Why you should consider deferring your state pension
Deferring your state pension entitlement when you turn 66 still makes sense in some circumstances, says David Prosser.
Not everyone turning 66 and becoming eligible to draw their state pension needs the money straight away. In which case, does it make sense to defer taking the cash in return for a more generous pension when you do start taking it? The answer for increasing numbers of people appears to be no: state-pension deferral rates have fallen to an all-time low.
In 2021/2022 the state pension, assuming you qualify for the full amount, is worth around £9,340 a year. However, if you are about to become eligible for this money, you are not obliged to claim it. For each year that you defer taking the money, you will receive 5.8% more income when you do start drawing it. So, for example, put off claiming this year’s £179.60 weekly state pension for 12 months and you would be entitled to claim £190.02 in 12 months’ time.
If you have other pension income to live off, that might be an attractive option. You are effectively treating your state pension as a savings account, and 5.8% a year is far more than you could earn right now by taking the money and depositing it in a bank or building-society account.
Despite this logic, data from the Department for Work and Pensions (DWP) suggests that just 7.7% of all state pensioners are currently receiving a higher income because they deferred drawing it – down from 11% in 2004.
A less generous system
One explanation for the fall may simply be a lack of awareness. The DWP does not make much effort to publicise your right to defer.
But a big part of the story is that the system has become less generous. Anyone reaching state-pension age before April 2016 was entitled to a 10.4% uplift in their entitlement for each year of deferral.
The effect of the change has been to extend substantially the breakeven point for those who defer – the time it takes to earn back, through your higher income, the pension you missed out on when deferring.
Under the old system, someone deferring for a year would break even approximately nine years after taking their money. Under the new system, it takes 17 years to reach the same point.
That changes the decision-making process considerably. Official statistics suggest that a 66-year-old man today can expect to live, on average, until the age of 83; a 66-year-old woman can expect to reach 86. Substantial numbers of people will therefore not be around long enough to benefit from deferring their pension.
So where does that leave you? Well, if you are in good health, deferring your pension is still worth considering. The case for doing so will be even stronger if you will have moved down a tax rate by the time you start claiming.
If you are still working, say, you may be paying higher-rate tax on your income at 40%, so this is what you would lose on your state pension too.
If you defer taking your pension until you have become a basic-rate taxpayer, you will halve the tax deduction on it – and thus shorten your breakeven period from deferral.
Some expats will benefit
Another group that should consider deferral is expatriate pensioners living in countries where UK state-pension benefits are not increased each year in line with what pensioners in the UK receive.
If you spend your retirement in certain countries – Australia, Canada and New Zealand, for example – your UK pension benefits will be fixed at the time you start drawing them. So, if you can afford to do so, it may make sense to maximise this rate.
By contrast, anyone with reason to think they may not reach average life expectancy should almost certainly take their state pension as soon as they can. If you do not need the income, you can save or invest it, so that the cash is available to your heirs. State-pension benefits, on the other hand, cannot usually be passed on.