State pension deferral - worth while??

kidmugsy

I've done the algebra for the case of taking your reward as extra pension. We're in a period of unusually low interest rates, so I've ignored the interest you might get from drawing pension and saving it, and made a few other minor simplifying assumptions. The upshot is that, rounding the numbers, you start to make a profit from your deferral 10 years after you restart the pension. Note that it doesn't matter whether you deferred for one year or five: 10 years after you restart, you're in the money. So if you are 68 and restart now, you'll be in pocket once you're 78. Linton says that you might reasonably expect to live to 87 so, even if you ignore your widow "inheriting" (most of) your extra pension, it sounds pretty attractive. It might be particularly attractive for somebody whose other pensions have poorer inflation-protection than the state pension.

As for the merits of taking your reward as a lump sum instead; since interest rates are so low at the moment, the rate of 2.5% gross isn't too bad - even after tax, it's better than most Cash ISAs are paying at the mo'.

Telegraph_Sam

Many thanks for your efforts with the number crunching. I tried myself some time back but had to admit defeat.

I would like to be sure that I have understood you correctly. It so happens that I am single but I suspect the principles are the same.

What you say COULD be interpreted to mean that any deferral is a waste of time (literally) if in effect the 10-year clock only starts ticking from the date of starting to take the pension. My assumption up to now had been that I had to defer for approx 10 years (I think my calculations led to 13, but no matter) after SRA at which point the rewards from deferring equalled the interim income sacrifice. I confess that I am in danger of tying myself up in knots now, may be you can help unravel the threads! Perhaps a very simplified example might help??

kidmugsy

Telegraph_Sam wrote: »

What you say COULD be interpreted to mean that any deferral is a waste of time (literally) if in effect the 10-year clock only starts ticking from the date of starting to take the pension.

No, the difference is this. Say you reach State Retirement Age of 65 and defer your £10k p.a. state pension for 1 year, and then start the pension, taking extra pension as a reward. You have achieved an extra pension of £1040 (index-linked) added to the £10k; you break even when you are 76 and are in profit every year afterwards.

Now, say instead that you deferred for 5 years. Then you don't break even until you are 80. But your extra pension is much more handsome, being £5200 (index-linked).

So, the longer you defer, the later you break even but, on the other hand, the bigger your annual profit is after break-even. What is the best trade-off? That would require a crystal ball and, anyway, we now enter the realm of the decision being about you as an individual, not about abstract algebra. Perhaps you should start drawing the pension now. Would you like to?

Telegraph_Sam

I can visualize a kind of a graphical representation of what you describe with lines of different slopes intersecting at various points on horizontal and vertical axes ..!

I suppose the crystal gazing bit comes in "selecting" a particular terminal age (= average 87?) and ask the system what the optimum pension-deferral age is to provide max benefit for a single in the period leading up to it!

Gut feeling - which isn't always fool-proof - is to defer for as long as personal circs permit. But that was formed before I learned that it was possible to reverse the decision ..

PS I think there's a glittering future awaiting you in the Pension Advisory Service!

jamesd

Linton wrote: »

Yes the more one looks at what is apparently a simple question, the more complex it gets.

Yes. For guidance here I think it's necessary in general to allow for both the effects of dying and alternative investment returns, though the effect of dying can be disregarded if just trying to provide for the long life case.

In the long life provision case the investment return is the significant issue because it's long term and compounded, while the deferral increase isn't compounded.

Linton wrote: »

If you die early before you have recouped the costs of deferring you dont care because you are dead

While I'm not in a position to care because I'd be dead, my ghost does care because I was worse off while alive than I could have been. Maybe I could have spent that money on better medical care and still been alive...

This can be very significant for the death before breakeven case because the lump sum payment may compensate and change that into something much closer to the long life provision case. If the deceased thinks there's some value in someone other than them getting the money even though they personally lost out.

jamesd

Telegraph_Sam wrote: »

What you say COULD be interpreted to mean that any deferral is a waste of time (literally) if in effect the 10-year clock only starts ticking from the date of starting to take the pension.

That reply ignored two huge factors, death and 6% compounded interest rate available from a regular saver account, or the alternatives from investing. Completely ignoring investment returns during a break even time that is likely to be fifteen to twenty and more years from starting to defer is very unwise.

Telegraph_Sam wrote: »

My assumption up to now had been that I had to defer for approx 10 years (I think my calculations led to 13, but no matter) after SRA at which point the rewards from deferring equalled the interim income sacrifice. I confess that I am in danger of tying myself up in knots now, may be you can help unravel the threads! Perhaps a very simplified example might help??

Just read How long should you defer?: "the implied real rate of interest on the first year of deferral is 6.6% pa; for the second year 5.1% pa; for the third year 3.6% pa; for the fourth year 2.2% pa; for the fifth year 0.8% pa." If you can beat those rates, you should not defer for the applicable years if you expect normal life expectancy, unless you are deliberately planning for the long life case in case you live longer than average.

Telegraph_Sam wrote: »

I suppose the crystal gazing bit comes in "selecting" a particular terminal age (= average 87?) and ask the system what the optimum pension-deferral age is to provide max benefit for a single in the period leading up to it!

Already been done in one of the studies mentioned earlier. Today you can probably beat 3.6% real (add inflation) return using the 6% regular saver account from First Direct. So deferring for three years is currently only a marginal choice for 65 year old males who expect average life expectancy but two years is quite likely to be good, while four is likely to be bad.

That can change in two main cases:

1. If you care about inheritance. Then you might be content with making yourself worse off while alive because of the inheritance. Those in a marriage might easily fall into this category, but single people are less likely to.

2. If you deliberately want to provide for living longer than average. The inflation-linked state pension is cheap compared to inflation-linked annuities so it is a good buy for even five years, and perhaps sometimes longer, for the long life case, depending on what investment returns you can get. The How long should you defer? rates given earlier allow for the cost of dying so those aren't the ones to use for this calculation.

patanne

There are many questions you need to ask yourself before making a decision on this. Are you actually retiring, will taking the SP make you a higher rate tax payer? Remember that you stop paying NI at 65 (I think this goes up with male state pension age now) so if this does send you over it will cost all 40%. How much other pension do you have & how much pension will you actually need so as not to impinge too much on your lifestyle. Remember that the lower your current income, the higher the percentage you will need in retirement. Also are you fit & healthy. If you are not fit & healthy at 65, then you will be even less so at say 67 so deferring might not be a good idea. The good thing is that you can decide today to defer for 5 years & change your mind in a couple of months. Whatever you decide to do it is not a firm commitment and only you can decide.

zygurat789

patanne wrote: »

There are many questions you need to ask yourself before making a decision on this. Are you actually retiring, will taking the SP make you a higher rate tax payer? Remember that you stop paying NI at 65 (I think this goes up with male state pension age now) so if this does send you over it will cost all 40%. How much other pension do you have & how much pension will you actually need so as not to impinge too much on your lifestyle. Remember that the lower your current income, the higher the percentage you will need in retirement. Also are you fit & healthy. If you are not fit & healthy at 65, then you will be even less so at say 67 so deferring might not be a good idea. The good thing is that you can decide today to defer for 5 years & change your mind in a couple of months. Whatever you decide to do it is not a firm commitment and only you can decide.

You stop paying NI class 1 as from the date you achieve state retirement age.

Telegraph_Sam

patanne wrote: »

There are many questions you need to ask yourself before making a decision on this. ..... Whatever you decide to do it is not a firm commitment and only you can decide.

This is it: The issue is or can turn out to be vastly too complex for the average Joe Soap to resolve taking all these factors into account. In my experience the Pensions Advisory Service cannot and (most) IFA's will not provide more than the most general of advice, which throws the ball back into the poor "beneficiary's" court. Ideally there would be an online spreadsheet system or something where one could input at least some of the key variables and it would come up with first line conclusions. In the absence of this desirable state of affairs what does one do? Toss a coin, apply gut feel and sign up (or not) ???

It's easy - and relevant - to ask the various questions but very much more difficult to come up with the answers!

napaul

I have deferred my state pension for 8 years. I am a 68 year old woman and currently pay 20% tax as I still work. Am I silly to have deferred it for so long? What should I do? Is the 2% interest above base rate cumulative or just 2% for each year?