Earlier this year, a report suggested that half a million people could be paying ‘unnecessary’ tax on their state pension.
The issue arises where someone carries on working beyond state pension age. At 65, state pension age is now the same for women as for men. It rises to 66 in October 2020 and is expected to rise again after this. As a state pension is taxable, working whilst at the same time claiming a state pension can simply generate more taxable income – hand-in-hand with higher tax bills. With an increasing number of people working in later life, the issue is worth exploring.
Deferring state pension
You can defer your pension simply by doing nothing when the Department for Work and Pensions (DWP) writes to advise that you are close to state pension age. Doing nothing effectively defers your pension until you decide that it is the right time to start to receive payment. If you are currently receiving a pension but feel deferral would be a better option, you can change tack by contacting the DWP and asking to ‘de-retire’. This puts the pension on hold. If you are economically active past state pension age and can afford to do without a state pension for the time being, the option to defer a state pension may be beneficial. However, the calculation can be complex.
The potential advantages of deferral are:
- keeping taxable income down now
- increased payments when you do claim – ‘extra’ state pension
- potentially paying a lower rate of tax, depending on your circumstances.
With the introduction of the ‘new state pension’, the rules have changed. Different provisions apply depending on whether you reached state pension age before 6 April 2016 or after this date. In terms of deferral, the option is more generous for those reaching state pension age before 6 April 2016. Here, a state pension increases every week of deferral, as long as you defer for at least five weeks. This equates to 10.4% for every 52 weeks. Qualifying under these rules also gives the option of receiving a one-off lump sum, rather than higher weekly payments.
If you reach state pension age on or after 6 April 2016, you have to defer for at least nine weeks to get increased weekly payments. The increase is just under 5.8% per 52 weeks. For instance, if you are eligible for the full new state pension at £168.60 per week and defer for 52 weeks, you would receive an additional £9.74 per week (at current rates). There is no lump sum option.
But there is a long payback period to recoup deferred income – ignoring tax. This means that any decision to defer is usually best taken in tandem with a consideration of overall health and wellbeing. If, for example, you reach state pension age before 6 April 2016, and you defer for one year, you only really start reaping benefits after nine to ten years drawing your pension. If eligible after 2016, you benefit after about 17 years. These payback periods are before tax. If you currently pay tax at 40%, but would pay at 20% when you receive a higher amount of state pension, the payback period is less than this.
There are other factors which might make taking the pension a better choice. Drawing your state pension, rather than deferring it, could mean you can postpone drawing on any other pension provision or investments you may have. For example, gains on assets and investment income on assets held within a pension fund will continue to contribute to the pension fund without an immediate tax charge.
Please do contact us for further advice in this area.
Please note: This article is a commentary on general principles and should not be interpreted as advice for your specific situation.