What is a deferred pension and how does it work?
Updated 06 March 2020
A deferred pension is simply one that you take later than you could have taken it – or later than the majority of your peers choose to take their pensions. You can defer your state pension, private pensions and most types of workplace pension – it’s up to you.
Here you can find out about the different types of pension deferral, how and why you might do it, what the benefits can be, and how to claim a deferred pension.
Why might you defer a pension?
There are two main reasons why you might want wait longer before taking your pension.
- You don’t need the income yet (e.g. you are still earning)
- You want to receive a higher income in the future
Either or both of these might apply to you. Furthermore, if you already have a source of income, receiving a pension on top of your earnings will increase your tax bill. If your current income is sufficient, you may decide to delay your pension until your earnings stop or reduce.
Deferring your state pension
You can choose to start receiving your state pension after your official state pension age (currently your 65th birthday). If you choose to start claiming it later, you’ll receive a higher income.
How do I defer my state pension?
To defer your state pension, just don’t claim it when you are invited to do so. You should receive a letter around two months before you reach state pension age. To defer your state pension, just ignore this letter (but keep it safe for reference).
You can find out how to claim your deferred state pension on the government’s website. What you’ll get will vary depending on whether you reached state pension age before or after 6 April 2016.
If your state pension age comes later than 6 April 2016
If you reach the age of 65 after 6 April 2016, you’ll receive the new state pension. The standard maximum income from this is £168.60 per week. This amount will rise by 1 per cent for every 9 weeks you defer your state pension. So for example, if you delay for a full year, the income will increase by 5.8 per cent to £178.34 a week.
If you reached state pension age before 6 April 2016
Anyone able to claim state pension before 6 April 2016 is eligible for the old state pension (and perhaps the additional state pension too). If you chose to defer this, then the income you’re entitled to will have increased by 1 per cent for every 5 weeks you have deferred it. You can also, if you wish, take the deferred portion of your state pension as a lump sum (something you can’t do with the new state pension).
How to claim your deferred state pension as a lump sum
If you qualify for the old state pension, then when you claim it the DWP will write to you asking how you want to receive it – as higher weekly payments, or as a lump sum. The lump sum will comprise all your deferred payments, plus interest at 2 per cent above the Bank of England base rate.
Does a deferred pension increase in value?
As you can see from the examples above, both the old state pension and the new state pension will increase in value the longer you defer them.
Furthermore, you will continue to benefit from any general increases in the level of the state pension. Currently the state pension increases every year at least in line with inflation, thanks to the state pension triple lock. If you defer your state pension, any annual rises will be added on top of the increases you get from deferring (so you won’t lose out on them even if you’re not taking your pension at that time).
Deferring a workplace or personal pension
If you have a defined contribution workplace pension (most employees do) or a personal pension, you can access your pension pot at any time from your 55th birthday onwards. However, you may not want to retire as early as that (and you may not be able to afford it, either). Ultimately, from the age of 55 it’s entirely up to you when you access your pension pot, so you’re not really ‘deferring’ it if you wait until your late 60s or early 70s – you’re just leaving it for later.
Why might I want to defer taking my pension pot?
A pension pot is a finite sum of money, which you don’t want to run out during your lifetime. It’s therefore good sense to try and grow it for as long as possible, and then make it last as long as you can.
You can continue to pay into a pension pot and receive tax relief until you’re 75 years old, within your pension allowances. You should also continue to receive employer contributions to your workplace pension. Even if you’re no longer contributing to it, the pot can still grow with the stock market.
There are advantages to waiting before taking your pension, whether you opt for an annuity or drawdown. For instance if you choose an annuity, you can obtain a higher income the older you are when you buy it (any health problems will further improve the value you can get).
On the other hand, if you choose drawdown, your pot has more chance of lasting into your old age if you start to access it later. The more money you take out of a drawdown fund, the slower it can grow, so the faster it will shrink (similar to how a half-full cup of tea gets colder faster than a full one). Therefore you need to pace yourself very carefully.
Pensions and inheritance – another possible reason to defer
Pension pots have a major advantage over other assets, in that they are not subject to inheritance tax. This is why some experts recommend living off other savings and investments for as long as you can before using your pension pot, as you beneficiaries may then inherit more. ‘Spend your pension last’ can sometimes be a good rule of thumb if you are thinking about your legacy.
What are the risks of deferring my pension?
Some pensions have certain guaranteed benefits that can only be taken at a particular retirement age, or even a specific date. An example is a guaranteed annuity rate, which allows you to buy an annuity at (usually) a preferential rate. This can increase your retirement income by many thousands of pounds, so it is worth checking to see if you have one (especially on older pensions schemes dating from the 80s and 90s). By deferring your pension, you might miss out on benefits like these.
The only other real risk of deferring your pension is that the future is uncertain. For example, if you plan to buy an annuity, it makes sense to do so when the stock market is strong. Delay could mean that the stock market falls before you can buy your annuity. Conversely, delay can be a good idea if the stock market is currently weak, as you can then wait for it to rise again.
Can I defer a final salary pension scheme?
If you have a final salary (defined benefit) pension from your employer, then it may technically be possible to defer it – however, there will probably be no benefit from doing so. Deferring this kind of pension generally won’t increase your income, and all you would be doing is losing out on income you’re entitled to. Your options will be either to start taking the money now, or (perhaps) to transfer your pension into a defined contribution scheme. For this you will need to see an independent financial adviser.
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