Having deferred my state pension for five years, what are the key issues I should be considering in deciding whether to take the lump sum or an enhanced pension?

David

Tom Selby, AJ Bell Senior Analyst says:

The ability to defer when you claim your state pension is one of the less well-known features of the UK retirement system. In fact, the Government won’t pay your state pension at all unless you actively claim it.

First off, a bit of background. Anyone who reached state pension age after 6 April 2016 can claim the full ‘new’ flat-rate state pension – usually payable to UK residents with a 35-year National Insurance contribution record. In 2020/21 this is worth £175.20 a week.

Anyone who built up state pension rights under the pre-2016 system – such as ‘state second pension’ or SERPS – has these honoured under the flat-rate system, meaning if you reach state pension age after 2016 you might get more than the flat-rate amount.

Those who ‘contracted-out’ under the old state pension system may get less than the full flat-rate amount.

For those who started receiving their state pension before 6 April 2016, the basic-rate state pension for 2020/21 is £134.25 a week. They may receive additional amounts from SERPS or state second pension on top of this amount.

DEFERRAL DILEMMA

For anyone who reached state pension age on or after 6 April 2016, your state pension amount will be increased by 1% for every nine weeks you defer receiving it (you must defer by at least nine weeks to receive an uplift) or 5.8% per year. The extra amount is paid via an increase in your state pension.

For those who reached state pension age before 6 April 2016 the deferral rules are slightly different. Your state pension will be increased by 1% for every five weeks you defer, subject to a minimum deferral of five weeks. This means if you defer for 52 weeks you will receive an extra 10.4% in state pension.

If your state pension age was before 6 April 2016 then you usually have the option of either increasing the annual amount of state pension you receive or taking the entire deferral as a lump sum.

You can receive a lump sum payment if you have deferred claiming your state pension for at least 12 months in a row. This will include interest of 2% above the Bank of England base rate, and the lump sum will be taxed at your current income tax rate (e.g. if you are a basic-rate taxpayer it will be taxed at 20%) – but you won’t be pushed into a higher tax rate because you received a lump sum.

Some of the things you should consider in deciding whether to take your deferral payment as a lump sum or income include:

Your health (the longer you live, the more valuable a guaranteed income stream will be)

Your current income and spending priorities (do you have enough income from other sources to fund your lifestyle?)

Whether you want to pass money on to someone who isn’t your spouse after you die. While a spouse can inherit some of your state pension entitlement, other relatives or loved ones cannot. A lump sum can be passed on to whomever you choose, although it may be subject to inheritance tax.

Inflation protection – any extra state pension you receive as a result of deferral will usually increase in line with Consumer Prices Index inflation. If you take a lump sum you will lose this protection.

DO YOU HAVE A QUESTION ON RETIREMENT ISSUES?

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Please note, we only provide information and we do not provide financial advice. If you’re unsure please consult a suitably qualified financial adviser. We cannot comment on individual investment portfolios.

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