Recent analysis from mutual insurer Royal London found that large numbers of people working past state pension age could be paying unnecessary tax on their state pension because they have failed to take up the option of deferring their state pension until they stop work. As a result, the whole of their state pension is being taxed, in some cases at 40%.
If they defer taking their state pension they will get a higher pension when they do retire, and their personal tax allowance will then cover all or most of their state pension, dramatically reducing the amount of tax they have to pay on their pension.
Steve Webb, director of policy at Royal London, said the mutual insurer is now calling on the Government to make people more aware of the option of deferring their state pension, especially those who are working past state pension age.
He said: “There has been a huge increase in the number of people working past the age of 65, and this research finds that most of these people are claiming their state pension as soon as it is available.
For around half a million workers, this means every penny of their state pension is being taxed, in some cases at the higher rate. If their earnings are enough to support them, it makes sense to consider deferring taking a state pension so that less of their pension disappears in tax.
A typical woman could be around £4,000 better off over the course of her retirement by deferring for a year until she has stopped work, and a typical man could be £3,000 better off.
Those who have worked hard to build up a state pension through their working life do not want to see a big chunk of it disappear in unnecessary taxation. The government should be doing more to alert this group to the option of deferring, as current publicity is clearly not working.”
The research found that in 2017 there were around 1.1 million people in the workforce who were 65-years-old or over. Of these, roughly 950,000 were combining paid work with drawing a state pension.
Out of this 950,000, around 520,000 were earning enough to take them over the tax threshold. This meant that the whole of their state pension was taxed. Those who defer their state pension can get an extra 5.8% per year on their pension for the rest of their life for each year that they defer.
Scott Gallacher, chartered financial planner at Rowley Turton, said: “Whilst Royal London are correct that drawing your state pension whilst still working can create an additional, and perhaps unnecessary tax burden although there are other considerations.
“For those reaching state pension age before the 6th April 2016 the state pension was increased by 10.4% for every year you deferred, this means that it will take you just under 10 years to recover the pension you could have received in the meantime and factoring in a potential 40% income tax saving reduces this recovery time to just under 6 years.
“They could elect to take that their deferred state pension as a lump sum. For example, you could in effect defer your state pension from a year when you are working until a year when you are not working and thereby significantly reduce the tax on that pension.
“Consequently, state pension deferral was a popular option for many clients who continued working past state pension age.
“However, for those whose become entitled to their state pension on or after 6th April 2016, their increases in deferral are much lower – just under 5.8% for every year you defer. This means that it will take you around 17 years to recover the pension you could have received in the meantime although factoring in a potential 40% income tax saving does reduce this recovery time to just over 10 years.”
Aamina Zafar is one of the UK’s leading financial journalists. She has previously worked as a senior reporter at FT’s Financial Adviser. The award-winning journalist writes regularly on the IFA community, mortgages, pensions and financial regulation.
Further reading on this topic: