Probably the first question to ask is why would you want to defer your state pension? As people’s lives and circumstances are complex and different, there could be a range of reasons. Perhaps some of the most common might be:
- There is no financial need for you to take the income immediately and you regard the financial terms for deferral offered by the Pensions Service as an attractive form of saving.
- As a method of saving tax by converting taxable pension into a tax free or lower taxed lump sum.
- As a method of maximising your tax credits claim.
- As a method of receiving a better value from your state pension if you are resident in a country where the UK does not give annual increases (for example, Australia).
We explore all of these possibilities in what follows. We have tried to simplify things where we can, but it is a complicated subject.
When can you defer?
There are two opportunities for deferring your State pension:
- when you reach state pension age and you first become entitled;
- when it is in payment (but you may only defer it once).
Reaching state pension age
When you reach state pension age (currently 65 for a man and 60 for a woman born before 6 April 1950 – for a woman born after 5 April 1950 the state pension age is gradually being increased)you may either claim your state retirement pension or you can defer claiming it.
Simply not claiming it counts as deferral whether this is deliberate or accidental. It is likely that there are several thousand people who are technically deferring their pensions but do not realise that they are doing so.
For example, a man over 60 on a low income may have claimed pension credit when he was 62 and he continued to claim this when he reached 65.
Many people think that continuing to work after state pension age means they should not claim the state pension. This is not correct. There is no connection between being entitled to receive the state pension and working. Some women, in particular, do not believe that they are entitled to a state pension if their husband is continuing to work.
If you defer claiming you have two options when you decide eventually to claim it:
Extra state pension
You can earn extra state pension at 1% of the weekly pension for every five weeks you put off claiming. You must put off claiming for at least five weeks to get extra state pension. So if you defer your state pension of £100 for the minimum period of five weeks your state pension would go up to £101 a week from week six when you start to take it.
Lump Sum Payment
You can choose to take a lump sum rather than an increased rate of pension. The amount of the lump sum is the amount of state pension not claimed plus interest which will be added each week and compounded. The rate will be roughly 2% above the Bank of England's base rate. In order to get a lump sum you will have to put off claiming your state pension for at least 12 consecutive months.
Most people will probably decide to take the lump sum rather than a higher pension.
When do I have to decide?
About four months before your state pension age you should receive a pension information pack. If you wish to claim your state pension there is a claim form to complete. If you do not wish to claim it immediately you do not need to do anything. If your pension includes a dependant’s increase the dependant needs to agree. If you do not normally live in the UK this option might not be available to you.
Once you have deferred you will need to tell the Pension Service when you wish to start to claim your state pension. You will then have three months in which to decide whether to take the extra state pension or a lump sum payment (for deferrals of at least 12 months).
| Example 1 Fred and Elsa decided to defer their state pension from 6 April 2012. In May 2013 they decided that they wanted to stop deferring and claim their pension. They informed the Pension Service of this decision. They would then have received a notice which explained to them that they could choose to receive some extra state pension or they could choose to receive a lump sum. The notice also explained that they had three months from the date on the notice to make their decision. They waited until July 2013 before choosing a lump sum. Meanwhile they received their normal state pension, and the lump sum that had accrued to them between 6 April 2012 and May 2013 was paid to them. |
In some cases when a person chooses a lump sum it is not possible to determine a final amount for some reason (for example because of an unresolved issue about their contribution record). In these cases the person will receive a payment on account of the final amount of the lump sum they will eventually be entitled to.
To defer or not - do you need the money immediately?
If your state retirement pension is the only or major source of income that you will have in retirement it is unlikely that you will want to defer receipt as you will be in need of the immediate income that it will provide. The basic state pension is currently (in 2012/13) £107.45 pw for a single person and £171.85 pw for a couple.
However, if you have or expect to receive an occupational pension or you intend to carry on working or you have some accumulated capital (for example, through cashing in a pension plan) then you might wish to defer receipt of your state pension.
Ignoring the impact on other benefits a simple calculation shows that £100 of pension deferred for 5 weeks means the giving up of £500 of income. The extra state pension will provide an additional £1 of income when the pension is paid and so it will take around 10 years to recoup the income given up. Of course the extra pension continues to be paid for the rest of your life so whether it turns out to be a good decision therefore depends upon how long you expect to live (leaving aside tax considerations).
If you defer a £100 pension for a whole year the extra pension will be £10.40 or you could choose to take a lump sum of £5,270, an interest rate of roughly 2.5%.
When deferral does not give any extra benefit
For any days on which you are receiving the following benefits you will not accrue extra state pension or a lump sum for the deferral:
- carer’s allowance
- severe disablement allowance
- unemployability supplement paid under the Industrial Injuries or War Pensions Schemes
- widow’s pension or widowed mother’s allowance
- incapacity benefit
- maternity allowance
- another type of state pension (apart from graduated retirement benefit or shared additional pension)
- pension credit
For periods after 5 April 2011, you will not accrue extra state pension or a lump sum for the deferral if your partner receives any of the following benefits:
- income based-jobseeker’s allowance
- income related employment and support allowance
In addition if anyone receives an increase in any of the above benefits or their state retirement pension in respect of you then you will not accrue extra state pension or a lump sum if you defer.
It is important that you seek appropriate advice if you are already claiming or are likely to claim any state benefits before deciding to defer.
What is the effect of deferral on other benefits and credits?
The amount of pension deferred will not be taken into account if you are claiming housing benefit and/or council tax benefit but will be for pension credit. Similarly the amount of pension deferred will not count as income for tax credits.
What is the effect of taxation when you decide to stop deferring?
The state pension is, taxable income even though no tax is deducted when it is paid to you. HMRC take it into account when they set your PAYE code. If the state pension is your only source of income or your total taxable income is less than the personal allowance (currently £8,105) including the higher age allowance (currently £10,500 for 65-74 year olds and £10,660 for 75 year olds and over) no tax will actually be payable.
If you choose to take the lump sum it will be taxable in the tax year in which your deferred pension starts to be paid or in certain circumstances the following year. The tax rate on your lump sum will not exceed the rate at which you are already paying income tax. In other words, if before you received the lump sum you were paying tax at 20% or 40%, your lump sum will be taxed at the same rate even if it would otherwise take you into a higher tax bracket. If no tax is otherwise payable the there will be no tax on the lump sum. If the savings rate of 10% is payable then the lump sum will be taxed at 20%.
Similarly, if you are entitled to a higher age allowance, and a lump sum would otherwise take your income above the limit beyond which the age allowance starts to be reduced (currently £25,400), you will keep the higher allowance notwithstanding.
| Example 2 In Example 1, if Fred’s income was £22,750 he would be entitled to the full age allowance of £10,500. If he then received a lump sum of £5,500 he would remain entitled to the full age allowance even though adding £5,500 to his income would normally take him over the £25,400 and cause the age allowance to be reduced. Even if Fred’s income was over £25,400 and his age allowance was being reduced (giving him an effective marginal tax rate of 30%) his lump sum would still be taxed at 20%. |
In both these cases there is a tax advantage, at least in the short term, from the lump sum being taxed at a lesser rate than ordinary income.
The Pension Service will deduct tax from the lump sum on making the payment having taken account of information that you provide as to your rate of tax. As the calculation will be made during the tax year the calculation will not always be correct and an adjustment including a repayment if too much has been deducted will be made by HMRC after the year end.
Changing tax rates from year to year
In the year in which you retire or finally retire it might be that your tax rate will be higher, because of your employment income being included in the calculation, than it would be in the following year when you may have a reduced income in retirement. That situation might cause you to defer receiving your pension, extra pension or lump sum until the later year when your tax rate is lower.
If similar circumstances apply in the year in which you decide to stop deferring your pension you can ask for the payment of the lump sum to be paid in the following tax year.
If you are thinking of taking a trivial commutation lump sum then you need to co-ordinate when this is taken with any state pension deferral planning as this type of lump sum is taxable as ordinary income and might push you into a higher tax rate.
What is the effect on housing benefit and council tax benefit when you decide to stop deferring?
When you decide to stop deferring your pension the calculation of your housing benefit and council tax benefit will include any extra amount of pension arising from the deferral.
If you decide (or have decided) to defer your pension in favour of a lump sum then the an amount equal to the gross amount of your lump sum (or an interim payment made on account of a final lump sum as above) will be disregarded as capital in calculating your housing benefit and council tax benefit.
This lump sum disregarded will apply for the lifetime of the person who deferred the state pension and the disregard cannot be inherited should the person die. However, there are rules for inheritance of extra state pension and lump sums for partners (including civil partners) during the period of deferment. More information on this can be found using this link.
Finally the housing benefit and council tax benefit notional income provisions have also been amended so that extra state pension will not be deemed as notional income if a person initially chooses extra state pension but then decides to change to a lump sum.
Tax credits
Tax credits also have the concept of notional income but for tax credits purposes, the state pension you have deferred is not treated as notional income and therefore not counted in calculating your award. The extra state pension if and when received will count as income for tax credit purposes.
The lump sum will also count as income for tax credits purposes in the year it is received. It might be beneficial to elect to defer receipt of a lump sum to the start of the next tax year if for example you would not be entitled to tax credits for the later year.
Deferring your state pension after it has started
We have mentioned earlier that a state pension may be deferred once after it has started in payment and provided it was not originally deferred and is now deferred for at least 12 months. This opens up opportunities for saving tax.
| Example 4 Evelyn is 63 and had been drawing her State pension of £6,240 a year as well as having income from her part-time job of £8,000 a year. She paid tax of £1,227 per year due to receiving her State pension in addition to income from her job. She found out that she could defer her State pension and this she did for 24 months from her 63rd birthday (7 April 2011) until 6 April 2013. She gave up her part-time job on 5 April 2013. Evelyn was entitled to a lump-sum of £12,800 on 7 April 2013 and the resumption of her pension at the normal rate of (say) £6,600. She pays no tax on either the lump sum or her continuing pension as her tax rate is 0% when ignoring the lump sum. The lump sum is also ignored for pension credit purposes, so with her income of only £6,600 she is entitled to a pension credit top-up. She is better off financially through the deferral. |
Non-residents
If you normally live outside the UK and you have not already claimed your state pension, you can put off claiming when you reach state pension age.
When you finally do claim, your pension entitlement will be based on the amount you would have got if you had been claiming it at the time. This will include any yearly increases to the state pension, even if you are living in a country where these increases don’t normally apply.
Once you have started to get your state pension, you will only get yearly increases to your state pension and your extra state pension if you are living in one of the countries with which the UK has an agreement on social security.
If you have already claimed your state pension and are living abroad you will not be entitled to defer receiving your pension unless you are living with the European Economic Area and are a UK national or are otherwise entitled to live there.
If you live outside the UK, your extra state pension and lump sum payments are still counted as income for UK tax purposes.
- HM Revenue & Customs will work out the amount in the same way as if you were living in the UK
- you may not have to pay UK tax on your extra state pension or lump sum payment if you live in a country that has a double taxation agreement with the UK, and
- you will need to contact the tax authority in the country you live in to find out if you need to pay that country’s tax on your extra state pension or on a lump sum payment.
For more about tax if you live outside the UK or for information about countries with a double taxation agreement with the UK, contact HM Revenue & Customs at their Centre for Non-residents.
To find out more about the choices you have for your state pension if you live outside the UK, contact the International Pension Centre.
Contact details are as follows:
HM Revenue & Customs Centre for Non-residents
For more about tax for people living outside the UK:
Address: HM Revenue & Customs Centre for Non-residents
Fitzroy House
PO Box 46
Nottingham NG2 1BD
Phone: 0845 070 0040 or 0044 151 210 2222 (if you are calling from abroad)
Use the link to access the HM Revenue and Customs Residency website.
International Pension Centre
For more about State Pension options for people living abroad:
Address: International Pension Centre
Tyneview Park
Newcastle Upon Tyne NE98 1BA
Phone: 0191 218 7777 or 0044 191 218 7777 (calling from abroad) Textphone: 0191 218 7280 or 0044 191 218 7280 (if you are calling from abroad). Lines are open from 8am to 8pm, Monday to Friday.
Fax : 0191 218 7021 or 0044 191 218 7021 (if you are faxing from abroad)
Use the link to access the International Pension Centre website
