No, not luxury puddings. Small pension pots, ones which are not central to the big picture of a client’s financial plan.
What could I do if I had say £25,000 in a small pot, that was not covering any particular need or objective, and was I looking at tweaking my retirement options? Could deferring my State Pension be attractive?
How does State Pension deferral work?
You don’t get your State Pension automatically – everyone has to claim it. And most people do that as soon as they get the letter explaining how to claim, around two months before reaching State Pension age. But if you want to defer, you just don’t do anything. Your pension will automatically be deferred until you claim it.
A little extra – the rules
The amount of extra State Pension accrued by deferring depends on when you reach State Pension age. For someone reaching State Pension age on or after 6 April 2016, State Pension will begin to increase for every week of deferral, as long as you defer for at least 9 weeks.
The increase is the equivalent of 1% for every 9 weeks of deferral or just under 5.8% for every full year and the extra payment is, ultimately, included with your State Pension.
This year the full State Pension is £164.35 a week or £8,546.20 a year. By deferring for one year, State Pension will increase by an extra £493 a year (just under 5.8% of £8,546.20). Increases are calculated as percentages of the level of State Pension applying in the year that it is actually claimed so increases in cash terms may be larger, depending on the operation, and continuation, of the Triple Lock. This increases State Pension annually by the greater of 2.5%pa, inflation or average earnings.
Example – deferring for three years
So, where does my £25,000 come in?
Let’s assume I have £25,000 in a pension, which is surplus to my other financial goals at retirement. I decide to defer State Pension for three years, from 67 to 70. I spend that money to cover the shortfall in my income from my State Pension. For simplicity we will assume this £25,000 is after taking PCLS and is invested at low risk but achieves growth, at least in step with the Triple Lock.
After three years I am around £25,000 poorer, but have an extra £1479 p.a. of State Pension ignoring Triple Lock increases. What’s that worth to me? How much would it have cost me to buy that guaranteed income for life?
The truth is we can not be sure, principally because the Triple Lock is so good, you would be hard pressed to find or buy an annuity with that level of security. As a rough, guide an annuity with a 3% escalation for a 70 year old (with no guarantee) has a pay out rate around 4.5% making the extra State Pension comparable with a capital sum of at least £33,000. If the comparison is made with an annuity linked to increases in RPI, where the rate is around 3.9% for a 70 year old, the comparable capital sum is £38,000.
That looks like a little pot of happiness to me.
Points to check
Deferring State Pension can potentially increase payments but it’s important to note that any extra payments could be taxed and extra State Pension is not available to those receiving certain benefits. Deferring can also affect how much you can receive in benefits so those looking to defer and receive benefits should check their situation with the Pension Service.
Sources: YouGov, Sharing Pensions, Pension Choices
This article is for financial professionals only. Any information contained within is of a general nature and should not be construed as a form of personal recommendation or financial advice. Nor is the information to be considered an offer or solicitation to deal in any financial instrument or to engage in any investment service or activity. Parmenion accepts no duty of care or liability for loss arising from any person acting, or refraining from acting, as a result of any information contained within this article. All investment carries risk. The value of investments, and the income from them, can go down as well as up and investors may get back less than they put in. Past performance is not a reliable indicator of future returns.