The UK faces a retirement savings crisis with the State Pension age rising and a large swathe of people approaching their post-work life with insufficient private savings.
Deferring the State Pension and working extra years to pay more into it may seem an attractive solution. The State Pension increases every week a person delays claimingthat is delayed claiming, providing the personthey defers for at least nine weeks. For each year deferred, the State Pension rises 5.8%.
However, there are groups that deferringit is less effective for. The government has signalled it plans to deal with the fact that the State Pension is set to go above the personal allowance threshold, with one solution being that those who rely solely on the State Pension for income will not have to pay tax.
Yet the same is not true for those with an enhanced State Pension. Anyone who deferred and chose to take extra income face a bill each year, leading to potential budgeting issues and money worries with a letter from HMRC demanding payment.
Steve Webb, partner at pension consultants LCP and former pensions minister, said: “It's an issue because you earn the money and you spend it, and then in the July after the financial year or so, you get a bill.”
This could have made a big difference for someone choosing whether to defer the State Pension or not, said Webb, who noted that an individual in this circumstance “might have made a different decision had they known that in future there'd be special treatment for people with no increments”.
And people’s awareness of their options around State Pension deferral is low, said Robert Cochran, pensions expert at Scottish Widows.
“Many people devote significant attention to their workplace pension but assume the State Pension is simply something that automatically starts when they reach State Pension age. As a result, decisions around claiming, deferring and tax planning are often overlooked,” he said.
Webb noted that deferring is not an act, but rather an “omission”. “In other words, unless you claim your pension, you are deferring. But you don't actually write to the government or tell anyone you are deferring or inform them you intend to defer. You just don't claim,” he said.
So what options are there? Matthew Blakstad, deputy director for strategic policy and research at Pensions UK, noted the current rules allow for deferred State Pension benefits to be taken in three ways.
The first is an increased weekly State Pension for life as mentioned above. There is also the potential for a one-off arrears payment of up to 52 weeks' worth of missed State Pension. No interest is added to this payment.
Lastly, there is the combination of the two, where up to 52 weeks is paid inas arrears and any additional deferred period is converted into a higher ongoing weekly pension.
Cochran noted that, while technically correct, framing this as three options may not be true in reality. “From a financial planning perspective, it's perhaps more accurate to view this as one deferral mechanism with different ways of taking the benefit, rather than three completely separate financial strategies,” he said.
A growing issue for retirees
Blakstad noted that working beyond State Pension age is becoming a more common part of modern retirement. For some it reflects greater choice and flexibility, while for others it highlights the challenge many people face in building sufficient retirement savings.
A recent Pensions UK survey found around two-thirds of people in their early 60s who have not yet retired say they could not afford to at present.
“As State Pension age rises to 67 and beyond, we expect more people to combine work and retirement income, either by working longer or transitioning gradually into retirement rather than stopping work altogether,” he Blakstad said.
Cochran noted there are more than 1.1 million people aged 66 and over still in employment, up from around 880,000 people a decade earlier.
Is deferring worth it?
Blakstad noted the attraction of deferral is straightforward. People can give up income today in exchange for potentially higher guaranteed income later in retirement.
“Whether that represents good value depends heavily on individual circumstances, including how long they expect to remain retired and how much importance they place on guaranteed lifetime income,” he said.
Cochran added the additional income may be more appealing for someone expecting to live out a long retirement, while others may prioritise immediate access to funds, whether it be to fund a holiday or other large expense while still in rude health.
Webb noted that, for people who expect to be on a low income in retirement, another aspect to consider is the impact of a higher State Pension on benefit entitlements.
“In an extreme case, the increments to the State Pension could push regular income above the pension credit level, leading to the loss of extra help with things like council tax bills and energy costs,” he said.
An alternative option to deferral
For some, they can continue to work while claiming the State Pension. However, this risks pushing someone into a higher income tax bracket than they were in previously.
Cochran, however, had a solution to this particular problem that may be applicable to some people with defined contribution (DC) pensions.
Those with a DC scheme can choose to take the State Pension when available and use some or all of that additional income to increase workplace pension contributions, including through salary sacrifice arrangements where available.
“Depending on an individual's circumstances, this can help them continue building retirement savings in a tax-efficient way while potentially creating a larger pension fund that may provide greater flexibility in retirement and valuable death benefit options for beneficiaries, taking away one of the risks around deferral of getting nothing back on death,” he said.
However, under contribution rules, this option may be limited for people who've already drawn on defined contribution pensions beyond their tax-free cash, since the Money Purchase Annual Allowance caps further contributions at £10,000 a year.