Is deferring the State Pension still a good deal?
Should clients of advisory firms defer taking the State pension in order to increase later life payments? Fiona Tait, technical director, Intelligent Pensions, crunches the numbers
It has been well documented that the State Pension age (SPa) is going up, and that this has been very unfortunate for certain groups of individuals who were expecting to receive it at 60, if they are female, or 65 if not. There is however a lucky group of individuals who find that due to their savings and/or ongoing earnings they do not need the income from the SPa even at the later age that they become eligible.
Given the advantages of taking financial advice, it is likely a significant proportion of this group will be your clients, and given that they are your clients, they will probably be aware they have the option to defer the State Pension in exchange for a higher initial pension income. The problem is that the exchange rate is not as good as it used to be, so the important question has to be “is it still worth it?”.
The exchange rate
Individuals who reached SPa prior to 6 April 2016 got a very good deal for deferral. In exchange for each 5 weeks delay their annual State Pension was increased by 1%, equating to 10.4% for a full year’s delay. Those reaching SPa now will only get 1% for every nine weeks, equal to 5.8% for a full year, always remembering that 52 weeks of income are “missing” and may never be caught up.
Some quick calculations show that, in total monetary terms, deferring the State Pension for 1 year is just about worth it if you are a man who lives to his average life expectancy of 82 and there is no increase to the State Pension itself.
If you factor the current applicable rate of the triple-lock, 2.5% p.a., a male would have to live to 88 to break even on a 1 year deferral, 89 for 3 years’ deferral and 90 for 5 years. Of course if they do live that long, and more affluent individuals are more likely to, the bigger the win will be.
The main advantage therefore is not that the individual will receive more in the long run, but that a higher level of income is paid when it is taken. And as things stand that income is fully inflation-proofed and underpinned by the UK Government.
Another feature that was lost in 2016 was the ability to take the deferred amount as a lump sum. Under current rules the extra benefit may only be paid as a higher income which will be taxable every year (the lump sum was also taxable but the liability would only apply in the year of payment). If a client does not need the additional income and they have the flexibility to manage the rest of their pension income this may not matter. If however they are unable to reduce the other payments they receive, from ongoing earnings or perhaps a large final salary entitlement, the extra income may actually be unwelcome. Clients who are currently paying higher rate income tax, but who can foresee a point in the future where they may be liable at basic rate, may find deferring the State Pension until their income drops would be particularly advantageous.
Another factor to consider is what happens on death. For couples, where only one partner has worked for the majority of their married lives the changes which were introduced in April of last year may be very significant.
Under the previous State Pension regime a widowed spouse would receive a widow(ers) pension based on the National Insurance Contributions (NICs) made by their partner. In broad terms spouses who had already reached their SPa by 6 April 2016 can still inherit the State Pension, however those who have not may only receive a State Pension based on their own NIC record, which could be considerably lower.
In fact the situation is slightly more complicated than that, as a widow(ers) whose spouse had reached SPa before the rules changed can still claim their additional state pension, and those whose spouses had built up a State Pension above the current flat rate can claim the excess “protected payment”.
For clients who have private pensions, or other heritable assets, it may make sense to take the State Pension as soon as they can to minimise the income they need from other sources.
All in all, it’s certainly not as good a deal as it was, but it could be suitable for some clients who do not need or want the income immediately.