Deferring your state pension is a popular choice for people who continue to work after state pension age and do not wish to pay Income Tax on it, especially if they are higher-rate taxpayers. However, before you decide to defer your state pension I am going to explain to you why you should never defer it.

Firstly it takes 17 years and 3 months to get to the break even point when the total amount of state pension you have received at the enhanced rate exceeds the pension given up during the deferment period.

Admittedly a 5.8% increase for every year of deferment of your state pension does sound very advantageous but when you dig deeper you find out that all is not what it seems. After all there is no such thing as a free lunch. Why would the government apparently be so generous to you in your retirement years? The fact is they aren’t being generous at all. It’s all smoke and mirrors.

The fact remains that you do not know how long you are going to live. You are highly likely to pay tax on your state pension whether you take it at age 66, 67 or 68 anyway unless it is your sole source of income in which case you are in a perilous financial position anyway. The decision to defer the state pension is usually only made by people who have continued to work past state retirement age and do not wish to pay tax on their state pension as well as their salary.

In reality, most people have sources of income other than the state pension at retirement anyway so they are already paying tax on their state pension but mostly at the basic rate of 20%. Those people who continue to work post-state retirement age may potentially be paying tax at 40% so they understandably wish to avoid the higher rate tax charge on their state pension. In practice, they are only going to suffer an extra tax charge of 20%, the difference between the higher rate of 40% and the basic rate of 20%, on their state pension anyway.

The most telling reason why you shouldn’t defer your state pension is because if you were to die during the deferment period your spouse would receive at best a reduced widow’s/widower’s pension and possibly nothing depending on your individual circumstances. That strikes me as an inherently bad outcome.

Also wouldn’t you rather take your state pension while you are still young enough to enjoy it? Better to have a lower state pension today, even if it is taxed, than to take it later when you are more likely to be unable to enjoy it. Let’s face it as you get older your health isn’t going to improve. It’s likely to worsen. So why not take the state pension now and enjoy it while you are in the early retirement years and more likely to be able to enjoy it?

If you are going to continue to work post-retirement you can avoid paying tax on your state pension by simply re-investing it 100% into a personal pension. You start taking your state pension of c.£10,000 a year at 66, reinvest £8,000 net of tax into a personal pension and claim back the balance of £2,000 from HMRC assuming you are a 40% taxpayer with at least £10,000 of income subject to higher rate tax. The 40% tax saved completely offsets the 40% tax due on your state pension. This presupposes that you have earned income of at least £10,000 p.a. of course because you can only pay into a personal pension if you have earned income from employment, self-employment or partnership. If you have no earnings whatsoever you may still pay £3,600 gross (£2,880 net) into a personal pension.

Adopt this strategy for 9 years until age 75 and you will invest c.£90K* into your personal pension funded 100% from your state pension. In reality, the amount you pay into your personal pension is more likely to be at least 150,000** because of the triple lock inflation protection of your state pension. This is a pretty cool way to fund your personal pension courtesy of the government. Add in some growth and your personal pension from government funding alone could well exceed £250,000.

Furthermore, when you die your state pension either dies with you or on the death of your widow/widower whereas your personal pension can be left 100% to your spouse, your children, your grandchildren etc. Your 100% government-funded post-state retirement age personal pension can be inherited by your family down the generations. Now that’s what I call financial planning.

So don’t defer your state pension. Re-invest it into a personal pension instead. You know it makes sense.***

* 9 years x £10,000 (estimated state pension currently).

**This assumes that the state pension would have increased by the triple lock.

***Risk warnings

A pension is a long-term investment not normally accessible until age 55 (57 from April 2028 unless the plan has a protected pension age). The value of your investments (and any income from them) can go down as well as up which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change. You should seek advice to understand your options at retirement. Past performance does not guarantee future results. The contents of this blog are for information purposes only and do not constitute individual advice. This blog is based on my own observations and opinions.

Tony Byrne

Chartered and Certified Financial Planner

Managing Director of Wealth and Tax Management

If you are looking for expert guidance in Financial Planning contact Wealth and Tax Management on 01908 523740 or email wealth@wealthandtax.co.uk