To defer, or not to defer?

Zudecke_2

Hi,

My mum would like to know whether or not she should defer her state pension, or if she should start taking it now?

She is currently still employed at 65 and working full time.

She has no other income.

I advised she should probably wait until she retires and then lump sum cash out at the beginning of a financial year, so that £10k or so will count towards her tax free allowance. But is there anything else to consider?

Many thanks,

Z

kidmugsy

Zudecke wrote: »

I advised she should probably wait until she retires and then lump sum cash out at the beginning of a financial year, so that £10k or so will count towards her tax free allowance.

You're quite right that she'd do best by awaiting retirement, so that she avoids income tax.

The lump sum doesn't really count towards the personal allowance: it's taxed at whatever is her marginal tax rate on the rest of her income. For example, if her only income in her first year of retirement were her State Pension and it came to (say) £7k p.a., then she'd be a 0% taxpayer, and the lump sum would be taxed at 0% too.

If instead she took the extra pension, then her income would instead be £10.5k p.a. (£7k multiplied by approx 1.5); being less than £11k that would pay 0% tax.

bouicca21

As has been pointed out the deferred lump sum is taxed at the marginal rate so if she takes it in a new tax year and that is her only income then it will be tax free.

Whether to take it as a lump sum or as additional pension is up to her. She would have to survive roughly 10 years for the additional pension to break even with the lump sum, and unless she has health issues, the odds are on surviving that long.

If on the other hand she wants to pay off debts, wants some money in the bank to pay for unexpected repairs to home or white goods, give some money away, or live it up/do a round the world trip while she is still fit enough to enjoy it, then she should consider the lump sum. If she is 65 now then she presumably has about 4 years worth to claim. That will be a tidy sum.

Jam today or jam tomorrow?

jamesd

Assuming she's in good health the best option would be to take the higher income for life rather than the lump sum.

Assuming she's in good health there's no pressing need to stop deferring at present. Around the ten year mark is where it is likely to cease to be break even over normal life expectancies.

If she has inheritance concerns, or you do, term life insurance for say ten years of cover is very cheap and can cover the state pension money not received while deferring.

jamesd

On a slightly different subject, assuming her gross income is at least £10,000 a year she can get £500 a year of tax free money by paying into a pension and taking it out each year. Ask if she's interested in learning more about this free money. If her earned income is less than 10k there's still free money to be had, just less. It's available only to those aged 55 or older.

DREKLY

Jamesd - your post above seems VERY interesting!
Almost too good to be true !!
Can you please explain further, if it does not detract from the original thread topic, thankyou....

CathA

On the subject of deferring and taking either the lump sum or increased pension, is it possible to do both? i.e. have half the lump sum and the rest as increased pension? No particular reason I want to know, just curious? Thanks.

kidmugsy

patanne wrote: »

I believe not but you can defer take the pension whichever way and then defer again.

Yes; the second time the reward must be taken as Extra Pension.


UPDATE: I was wrong - see next two posts.

LXdaddy

kidmugsy wrote: »

Yes; the second time the reward must be taken as Extra Pension.

Are you sure? I thought that as long as the second period of deferral was at least 12 months, you have the option of a Lump Sum.

If you are already getting your State Pension, you can choose to stop getting it for a while to build up extra State Pension or a lump sum.

kidmugsy

LXdaddy wrote: »

Are you sure? I thought that as long as the second period of deferral was at least 12 months, you have the option of a Lump Sum.

You're right.

"You would need to stop claiming for 12 months or more the second time to be able to get a lump-sum payment."

jamesd

jamesd wrote: »

On a slightly different subject, assuming her gross income is at least £10,000 a year she can get £500 a year of tax free money by paying into a pension and taking it out each year. Ask if she's interested in learning more about this free money. If her earned income is less than 10k there's still free money to be had, just less. It's available only to those aged 55 or older.

DREKLY wrote: »

Jamesd - your post above seems VERY interesting! ... Almost too good to be true !! ...Can you please explain further, if it does not detract from the original thread topic, thankyou....

Pay £8000 into a pension at basic rate income tax or lower and it's grossed up to £10,000 in the pension. Take 25% tax free lump sum and the rest, gain is:

1. If all £7,500 of the taxable part is within personal allowance: £2,500 (tax free) + £7,500 (taxable but no tax to pay) - £8,000 (paid in) = £2,000 a year.

2. If all £7,5000 of the taxable part is taxed at basic rate: £2,500 + £7,500 * 80% - £8,000 = £500 a year.

3. Some personal allowance used. Depend on the amount of allowance remaining.

Someone with no earned income can pay in up to £2,880 net, £3,600 gross and make similar but numerically smaller gains.

The £10,000 comes from the limit of £10,000 a year of pension contributions once money in excess of the 25% tax free lump sum has been taken from a pension. Until that time you can pay in your whole earned income, subject to a £40k cap plus any carry-forward of the unused annual allowance from the previous three years. After taking some of the non-25% your limit is reduced to £10k for life, no carry forward allowed either. There are various rules relating to recycling of tax free lump sums that can come into play once the tax free lump sum taken in a twelve month rolling period goes over £7,500, if lump sum recycling was pre-planned. No limit on doing it out of ongoing income, including ongoing pension income. You can set up direct debits and drawdown income to automate much of this - just set up to take in and pay out the same amount from the taxable part and top up with the 25% lump sum one a year when you take it to get to the full annual contribution allowance available.

Deferring taking the state pension can be helpful to maximise the gain, so can deferring taking a work pension. In effect it increases the potential gains from deferring by increasing the amount of unused personal allowance. For those working the pension contributions reduce taxable income, freeing up personal allowance as well. Of course you do need money from somewhere to live on while doing this - savings, say, or borrowing at suitably low rates.

The age 75 limit is because that's the age at which you can no longer make new pension contributions.

On the more prosaic side, those who find themselves long term unemployed or unable to work can benefit from both the ongoing contributions and from being able to take out their pension money with lower income tax bill. It's far from all about the ongoing doing of it that I describe here.