some pitfalls to watch out for, for example, the fact that the 0% rates applying to dividends within dividend allowance and savings income within personal savings allowance/starting rate band are ignored, and any tax reducers such as marriage allowance are also ignored. The making of gift aid donations or pension contributions have the effect of either widening the basic rate band (with the other bands then sitting on top) if relief at source (such as a PPP) or reducing income (net pay occupational scheme).

https://www.litrg.org.uk/tax-guides/pensioners/what-tax-do-i-pay-my-state-pension-lump-sum

https://www.gov.uk/hmrc-internal-manuals/employment-income-manual/eim75750

Although it is tempting to take the lump sum, wouldn’t it be better for him to take the higher state pension and leave a widow’s pension to his wife who is 10 years younger than him? I would be inclined to first confirm exactly what would be available to the spouse in the event of his death – see pages 17/18  of the guide – for example, is there additional state pension as well as basic state pension available or was he self-employed. Also, such matters as whether he has an IHT issue?

As long as the total income he will actually receive in the tax year that he takes his lump sum is within the personal allowance (and he has a full personal allowance available, i.e. no strange quirks where personal allowance has been reduced to pay for outstanding tax from earlier years or anything like that), then his highest rate of Income Tax for that tax year will be  0% so the tax payable on the lump sum will be 0%.

So he has decided to retire at the end of March 2024, continue taking his existing pension of £350 pm and start taking his state pension in September 2024 at a rate of £223 pw.  This means his total income will be approximately £10,000 next tax year which is comfortably below his personal tax allowance of £12,570.

Interestingly if he had taken the deferred state pension lump sum during the current tax year (2023/24) he would have been a basic rate taxpayer and paid £24,000 Income Tax (£120,000 x 20%) because his part-time employment income would have been added to his existing pension!  So with a little tax planning, a tax saving of £24,000 can be achieved.

Because the state widows/er’s pension has been so severely reduced for state pension retirees since 5.4.16 – for most widows/ers it amounts to just three months’ of the late spouse’s state pension – it will be increasingly the case that state pension deferment will be unwise for married state pensioners.

Take myself as an example. I recently had my 65th birthday. My state pension will start from 10 September 2024. However, I have no plans to retire and I expect to carry on working until at least age 75. I will not defer my state pension even though it will be taxed because if I were to die during deferment my wife would only receive a state widow’s pension for 3 months! Clearly, it makes no sense for me to defer my state pension even though it is taxable.

CONCLUSION

Deciding whether to defer your UK State Pension is not a decision to take lightly. It requires careful consideration of your personal situation, financial goals, and health outlook. While deferring can lead to higher payouts and increased financial security down the road, it also means delaying your income and comes with some level of uncertainty. Therefore, it’s essential to weigh the pros and cons and seek advice if needed. Ultimately, the right choice will depend on your individual circumstances and what you envision for your retirement years. You know it makes sense.*

 

*RISK WARNING

The Financial Conduct Authority does not regulate taxation advice, estate planning or Inheritance Tax planning. The information provided in this article is for educational purposes only and should not be considered financial or investment advice. Please consult with a qualified professional before making any investment decisions. The value of investments can fall as well as rise. You may not get back what you invest. The information contained within this blog is for guidance only and does not constitute advice which should be sought before taking any action or inaction. All information is based on our current understanding of taxation, legislation, regulations and case law in the current tax year. Any levels and bases of relief from taxation are subject to change. Tax treatment is based on individual circumstances and may be subject to change in the future. This blog is based on my own observations and opinions.