If you are approaching State pension age (65 for men and women born after March 1955), or you are already in receipt of the State pension, there are two key options that you should be aware of. The options are; firstly to defer your State Pension and, by doing so, build up an entitlement to additional weekly pension in the future.  Secondly, to defer your State Pension and build up an entitlement to a lump sum in the future. In order to build up an entitlement to additional weekly pension benefits, the State pension needs to be deferred for at least 5 weeks.  When you decide to take or restart your pension, it will be increased by 1% for each 5 week period you have deferred it.  Therefore, deferring your State pension by 12 months results in an enhancement the pension of 10.4%. However, the additional pension needs to be balanced against the cash foregone in the meantime. On the face of it, without allowing for inflation or tax, it could take nearly 10 years to recoup the cash amount deferred. If you are still working, or have other income and you can do without the income from the State pension this may be beneficial.  You could defer receiving it while you are paying higher rate tax and elect to receive it later on, i.e. when other income sources may have ceased and you are then in a lower tax bracket. In these circumstances, not only will you receive a higher pension but you would also end up with more of it in your pocket. To build up an entitlement to a lump sum, the State pension needs to be deferred for a period of at least 12 months.  The lump sum will be the pension you would have received, plus interest added each week and compounded.  The interest earned is broadly equivalent to an interest rate of 2% per annum over the Bank of England base rate, which is extremely competitive. When you choose to start receiving your pension again it will be paid at the normal rate, plus any increases in the meantime.  The lump sum can be paid at that point, or you can elect to receive it in the following tax year, when perhaps you will be paying tax at a lower rate. The lump sum is taxable in the year you receive it at your highest rate of income tax.  This lump sum is not added to your total income, either for the purposes of seeing if you fall into the higher rate tax bracket, or for the purpose of calculating any entitlement to age allowances. If you die while your pension is still in deferment, your surviving spouse/civil partner may be entitled to extra State pension or a lump sum payment, when they claim their own State pension. Rules that apply until April 2010 mean that this entitlement will only arise if your surviving spouse/civil partner is also over State pension age when you die. If you are in receipt of extra State pension when you die, because of a previous deferment, your surviving spouse/civil partner may have the extra State pension added to their own State pension. So, some thought can be put into your state pension, to tailor it to your circumstances.  Combining this with other tax planning can be very beneficial and should not be overlooked.
  First published in The Western Morning News

Posted on 20 Jan 2007