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Wednesday, 14 October 2015

BIGGER PENSION FROM DEFERRING

One of the best ways to boost your state pension is to defer it - just don't claim it and it will be increased for every few weeks you put it off. Needless to say the rules are complex. And they are different for existing pensioners and those who reach pension age from 6 April 2016. 

The rules depend on when you were born. Men born 5 April 1951 or earlier and women born 5 April 1953 or earlier reach pension age before 6 April 2016 and come under what I will call the ‘old rules’. Men and women born later than those dates will come under the new rules when they reach pension age on 6 April 2016 or later.

The old rules
You can claim your state pension as soon as you reach state pension age – 65 for men and just over 62½ for women at the moment. But if you do not claim it that is called ‘deferring’. You do not have to do anything special to defer, just not claim your pension. When you eventually do claim it the amount you get will be increased. For each five weeks delay the whole of your state pension is increased by 1% which works out at a 10.4% increase for a year’s delay. So a pension of £120 a week would become £132. If you delay by five years it will be 52% higher – turning a £120 pension into £182. The actual amount you get will be more as the basic state pension rises each year with the so-called ‘triple lock’ of at least 2.5% a year

As an alternative to the higher weekly pension you can choose to be paid a lump-sum equal to the pension you have not received. The Government adds interest to it at a good rate of 2.5% a year. The lump-sum also gets favourable tax treatment. It is taxed at the same rate as the rest of your income that year. So if you were a non-taxpayer the lump-sum would be tax-free and if you pay basic rate tax the lump-sum can never push you into paying a higher rate of tax. 

The new rules
If you reach pension age from 6 April 2016 the rules for deferring your state pension are far less generous. You get an extra 1% added to your pension for each nine weeks you defer rather than five weeks. So each year’s delay enhances your pension by a shade under 5.8%. A one year delay will increase a £120 a week pension to £127 and a five year delay to less than £155 – much lower amounts than people get under the old rules. The new rules do not allow you to take a lump-sum.

Is it worth it?
During those years of deferring you do not get your pension. If you defer a year and give up £120 a week you will have lost £6,240 in pension you did not draw. So you will have to live quite a while to get that amount back from the higher pension – in fact under the old rules it is about 11 years to show a profit. But as life expectancy at 65 is around 20 years most people will gain from deferring for a year. Women retire at a younger age and live a couple of years longer than men so it is even more worthwhile for them.

The arithmetic is much the same for a five year delay. You need another ten years of life to make a profit under the old rules. Most men will live longer than that, and most women will live longer still. On the other hand if you defer until you are 90 you will get an enormous weekly pension but you probably won’t draw it for very long if at all. So you will end up with less pension over your lifetime.

That raises the question ‘what is the ideal time to defer for?’ When will you make the most money from the state pension?

That was the question that statistician John Dagpunar unleashed his maths on in a recent article in the statistics magazine Significance.

He found that for an average man the optimum time to defer is five years. By doing that he will get the equivalent of an extra two years of state pension before he dies. In fact the gain is almost as high for deferring for four years and not much less for three. So if you do not want to delay five years then four or even three is almost as good.

For an average woman the calculation is more complex because of rising state pension age. But John’s calculations show that the optimum deferment is around seven years for those reaching pension age now and around eight years for older women.

For younger people who will get the new state pension, men should not defer at all – they will on average not make a profit. A woman may find a short deferment worthwhile especially if expects to live beyond the average age. But the new rules were designed to be cost neutral for the government, and John’s calculations show they pretty much are.

Life expectancy
These figures assume you will live the average length of time for someone of your age. If you live a shorter time than the average you will not gain as much or may even lose money. If you live longer than average you will do better.

If you defer under the old rules John has a simple rule to decide when to stop deferring. Add ten to the number of years you have deferred. If that is the same as your life expectancy then stop deferring. Under the new rules John doesn’t recommend deferring at all. But if you do then use 17 instead of ten in the calculation.

The ONS has published this handy way to check your life expectancy. It uses more optimistic projections than John did and shows a man of 65 can expect to live to 87 and a woman to 89.

If you expect to live longer you can defer for longer. If you expect to live a shorter time then start claiming your pension. If you have deferred and then discover you are unwell, claim your pension and take the extra as a lump-sum.

De-retiring
If you have already drawn your pension you can give it up temporarily. It is called ‘de-retiring’ and you will get your pension enhanced by 1% for every five weeks you give it up, or nine weeks if you come under the new rules. You can then reclaim your pension when you want to.

Once you have drawn your pension, the extra amount you earned by deferring will rise each April with inflation, currently measured by the Consumer Prices Index, not by the triple lock. So in April 2016 with inflation negative it will not go up at all.

Further information
·         ‘Deferring a state pension – is it worthwhile?’ John Dagpunar Significance, April 2015, pp 30-35.

·         Go to gov.uk and search ‘deferring state pension’ 

This blogpost is based on an article I wrote in Saga Magazine 'Delaying Tactics' July 2015.