State pension deferral - worth while??

kidmugsy

Telegraph_Sam wrote: »

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

I was amused that the algebra was so easy and delivered such a clean, memorable result!

Mind you, if you wanted to assume that you might instead make 6%p.a. in a regular saver, or lose 50% in a stock market crash, the elegance would evaporate.

You can also use schoolboy calculus to derive a simple result for the "optimal" length of deferral, but it's less memorable (or, at least, I haven't remembered it) and anyway I suspect that in practice it's an "upper bound" i.e. it's sufficiently sensitive to the simplifying assumptions that you should look on it as the maximum period for which to defer, rather then the best.

kidmugsy

napaul wrote: »

Am I silly to have deferred it for so long?

Not necessarily. It depends on so many things, including your health, your family's longevity, your tax status, your spending plans, and so on.

You might be happy to cash it in now, in which case your big decision is whether to take your reward as a lump sum, or as an extra pension.

Linton

napaul wrote: »

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?

If you look through the detailed hmrc document here you will find that the interest is cumulative and the lump sum is accumulated weekly using the then current base rate and pension value.

You still being alive means you have avoided one of the risks of deferment! If you didnt need the money and considering that at 60 your chance of dying before 68 was around 5-6% it seems to me you made a sensible choice, though perhaps you could have achieved the same or better result by taking the pension and investing it in an S&S ISA if you were familiar with investing assuming that its the lump sum you are after.

I havent done the maths, and as you will have read from earlier posts it is a little complex, but I guess that it would be more worthwhile to take your deferment as an increased pension rather than a lump sum.

kidmugsy

napaul wrote: »

I have deferred my state pension for 8 years.

One thing that could tip your decision towards the lump sum would be if you could get it tax-free. Do you pay income tax?

For what it's worth, on my urging my wife deferred for about five years, and is taking her reward as extra pension even though we could have taken the lump sum tax-free by timing the restarting of the pension carefully. She's in good health and from a long-lived family.

Telegraph_Sam

kidmugsy wrote: »

You can also use schoolboy calculus to derive a simple result for the "optimal" length of deferral, but it's less memorable (or, at least, I haven't remembered it) and anyway I suspect that in practice it's an "upper bound" i.e. it's sufficiently sensitive to the simplifying assumptions that you should look on it as the maximum period for which to defer, rather then the best.

Would that I could but unfortunately my abilities with what remains of schoolboy calculus have got a very definite upper bound also and this has long since been reached.

kidmugsy

Linton wrote: »

perhaps you could have achieved the same or better result by taking the pension and investing it in an S&S ISA .

True: but then again, eight years ago gets us to 2006; if after a couple of years investing in an S&S ISA one got hammered by the crash of 2008 (was it?), lost a large proportion of the capital, and got scared out of S&S investing again, one might have lost badly by drawing the pension. Somewhere there's probably a lucky so-and-so who deferred, thereby avoided the crash, cashed in as a lump sum, and put the lot into equities just in time for the rebound. No algebra, calculus, or spreadsheet can usefully allow for such varieties of experience.

I suppose I conclude that deferring and then taking the extra pension has that unusual combination of being a strategy that is both cautious and well-rewarded. Your main risk, apart from dying early, is a political risk that a future government won't honour the promise to pay the extra pension, or to index-link it honestly. That's one reason I was happy that my wife started her pension after five or so years of deferral rather than waiting for my "optimal" period. "Optimal" is too optimistic.

Telegraph_Sam

Solution must surely be to arrive (somehow) at a mathematically optimal solution and then modify it by intangibles, crystal ball gazing and what have you. I'd be happy if I could get to stage one!

bigadaj

Telegraph_Sam wrote: »

Solution must surely be to arrive (somehow) at a mathematically optimal solution and then modify it by intangibles, crystal ball gazing and what have you. I'd be happy if I could get to stage one!

There isn't a single mathematically optimal solution there, there are a range of outcomes. For most people this would require a range of calculations to determine how much benefit accrues dependent on deferral time and life expectancy. James d response previously shows this approach.

As well as the intangibles of individual life expectancy, which is a probabilistic rather than a fixed number, the actual value of the money will vary, many people comsider that money is of more value early in retirement when people are generally more active and in better health, but this is a personal decision.

jamesd

kidmugsy wrote: »

For what it's worth, on my urging my wife deferred for about five years, and is taking her reward as extra pension even though we could have taken the lump sum tax-free by timing the restarting of the pension carefully. She's in good health and from a long-lived family.

Good job! In her situation I might even go as far as eight years but it's really hard to justify doing it that long when the money can be taken and invested.

napaul wrote: »

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?

You're not silly but you have deferred past the point where women in general can be expected to benefit compared to taking the money and saving or investing it, if you live a normal time.

That is not necessarily a bad thing because the increased payments, once you start to take them, do increase with CPI inflation, though without the triple lock. However, the 10.4% increase a year is fixed and that part never increases, so all you get for the fist year and 8th year is the same 10.4% increase, no compounding at all.

It's also not necessarily a bad thing because there is nothing wrong with deferring past the limit where it's expected to be possible to break even. You can sensibly do this just to protect yourself with a nice inflation-linked income in later life. Even for that purpose, eight years is a bit on the long side even for a woman.

Given average life expectancy it is now unlikely that you will even break even on the deferring you have already done. You're more likely to die before breaking even than to live long enough for it to happen. But that's OK: one use for deferring is to improve your situation if you do live substantially longer than average.

What you've done is buy yourself a nice inflation-protected income that will continue even into long old age. Time to collect that income. It's becoming way too hard for you to even break even compared to taking and saving or investing the income.

napaul wrote: »

What should I do?

In general by this point you should claim your state pensions. Unless you are deliberately providing for living a long time, about five years is the maximum amount of deferring that makes sense for a woman with normal life expectancy.

But how will your finances be alter in life if you do that now? Will you have plenty of income once you're no longer working?

Are you from a long-lived family? Eight years is probably beyond the sensible limit even for very long-lived families, though.

How is your personal health? If it's good then the higher income is likely to be the best deal still. If it's not, say if you're diabetic, overweight or a smoker, bad though the deal normally is, you might be better off taking the lump sum so you can enjoy the money while you're still alive and young enough to enjoy it.

What would your taxable income be if you took it now? What about after you stop working? The reason I'm asking is that I wonder whether you might end up as a higher rate tax payer while working but also might end up with more than £20,000 in guaranteed income from work final salary pensions, annuities and the higher state pension. If you do end up with an income that high you can get a really good deal on pension contributions, "flexible drawdown". That gets you the tax relief on the way in, a 25% tax free lump sum, then eliminates the limits on taking the rest, you can just take it as taxable income whenever you want it. It's a nice way to make some extra tax gain for those who qualify.

I'm also cautious about the pension lifetime allowance for any work or personal pensions. the state pensions don't matter for this but if your personal pension pots plus twenty times the anticipated income from any work pensions plus the work lump sum is approaching or above a million Pounds please say so.

jamesd

Telegraph_Sam wrote: »

Solution must surely be to arrive (somehow) at a mathematically optimal solution and then modify it by intangibles, crystal ball gazing and what have you. I'd be happy if I could get to stage one!

The closest you're going to get to that is this table of required investment returns to break even by deferring, as a man (women can go up to two years longer, due to longer life expectancy):

one year: if you can't beat 6.6% a year plus inflation
two years: if you can't beat 5.1% a year plus inflation
three years:if you can't beat 3.6% a year plus inflation
four years: if you can't beat 2.2% a year plus inflation
five years: if you can't beat 0.8% a year plus inflation

This is the best simple guidance I've seen that includes some allowance for life expectancy and gives you some idea of how hard it starts to become to break even on average due to dying and possible investment returns. I normally use the even simpler guidance of deferring for one to three years if a man or two to five if a woman, both assuming normal good health and life expectancy. I know that some people will die before being better off even with those ranges but the number who will isn't excessive.

Normal investment returns from UK stocks are about 5% plus inflation after deducting 0.25% or so for costs. The 6% regular saver is in the 3-4% range when allowing for inflation. A mixture of investments would be best and if you do that it's hard not to expect to do well enough to beat the three year result, making two years the limit if you consider life expectancy.

But then you move on to things like catering for a long life and the relative certainty of the extra income. Even at five years, deferring for a man is still offering a good deal compared to an RPI or CPI annuity. So someone who is so cautious that they would buy a CPI annuity might want to defer for that long. perhaps longer, but eventually the open market annuity options mean that it'll be better to take the income and buy one of those instead. You can use this check against annuity rates as the final no way you can gain from waiting longer test: take the income when the annuities start to pay more and start to buy them instead. At the moment annuity rates are pretty low so it's way longer than is likely to really be sensible, just think of it as a final back stop to indicate that you've really waited too long.

You do need to remember that the 10.4% for deferring never goes up, so just inflation and time causes the value of the boost to drop if you don't take the money. It's not as if it was compound interest which at least would reduce the penalty of waiting too long. The amount it's 10.4% of does go up, though.

You really need to think about your own health, that of your family and how cautious you are. Even at the best long life in good health case with a high degree of caution, going beyond six to eight years for a man and eight to ten for a woman is really getting beyond the bounds of what is sensible unless you really will buy CPI annuities or value a larger estate more than your own spending while alive.

Say you have some personal pensions. What would you do with the money? If the answer is, buy an inflation-linked annuity, you should compare buying an annuity to deferring and drawing from savings one year's worth of state pension income. Deferring for another year will probably be the better deal (but it makes past years of deferring a worst deal because the 10.4% for them doesn't go up, so don't get carried away with this!). But something like 90% of annuities purchased are level annuities, not inflation-linked. And income drawdown is very likely to offer both higher income and higher inheritance than annuity buying, for those who can take some degree of investment risk.

I really like the providing for long life argument but even with that, there are sensible limits.