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State pension: to defer or not to defer (Part 2)
In our previous article we discussed the new legislation allowing deferral of your state pension in favour of a lump sum. We also outlined the effects on tax and various benefits during the period of deferment. This article seeks to explain in more detail what happens to your tax and benefits once you stop deferring and start receiving extra state pension or a lump sum payment.
Summary of position during deferment
Since April 2005 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.
The previous regime also continues which allows you to defer your state pension in order to receive a higher state pension when you finally choose to claim it. (The extra amount you receive in addition to your basic state pension will be referred to in this article as extra state pension.)
If you are claiming or are going to claim pension credit, the amount of the state pension which you defer will still be taken into account as income when calculating your pension credit (even though you are not actually receiving it).
If you are still eligible for Pension Credit once you have chosen to defer your pension, then your housing benefit and council tax benefit will be calculated using the income figures from your pension credit calculation.
Since the pension credit calculation will have taken into account as income the pension you have deferred (even though you are not receiving it) your housing benefit and council tax benefit will be calculated in the same way.
The only exception to this is for those people who are not eligible for pension credit. If they then claim housing benefit and council tax benefit the amount of the pension they are deferring will NOT be taken into account as income.
Choosing between a lump sum and extra state pension
If you decide (or have already decided) to defer your state pension in favour of a lump sum you must defer for a minimum of 12 months. Therefore the first group of people eligible to receive a lump sum will reach the end of this 12 month period in April 2006.
When you decide to stop deferring your State Pension you will need to inform the Pension Service. You will then have three months to choose either extra state pension or a lump sum payment (the earliest date you can get a lump sum is the 6th April 2006).
These three months will run from the date of the notice sent to you after you have made your claim for your pension following your period of deferment. Until this choice is made your normal state pension will be paid.
Fred and Elsa decided to defer their state pension from 6 April 2005. In May 2006 they decide that they want to stop deferring and claim their pension. They inform the Pension Service of this decision.
They will then receive a notice which will explain to them that they can choose to receive some extra state pension or they can choose to receive a lump sum. The notice will also explain that they have three months from the date on the notice to make their decision.
They wait until July 2006 before choosing a lump sum. Meanwhile they receive their normal state pension, and the lump sum that has accrued to them between 6 April 2005 and July 2006 is paid to them.
In some cases a person may choose a lump sum but for some reason (for example because of an unresolved issue about their contribution record) it is not possible to determine a final amount. 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.
Changing your decision
It will be possible to change your decision. You will have a further three months during which you can elect to change from receiving extra state pension to a lump sum or vice versa.
However it is not possible to change more than once. If you initially chose the lump sum this must be repaid and extra state pension will be awarded. If the first choice was extra state pension, the amount already paid will be netted off the lump sum.
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 one of the higher tax brackets.
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.
If you decide (or have decided) to defer your pension in favour of extra state pension then the whole of your weekly state pension (including this extra amount) will be taken into account when calculating your entitlement to pension credit.
If you have an existing award of pension credit your award will be re-calculated to include this extra pension. In some cases this may mean that you will no longer be entitled to pension credit as your income may be too high.
If you decide to defer your pension in favour of a lump sum then the gross amount of this lump sum will be disregarded from your savings for your lifetime. This will be the case even if you spend the lump sum and also if you stop claiming pension credit and then claim again at a later date. If you have an existing award of pension credit your pension credit will be re-calculated and a disregard equal to the gross amount of the lump sum will be applied to your savings.
Say that Fred and Elsa (see example 1 above) are entitled to £36.11 per week in pension credit. If they take an increased state pension in 2006, increasing their state pension by £22.45 a week, then that will be taken into account as income when their pension credit entitlement is calculated, reducing their pension credit entitlement to £18.37 a week.
If they choose a lump sum instead, because it is disregarded, they will continue to receive pension credit of £36.11 a week.
Since you are entitled to a disregard equal to the gross amount of the lump sum payment, there may be some spare disregard that would be available to offset against other savings if you have tax deducted from the payment. That would increase the amount of pension credit you receive.
The notional income rules for pension credit have also been amended. Notional income is income that you are treated as having although you do not actually possess it. The purpose of notional income is to stop you increasing your benefit entitlement by artificially reducing your income by, for example, manipulating your earnings with the agreement of your employer.
Where a pensioner who has been receiving extra pension changes their mind, deciding to take a lump sum instead, the extra pension which they have foregone will not be treated as 'notional income' for pension credit.
Without this amendment to the notional income rules, the extra pension which they were no longer receiving would nonetheless be treated as income when calculating their pension credit. As it is, the amended rules enable them to increase their pension credit entitlement by taking a lump sum instead.
Housing Benefit & Council Tax Benefit
Calculation of your Housing Benefit and Council Tax Benefit will depend on whether or not you receive pension credit.
There are two types of Pension Credit - Guarantee pension credit and Savings Credit. Depending on your circumstances you may receive one of these elements or both.
Guarantee Credit is for people aged 60 or over. It is extra money each week to bring your income up to the minimum amount that the Government say you need to live on. Currently this is £109.45 for a single person and £167.05 for a couple. These amounts may be higher if you have a disability or if you are a carer.
Savings Credit is for people aged 65 or over. It is extra money to reward those who have some savings or who have made some other provision for their retirement.
You can find out which element of pension credit you receive from your award letter. If you are unable to find this on your award letter then you can contact the pension service who will be able to advise you which element of pension you receive.
If you are in receipt of guarantee pension credit
If you continue to be eligible for guarantee pension credit once your pension credit has been re-calculated to take account of any extra state pension or a lump sum, then you will continue to be eligible for housing benefit and council tax benefit as you have been previously.
The local authority will disregard all of your income when calculating housing benefit and council tax benefit if you are receiving guarantee pension credit.
In some cases where you have opted for extra state pension you may no longer be entitled to guarantee pension credit as your income is too high. If this is the case you will still be entitled to claim housing benefit and council tax benefit, but your amount will be reduced depending on how much extra state pension you earn.
As shown above (example 2) Fred and Elsie will be entitled to less Pension Credit if they choose extra state pension instead of a lump sum. However because they will remain on Guarantee Credit they will still receive full housing benefit and council tax benefit.
Bob decides to defer his pension from 5th April 2005. He defers until December 2005. At this point he decides to stop deferring and receive extra state pension. (He is not entitled to a lump sum because he has not deferred for more than 12 months).
During his deferral Bob receives £19.34 per week pension credit. This is comprised of £2.90 per week guarantee credit and £16.44 per week savings credit. However once he stops deferring and receives extra state pension his pension credit will drop to £15.30 which is made up of savings credit only.
Bob will no longer get guarantee credit and therefore he will get less housing benefit and council tax benefit. He will also lose his automatic entitlement to some health benefits such as free dental treatment and vouchers towards the cost of glasses.
If you are in receipt of savings credit only
If you receive savings credit only then the local authority will use the income and capital figures given to them by the pension service to calculate your housing benefit and council tax benefit.
This means that if you are awarded a lump sum it will be disregarded when calculating your savings credit and therefore will not affect your housing benefit or council tax benefit. If you have paid tax on your lump sum it may mean that you receive more housing benefit and council tax benefit that you did previously.
If you choose to have extra state pension then this will be taken into account in full when calculating your entitlement to savings credit. Your housing benefit and council tax benefit will use the income figures that were used in calculating savings credit, and therefore the extra state pension will count in full in determining your housing benefit and council tax benefit. This may mean that you receive less housing benefit and council tax benefit than you did before receiving the extra state pension.
Tom is widowed and lives alone. Like Bob he decides to defer his pension from 5th April 2005 until December 2005. As Tom has a good occupational pension he does not qualify for guarantee pension credit, but he does get some savings credit of £9.60 whilst he is deferring. Bob also gets £8 per week in council tax benefit towards his Council tax bill of £10 per week, and £58.53 per week housing benefit towards his rent of £65 per week.
Once Bob starts to receive his pension and extra state pension he will only receive £7.30 savings credit. His council tax benefit will drop to 7.26 per week and his housing benefit to 58.53 per week.
If you do not receive pension credit
If you decide (or have decided) to defer your pension in order to get a higher pension later, then once you start to receive this extra amount it will be taken into account in full as income when calculating your housing benefit and council tax benefit.
If you decide (or have decided) to defer your pension in favour of a lump sum then the new regulations provide that 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. You can find out more on the Directgov website about the rules for inheritance of extra state pensionand lump sums for partners during the period of deferment.
In line with pension credit the disregard will apply even if you spend the money. Also since you are entitled to a disregard equal to the gross amount of the lump sum payment there may be some spare disregard that would be available to offset against other savings if you have tax deducted from the payment.
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. (The reasons for the this are the same as for Pension Credit notional income rules. See above)
Help with making the decision
Before deciding whether or not to defer your state pension, or if you have already decided to defer, before deciding whether to take extra state pension or a lump sum you should seek advice. This is particularly important if you are in receipt of any of the means tested benefits above.
Previous article: State pension: to defer or not to defer (Part 1)
Contact Name: Victoria Todd (Tel: 0844 579 6700 , Fax: 0844 579 6701)