State pension: to defer or not to defer (Part 1)
Since April this year it has been possible to defer your state retirement pension, and when you do decide to claim it to take a lump sum in lieu. In order to decide whether to defer or take the pension straight away, you need to consider what effect either course of action will have on your tax liability and entitlement to state benefits. This article looks at how the lump sum is taxed, and how it and your deferred pension are treated when working out your state benefits.
Before April 2005, when you reached state pension age (currently 60 for a woman and 65 for a man) you could either claim your state retirement pension or you could defer claiming it. If you deferred claiming, it meant that you would receive a higher state pension when you finally chose to claim it.
Before April 2005 you could only build up extra state pension for a maximum of five years after you reached state pension age, and you would earn 1% extra state pension for every 7 weeks you put off claiming.
However, The Pensions Act 2004 brought in new, more generous rules for those choosing to defer their state pensions. From 6th April 2005 there are two options available to people who defer their state pensions:
- Extra state pension: You can earn extra state pension at 1% for every five weeks you put off claiming. You must put off claiming for at least five weeks to get extra state pension.
- 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. You will have to put off claiming your state pension for at least 12 consecutive months after 5 April 2005, i.e. until at least 5 April 2006, to have the choice of a lump sum payment.
There are many things to consider before deciding whether deferring your state pension is a good choice for you. This article will look at the tax issues relating to deferment and the possible impact on other benefits.
Your lump sum will be taxed in the tax year in which you claim your deferred pension, 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 10% or 22%, your lump sum will be taxed at the same rate even if it would otherwise take you into a higher tax bracket.
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, you will keep the higher allowance notwithstanding.
Pension Credit has rules about notional income, or income that you are treated as having although you do not actually possess it.
Even if you defer your state pension, the amount of the state pension which you would be entitled to claim will be treated as notional income in your pension credit calculation, and will therefore be counted in full.
Example: Mr Jones reaches 65 on August 1st 2005. He would be entitled to claim a state pension of £82.15 per week. Mr Jones decides to defer his pension for a few years as he has an occupational pension of £150 per week which he is happy to continue living on. When he applies for pension credit his total income will be calculated as £232.15 per week even though he only physically receives £150 of this. This is because his deferred State Pension is counted as notional income - income which he is entitled to but has chosen not to claim.
When you do finally decide to claim your state pension it will be taken into account in full (along with any extra state pension which you have accrued) when calculating your entitlement to pension credit.
We are informed by the DWP that it is the Government's intention that the lump sum payment is to be ignored in the calculation of Pension Credit, and that they will be bringing forward legislation that will come into effect at the same time as the first lump sums become payable in April 2006.
Housing Benefit & Council Tax Benefit
The effect of deferring your state pension on housing benefit and council tax benefit will depend on whether or not you are claiming pension credit.
- If you are claiming guarantee pension credit then you will continue to receive the maximum eligible amount of housing benefit and council tax benefit
- If you are claiming savings credit only then your housing benefit and council tax benefit will be calculated using the income figure used to calculate your pension credit. This figure will include the amount of pension which you have deferred.
- If you do not claim any pension credit and you are deferring claiming your state pension this will NOT be counted as notional income in calculating your housing benefit and council tax benefit.
When you finally decide to claim your state pension it will be taken into account in full (along with any extra state pension you have accrued) in your housing benefit and council tax benefit calculation.
As above we have been informed by the DWP that it is also the intention of the Government that lump sum payments will be disregarded for housing benefit and council tax benefit.
Tax credits also have the concept of notional income. For tax credits purposes, the state pension you have deferred is not treated as notional income and therefore not counted in calculating your award.
It is also important to note that you will not accrue extra state pension or a lump sum if you defer your pension whilst in receipt of the following benefits:
- incapacity benefit
- carers allowance
- severe disablement allowance
- unemployability supplement paid under the Industrial Injuries or War Pensions Schemes
- widows benefit or widowed mothers 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.
Further information regarding deferral of your state pension can be found on the following websites:
Contact Name: John Andrews (Tel: 0844 579 6700 , Fax: 0844 579 6701)