Deferring State Pension

[HillManMill]

Following on from the recent thread about deferring state pension:

I reach state pension age next year. Until reading this thread I had not considered deferring it but am now wondering if this is worth revisiting this decision.

I currently receive a small occupational pension and over the last few years have been taking uncrystallised lump sums from my personal pensions. Each year I have taken a lump sum such that my total taxable income for the year is close to the tax allowance [e.g. £12570 for 22/23]. I am then reinvesting the lump sum in an ISA. I had thought that 22/23 would be my last year for this as for 23/24 my state pension plus occupational would exceed the tax allowance.

Following this thread it seems to me that if I deferred my state pension for a year or two I could then continue my approach. This would increase my index linked income once the state pension is taken. Any views on this?

Moderator Message:
Moved to the pensions Practical board. Please post such questions there in future! --MDW1954

[Kantwebefriends]

Here's a useful calculator to help you.

http://www.johnkay.com/pension/

[Steveam]

The John Kay calculator is certainly useful but you really do need to think about your objectives and your circumstances and your risk tolerance (in the future) and … and … and …

So, the JK calculator assumes your only objective is to maximise money received … this may be true and in that case you’ll “just” need to input sensible parameters (real return [good luck with that when inflation could go anywhere], longevity (if you can think of deferral you’re probably of a group likely to live beyond the average).

Now start thinking of other possible objectives: are you worried that inflation could stay elevated (perhaps 8-10%) for many years? Do you believe you can make positive real returns in all circumstances? (Inflation proofed bonds might help). Deferring offers likely inflation proofed income (but do you trust the government …)

I’m fairly comfortable and see the deferral as a way of purchasing an index linked annuity which I might never need but which covers off certain tail risks.

Very best wishes,

Steve

[scotview]

Don't wish to confuse issues but I read an article, somewhere, that recent high inflation might have unintended, negative consequences on deferred
state pension calculations. Maybe someone could elaborate on this one.

[mc2fool]

Don't wish to confuse issues but I read an article, somewhere, that recent high inflation might have unintended, negative consequences on deferred state pension calculations. Maybe someone could elaborate on this one.

Could you try and re-find that article and post a link please? It's not clear to me how high inflation would have unintended, negative consequences on deferred state pensions, as the 10.4%/5.6% pre/post 2016 per annum increases for deferring are on top of the triple lock.

[Lootman]

Don't wish to confuse issues but I read an article, somewhere, that recent high inflation might have unintended, negative consequences on deferred state pension calculations. Maybe someone could elaborate on this one.

Could you try and re-find that article and post a link please? It's not clear to me how high inflation would have unintended, negative consequences on deferred state pensions, as the 10.4%/5.6% pre/post 2016 per annum increases for deferring are on top of the triple lock.

Perhaps the argument is that since the state pension is taxable, then any increase a 40% taxpayer gets may only be worth 60% of the nominal increase..

So your costs increase by 100% of inflation over that period. Your pre-tax state pension amount also increases by that same 100%. But your after-tax pension only increases by 60%. You pay more tax but do not receive any real increase in the amount.

Now if I were getting a 10.4% uplift annually by deferring then I might still be ahead. But I am a post-2016 individual, and the 5.6% annual uplift is much less attractive, and may not warrant foregoing several years worth of payments.

My back of envelope computation at the time told me that the break-even period for a post-2016 retiree was something like 17 years. Meaning that a 66 year old who defers will only start pulling ahead when he/she is about 83. (Other things being equal, which they are not).

[scotview]

Don't wish to confuse issues but I read an article, somewhere, that recent high inflation might have unintended, negative consequences on deferred state pension calculations. Maybe someone could elaborate on this one.

Could you try and re-find that article and post a link please?

I can't find the article, sorry. It would be best to ignore my post.

Sorry for posting.

[scrumpyjack]

AFAIAA the uplift arising from deferral is only increased by CPI, not by the triple lock

[mc2fool]

AFAIAA the uplift arising from deferral is only increased by CPI, not by the triple lock

That's the case once the pension is in payment, but while it's in deferment the triple lock still applies. Deferring means that you'll get 10.4/5.6%pa more than your pension amount at the time you start taking it, not at the time you reached state pension age.

[mc2fool]

Perhaps the argument is that since the state pension is taxable, then any increase a 40% taxpayer gets may only be worth 60% of the nominal increase..

So your costs increase by 100% of inflation over that period. Your pre-tax state pension amount also increases by that same 100%. But your after-tax pension only increases by 60%. You pay more tax but do not receive any real increase in the amount.

Ah, no. If your gross pension income increases by 100% then (assuming you don't change tax band and there are no marginal changes) then your net pension income also increases by 100%.

Gross income £1000, tax @ 40% = £400, net income £600
Gross income £2000, tax @ 40% = £800, net income £1200

[Lootman]

Perhaps the argument is that since the state pension is taxable, then any increase a 40% taxpayer gets may only be worth 60% of the nominal increase..

So your costs increase by 100% of inflation over that period. Your pre-tax state pension amount also increases by that same 100%. But your after-tax pension only increases by 60%. You pay more tax but do not receive any real increase in the amount.

Ah, no. If your gross pension income increases by 100% then (assuming you don't change tax band and there are no marginal changes) then your net pension income also increases by 100%.

Gross income £1000, tax @ 40% = £400, net income £600
Gross income £2000, tax @ 40% = £800, net income £1200

Yes, I understand that. But the idea that the government gains from inflation is well enough established for it to have a term: "fiscal drag".

The point being that when you get an inflation-proofed increase in income, then that will only maintain your standard of living if the threshold of the income tax bands are also increased along with inflation. Which currently is not happening.

So individuals will be sucked into higher rate tax bands by increases in income that confer no real benefit.

That said, I was only speculating about what the article that Scotview read was arguing. And of course that argument applies to all inflation "protection" and not just pension increases. But I think the point stands that higher inflation can be bad even for someone with an inflation-proofed income.

Personally I changed my idea about the value of deferring the state pension when I realised that I would only get the much lower 5.6% accrual rate, pre-tax.

[mc2fool]

Perhaps the argument is that since the state pension is taxable, then any increase a 40% taxpayer gets may only be worth 60% of the nominal increase..

So your costs increase by 100% of inflation over that period. Your pre-tax state pension amount also increases by that same 100%. But your after-tax pension only increases by 60%. You pay more tax but do not receive any real increase in the amount.

Ah, no. If your gross pension income increases by 100% then (assuming you don't change tax band and there are no marginal changes) then your net pension income also increases by 100%.

Gross income £1000, tax @ 40% = £400, net income £600
Gross income £2000, tax @ 40% = £800, net income £1200

Yes, I understand that.

Well I'm glad you now understand, 'cos what you said above makes it clear you didn't before.

[Lootman]

Perhaps the argument is that since the state pension is taxable, then any increase a 40% taxpayer gets may only be worth 60% of the nominal increase..

So your costs increase by 100% of inflation over that period. Your pre-tax state pension amount also increases by that same 100%. But your after-tax pension only increases by 60%. You pay more tax but do not receive any real increase in the amount.

Ah, no. If your gross pension income increases by 100% then (assuming you don't change tax band and there are no marginal changes) then your net pension income also increases by 100%.

Gross income £1000, tax @ 40% = £400, net income £600
Gross income £2000, tax @ 40% = £800, net income £1200

Yes, I understand that.

Well I'm glad you now understand, 'cos what you said above makes it clear you didn't before.

I may well be guilty of not explaining myself well. But the point I was trying to make is that taxation is a major factor to be taken into account when considering the value of things like COLA increases and deferment uplifts.

If governments and tax authorities love inflation because it swells tax revenues then it is probable that the rest of us lose out accordingly. I prefer to perform such computations on an after-tax basis, when deciding my course of action.

And moreover if, as many believe, marginal tax rates are likely to increase in the future, then the value of deferment is even more degraded.

[vand]

The John Kay calculator is certainly useful but you really do need to think about your objectives and your circumstances and your risk tolerance (in the future) and … and … and …

So, the JK calculator assumes your only objective is to maximise money received … this may be true and in that case you’ll “just” need to input sensible parameters (real return [good luck with that when inflation could go anywhere], longevity (if you can think of deferral you’re probably of a group likely to live beyond the average).

Now start thinking of other possible objectives: are you worried that inflation could stay elevated (perhaps 8-10%) for many years? Do you believe you can make positive real returns in all circumstances? (Inflation proofed bonds might help). Deferring offers likely inflation proofed income (but do you trust the government …)

I’m fairly comfortable and see the deferral as a way of purchasing an index linked annuity which I might never need but which covers off certain tail risks.

Very best wishes,

Steve

The tail end risk in deferring which nobody seems to appreciate is the risk that you defer and then unexpectedly die before you even collect a penny. That is a far worse outcome than having 10-15% less in state pension that you would otherwise have over the last few years of your life.

As much as we all think we're going to make it to the average lifetime expectancy or even beyond, the simple reality is that a good deal of us will fall short.

[Steveam]

vand wrote: “That (not collecting a penny) is a far worse outcome than having 10-15% less in state pension …”

Why do you think it’s worse to receive no (or little) money? I doubt that I’ll enjoy longevity but if I do I want to minimise the risks from inflation etc. If I die early - I’m not expecting to miss the money (no pockets in shrouds). I buy travel insurance for similar reasons (a catastrophic claim) …

Best wishes, Steve

[CliffEdge]

Don't wish to confuse issues but I read an article, somewhere, that recent high inflation might have unintended, negative consequences on deferred state pension calculations. Maybe someone could elaborate on this one.

Could you try and re-find that article and post a link please? It's not clear to me how high inflation would have unintended, negative consequences on deferred state pensions, as the 10.4%/5.6% pre/post 2016 per annum increases for deferring are on top of the triple lock.

Perhaps the argument is that since the state pension is taxable, then any increase a 40% taxpayer gets may only be worth 60% of the nominal increase..

So your costs increase by 100% of inflation over that period. Your pre-tax state pension amount also increases by that same 100%. But your after-tax pension only increases by 60%. You pay more tax but do not receive any real increase in the amount.

Now if I were getting a 10.4% uplift annually by deferring then I might still be ahead. But I am a post-2016 individual, and the 5.6% annual uplift is much less attractive, and may not warrant foregoing several years worth of payments.

My back of envelope computation at the time told me that the break-even period for a post-2016 retiree was something like 17 years. Meaning that a 66 year old who defers will only start pulling ahead when he/she is about 83. (Other things being equal, which they are not).

That would be 17 years from when the deferred pension starts payment.

[CliffEdge]

Perhaps the argument is that since the state pension is taxable, then any increase a 40% taxpayer gets may only be worth 60% of the nominal increase..

So your costs increase by 100% of inflation over that period. Your pre-tax state pension amount also increases by that same 100%. But your after-tax pension only increases by 60%. You pay more tax but do not receive any real increase in the amount.

Ah, no. If your gross pension income increases by 100% then (assuming you don't change tax band and there are no marginal changes) then your net pension income also increases by 100%.

Gross income £1000, tax @ 40% = £400, net income £600
Gross income £2000, tax @ 40% = £800, net income £1200

You are assuming that all of the state pension is in effect taxed eg other incomes exceed the allowance.
This is not the case for many people, including some high worth people who keep their income low so it may not be as simple as your example. Though yours is a good illustration.

[mc2fool]

Perhaps the argument is that since the state pension is taxable, then any increase a 40% taxpayer gets may only be worth 60% of the nominal increase..

So your costs increase by 100% of inflation over that period. Your pre-tax state pension amount also increases by that same 100%. But your after-tax pension only increases by 60%. You pay more tax but do not receive any real increase in the amount.

Ah, no. If your gross pension income increases by 100% then (assuming you don't change tax band and there are no marginal changes) then your net pension income also increases by 100%.

Gross income £1000, tax @ 40% = £400, net income £600
Gross income £2000, tax @ 40% = £800, net income £1200

You are assuming that all of the state pension is in effect taxed eg other incomes exceed the allowance.
This is not the case for many people, including some high worth people who keep their income low so it may not be as simple as your example. Though yours is a good illustration.

Not only assuming but explicitly so, "(assuming you don't change tax band and there are no marginal changes)", by which I meant that the whole amount was taxed at the (same) marginal rate of 40%. However you are of course correct in that in reality it's never that simple. (And let's not get into tranches of income...!)

[Kantwebefriends]

I currently receive a small occupational pension

Before you make your decision I suggest you contact the provider and ask them whether starting/deferring your state pension has any effect on your occupational pension. In my case it did: by 'deferring' my State Pension a couple of years after it had started I got a "pay rise" from my occupational scheme.

Once upon a time I persuaded myself I understood the reason which was to do with having been "contracted out" I think.

Mind you the decision to defer under the old style state pension was dead easy - anyone who thought he could afford it should have grabbed the chance unless he'd objective reason to expect a short life. (The arguments I saw against it were uniformly feeble.)

With the new payment rate of only 5.8%, and the new rule that none of the extra pension passes to your widow, the case for deferral is harder to make conclusively unless it happens to permit a useful tax saving. But it might still be the cheapest insurance you can find against longevity risk.

There might also be indirect tax savings. Suppose you defer and simultaneously live off some capital rather than draw taxed income from your private pensions. Eventually that could save your estate Inheritance Tax (IHT) if the rule persists that you can "leave" private pensions without exposure to IHT.

[CliffEdge]

I currently receive a small occupational pension

Before you make your decision I suggest you contact the provider and ask them whether starting/deferring your state pension has any effect on your occupational pension. In my case it did: by 'deferring' my State Pension a couple of years after it had started I got a "pay rise" from my occupational scheme.

Once upon a time I persuaded myself I understood the reason which was to do with having been "contracted out" I think.

Mind you the decision to defer under the old style state pension was dead easy - anyone who thought he could afford it should have grabbed the chance unless he'd objective reason to expect a short life. (The arguments I saw against it were uniformly feeble.)

With the new payment rate of only 5.8%, and the new rule that none of the extra pension passes to your widow, the case for deferral is harder to make conclusively unless it happens to permit a useful tax saving. But it might still be the cheapest insurance you can find against longevity risk.

There might also be indirect tax savings. Suppose you defer and simultaneously live off some capital rather than draw taxed income from your private pensions. Eventually that could save your estate Inheritance Tax (IHT) if the rule persists that you can "leave" private pensions without exposure to IHT.

I'd be interested to know when and how you managed to defer your in payment state pension. I've found it to be impossible.