Should You Delay Taking Your State Pension?

Nick Pensions & Benefits pensions 6 Comments

I know many readers of Pounds and Sense are coming up to the state pension age. That includes me. I have just over three years to go, assuming the government doesn’t change the rules again!

One decision everyone in this situation has to make is whether to start claiming the state pension as soon as they are eligible, or defer it. You might wonder why anyone would choose to put off receiving their pension, but the government does offer a modest incentive for doing so. For every nine weeks you defer, you get an extra 1% added to your pension payments thereafter.

If you are in good health and don’t need the money (perhaps because you are still in work) delaying may be worth considering. Even so, it’s something to think carefully about, as you may have a long wait until you are in profit from doing so.

Crunching the Numbers

Here are my (admittedly somewhat simplified) calculations.

The current new state pension is £168.60 (people who retired on the old state pension are likely to be on less than this). One percent of this is £1.686 per week.

If you opt to sacrifice 9 weeks of the state pension, that has a total value of 9 x 168.60 = £1517.40. If you divide this by the extra weekly pension you will receive after this, you get a figure of 1517.40/1.686 = 900. In other words, you would need to be claiming for 900 weeks, or just over 17 years, simply to break even.

Deferring for a year will earn an increase in your pension of 5.8% but cost you – at the current rate – a total of £8767.20. The extra pension thereafter will be worth an extra £508.50 a year, but again it would take you a little over 17 years to recoup the year’s pension you didn’t get.

Overall, then, for most people I don’t believe that deferring will be a desirable or sensible option. This applies especially if you have any health or lifestyle issues that may reduce your life expectancy.

However, there is one other thing to take into account, and that is tax…

Tax and the State Pension

Not everyone realises this, but the UK state pension is taxable. That means if you have other sources of income that use up your personal allowance, you will have tax deducted from your state pension at your highest marginal rate.

If that applies to you, the case for postponing your state pension is stronger. Assuming you pay tax at the basic rate of 20%, then 168.60 x 20% = £33.72 would be deducted from your weekly pension in tax, leaving you with just £134.88. If you do this for 9 weeks, you will therefore receive 9 x 134.88 = £1213.92 in total after tax. Dividing this by the 1% extra you would get from deferring gives you a figure of 720 weeks or 13 years and 8 months to break even by deferring. That’s still a long time, but if you are in good health you are more likely than not to live this long after reaching pension age. Of course, this does assume that once you start claiming the state pension your total taxable income is covered by your personal allowance. If that’s not the case and you have to pay tax on your state pension, the payback period after deferring will be longer.

• Like all the calculations in this post, the above assumes for simplicity’s sake that the state pension remains the same in future. In practice it is likely to go up every year, increasing the value of that extra 1% (or whatever). That means the time period before you recoup all the money you turned down is likely to be a bit shorter. On the other hand, the effect of inflation is likely to offset this.

Another potential issue could arise if you are already earning a substantial income and claiming the state pension would push you into a higher tax band. This could be another good reason to consider deferring.

Summing Up

Overall, it seems to me that if you expect to be on a modest (or even average) income in retirement, there is unlikely to be much benefit to deferring your state pension (and I don’t intend to myself). If you are a higher earner and in good health, however, there might be.

Obviously everyone’s circumstances are different and I can’t give individual advice, but it’s well worth speaking to a qualified pensions adviser if you think that deferring the state pension may be beneficial for you.

Finally, if you do decide to defer, no special action is required. Four months before you reach state pension age, you should receive a letter and booklet from the Department for Work and Pensions (DWP) telling you how to claim your state pension. You can just delay claiming and it will be assumed that you wish to defer.

As ever, if you have any comments or questions about this post, please do leave them below.

My Experience of Putting My Pension into Drawdown

Nick Pensions & Benefits pensions 7 Comments

I recently decided to take the plunge and put my personal pension into drawdown. As I know many Pounds & Sense readers will be thinking about doing this (sooner or later), I thought I would share my experience of the process here.

To give you some background, I am 62 and a semi-retired freelance writer. I still do some writing work – and run this blog! – but that doesn’t in itself produce enough income to live on. I am fortunate to have some savings and investments, but won’t qualify for my state pension until I am 66 (in about three-and-a-half years).

I do have a SIPP (Self Invested Personal Pension) with Bestinvest, though, so I decided I would put this into drawdown to give me another source of income. As you will know if you read this recent post, drawdown is one of the options open to you if you have a defined contribution pension. Once you are 55 or older, you can withdraw a quarter of your pension pot tax-free and (if you opt for drawdown) take a taxable income from the remainder. The balance stays invested until you withdraw it, and hopefully continues to grow.

Mine is not a massive pension pot – it came to about £56,000 – but my financial adviser and I worked out that if I draw £200 a month, assuming average growth of the remaining investments in my portfolio, it should last me until I am well into my 80s. I will also have the option to reduce the amount I draw once my state pension kicks in and/or to top up my pension fund to a modest degree in later years (see below). Yet another option will be to use the balance in my pension pot 10 to 15 years down the line to purchase an annuity, by which point the rate available on this will be higher.

The Process

I have been managing my SIPP online for over 10 years, but there wasn’t much on the Bestinvest website about how to put it into drawdown. So I phoned them up and asked.

The woman I spoke to said they would email an application form. This duly arrived as a PDF. I was pleased to discover that I could complete it on my PC (I use the free Foxit Reader for reading and editing PDFs).

The form had 10 pages. As well as the usual personal information, it wanted to know how much I wanted to draw from my pension and at what intervals. It also asked whether I wanted to take the tax-free lump sum straight away (I said yes).

The other things the form asked were a bit less predictable. There were quite a lot of questions about other pensions I might have. This didn’t apply to me, but they have to ask in order to check that you aren’t exceeding your lifetime allowance of just over a million pounds (I wish!).

The form also asked whether I had taken advice from the government’s Pension Wise service and/or an independent financial adviser. This did strike me as a bit nanny-ish, but as it happened I was able to say yes to both.

Clarifications

There were a few things I wasn’t clear about, so I phoned Bestinvest back and asked them. Here’s what I discovered. I hope this information may be useful to anyone who is in this situation or will be soon, as it doesn’t seem to be widely known.

First of all, I assumed that when paying out from my pension, my provider would simply sell off funds on a pro rata basis (I have about a dozen funds and shares in my pension account). This turned out not to be the case, though.

The woman at Bestinvest explained they don’t do this, as people often have their own views on which funds they want to sell and which they want to keep long term. So she told me I should sell enough funds via the BI website to cover my lump sum and also to cover my monthly payments going forward. To avoid delays she advised me to do this as soon as possible.

I therefore sold around £15,000 worth of funds from my account, to cover the lump sum I was withdrawing and the first few monthly payments. As the months go by I will obviously need to sell more of my holdings, but hopefully the cost will be balanced to some extent by the value of my remaining holdings going up.

I also discovered that my online account would continue to function exactly as it did before going into drawdown. The only difference is that the government imposes a lower limit of £4,000 (including tax relief) for any further investments in a SIPP after you have “crystallised” your pension (i.e. started drawing a taxable income from it). This rule is to avoid people withdrawing large sums and immediately reinvesting them to get another big chunk of tax relief, which I guess is fair enough. In any event, it’s good that I will have the ability to top up my pension from my other savings and investments by a few grand a year in future if my remaining pot starts to shrink too much.

After all this I submitted my form, and everything so far has gone as promised. It took about a month for the tax-free lump sum to appear in my bank account, and around six weeks to get my first monthly payment. I had heard some horror stories about large “emergency deductions” being made from the latter by HMRC to cover any possible tax liability, but discovered they weren’t applying any deductions at source to my payments. Of course, I will have to add this money to my total taxable income for the year, and if it exceeds my personal allowance I will have to pay tax on it.

So that was my experience of putting my Bestinvest SIPP into drawdown. As of August 2018, I can legitimately describe myself as a pensioner! If you have any comments or questions, naturally, please do post them below.

Disclosure: This post includes affiliate links. If you click through and perform a qualifying transaction, I may receive a commission for introducing you. This will not affect in any way the product or service you receive.

What Should You Do With Your Pension Pot When You Retire?

Nick Pensions & Benefits pensions 0 Comments

In recent posts I’ve discussed various aspects of saving for your retirement, including the state pension and how to trace lost or forgotten pensions.

Today I’m going to discuss what happens when that fateful day arrives.

Most pensions nowadays, workplace and private, involve building a ‘pot’ that can be turned into regular income in retirement. This is known as a defined contribution pension.

• There are also still some defined benefit pensions, where on retirement you receive a set income based on the number of years you have been contributing. These are generally regarded as the ‘gold standard’ for pensions, and you should think long and hard (and get independent financial advice) before cashing one of these in for a lump sum.

If you have a defined contribution pension, in this post I will look at what you can do with your pot once you are ready to start drawing an income from it. Following George Osborne’s 2014 pension freedom reforms, in most cases you can do this from age 55 upwards.

There are four main options. I’ll run through them now.

(1) Keep Your Pension Invested

There’s no obligation to start taking an income from your pension at any particular age. If you don’t need the money, therefore, there’s a case for letting it carry on growing tax-free until such time as you do.

(2) Buy an Annuity

This is the traditional method of funding your retirement. Using your pot to buy an annuity gives you a guaranteed income for life.

How much you will get depends on various factors. These include how much is in your pot, your age, whether you want your income to go up every year, and whether you want to pass on the annuity (e.g. to your spouse) when you die.

Annuity rates in recent years have been relatively low, though you may be able to get a higher quote if your health is poor (as the company doesn’t expect to have to pay out for as long!).

The government lets you withdraw 25% of your pension pot tax free, and the rest can be used to buy an annuity. Annuities are taxable, so depending on your other income, tax may be deducted before you receive your payments.

To get a rough idea how big an annuity your pot will buy, you can use the online calculator on the government’s Pension Wise website. When I tried this with a sample pot of £100,000 and taking an income at 62, I got a quote of £25,000 tax-free cash and a taxable annual income of £3,300 (£275 a month) for life.

(3) Take the Money in Chunks

Another option (from age 55 onwards) is to withdraw money from your fund in chunks as and when you need it. If you do this, 25% of each withdrawal will be tax free and the rest will be taxed along with any other income you earn. Not all pension providers currently offer this option.

(4) Use Flexible Drawdown

This is becoming a very popular method. Flexible drawdown involves taking money from your pot to provide a regular monthly income, while leaving the rest invested, hopefully to continue growing.

With flexible drawdown, you can withdraw 25% of your pension pot as a tax-free lump sum. The rest is then used to provide a regular, taxable income.

The process is quite straightforward. You simply notify your pension provider (or self-investment platform) that you wish to go into drawdown. They will then arrange this for you (for which a fee may be payable) and ensure that a payment goes into your bank account the same day every month from then onward.

You can keep your money in the same investments as before or take the opportunity to adjust them (perhaps switching to funds with lower charges). You can set the monthly income at any level you like and vary it any time as well, although again there may be charges for doing so.

As well as its flexibility, the drawdown option has the benefit that the remainder of your money stays invested and can continue to grow tax free.

The main risk, of course, is that your money will run out before you die. This isn’t a precise science as it depends on two things that are impossible to predict accurately – how long you will live and how well your investments perform.

When deciding how much it’s safe to draw every month, it’s therefore essential to take into account how long you expect to live in retirement. A 65-year-old man in Britain today has a 50% chance of living to the age of 87 and a 65-year-old woman to the age of 90. So you may easily have 30 years in retirement, or even longer.

As for what rate investments may grow, in the current investment climate an estimate of around 4% a year is considered prudent – but in reality, obviously, your investments may do better than this, or they could do worse.

Again, the Pension Wise website has a calculator that will give you a rough idea how much you can safely draw from your pension pot and how long it is likely to last. There are no guarantees, though, so if you opt for drawdown it’s important to review your arrangements regularly and adjust them as appropriate.

Other Options

The above are the main options, but there are others as well.

If you wish, from age 55 you can withdraw your whole pension pot. Again a quarter of this will be tax free and the remainder treated as taxable income in the year concerned. If you have a substantial pot, this could result in you being pushed into a higher tax-rate bracket that year, so this course of action is not generally recommended. The one time you might want to do it is if you have a small pension pot and/or debts you want to pay off.

You can also mix and match. For example, if you have £200,000 you could draw £50,000 in tax-free cash, put £50,000 into an annuity for a secure life-long income, and leave the rest in a drawdown product for continuing growth. There is actually much to be said for having a variety of income streams in retirement.

Final Thoughts

Even if you’re not near the stage of drawing your pension, it’s still important to understand how the system works and plan accordingly. Nobody wants to end up having to rely on the state pension to fund their later years.

If you ARE getting close to retirement, I highly recommend speaking to an independent financial adviser to discuss your specific circumstances and needs. If you’re over 50 you can also book a free telephone or face-to-face appointment with a Pension Wise adviser. They will go through the options with you and answer any questions you may have.

In any event, though, it’s important to plan carefully to take advantage of the range of tax-efficient saving and investing opportunities on offer, and ensure that when the time comes you have enough money to enjoy your ‘golden years’ rather than struggle through them.

Good luck, and I wish you a long, happy and prosperous retirement!

• You might also enjoy reading this comprehensive article on How to Make the Most of your Retirement.