The new deal on taking state pension early is barely worth considering says Teresa Hunter
The Government may have shied away from slashing pensions tax relief for the better-off but it is clawing back cash as quickly as it can on every other front.
Deferring state pension used to be a steal of a deal thanks to generous incentives – a no-brainer for the better-off, who didn’t need the money straight away. But rule changes in April removed these incentives, so much so that, for many, deferring the state pension could now be a terrible idea.
The changes were introduced following a report from the Government Actuary’s Department on what ‘actuarially fair’ terms would be, because ministers were concerned that the existing regime was too generous. This was in itself problematic. Gad acknowledged: “The concept of an ‘actuarially fair’ rate of increment is subjective.”
The number-crunchers hit on a neutral formula so that retirees would be neither better nor worse off when they took their pension – given average life expectancy.
So far, so good, although it could be argued that, if the Government wanted to encourage people to work for longer – bringing extra revenue into its coffers and delaying the cost of a pension when deficits were high – then at least a little incentive was not unreasonable.
In the event, Gad recommended that a fair, “neutral” rate of return lay between 5.7 and 8.5 per cent a year. It also highlighted the obvious fact that, for true fairness to be achieved, different rates should be paid to different people based on gender and life expectancy.
The Government opted for a single rate at the lowest end of this range.
Before April, you used to be able to increase your pension by 1 per cent for every five weeks you delayed claiming – roughly equivalent to a 10.4 per cent annual rate of interest. But you had to factor in the pension you forwent as well.
A man retiring at 65 has an average life expectancy of around 20 years. So, if he gave up one year of pension and received the pension for 19 years rather than 20, he effectively lost 5 per cent of the value of the uplift. But this still left him with a 5.4 per cent net guaranteed return – a better secure option than could be found anywhere else.
The good news for anyone who reached state pension age before April, and is still deferring, is that you will continue to accrue benefit at the rate of 10.4 per cent a year. But anyone retiring from the start of this tax year will receive only a 1 per cent boost after waiting nine weeks for their state pension.
That is four weeks longer than under the old regime and is equivalent to a 5.8 per cent annual return. If you delay a year, thereby slashing 5 per cent off your rate of return, you are left with 0.8 per cent.
Not only is that not much to get excited about but, for some, it is very poor value indeed.
The Gad calculated that, for a man retiring this year and up to 2020, expected to live for 20 years past state pension age, a fair return would be 6.7 per cent – some distance ahead of the 5.8 per cent he will in fact be paid. A man with a high life expectancy required a 6.4 per cent return, according to Gad.
In other words, under the new system men will get anything but fair value, and women too will be short-changed. A female with an average life expectancy retiring this year would require a 5.9 per cent uplift to make it worth her while to defer, but this figure rises each year and hits 6.2 per cent by 2020.
Women who are expected to make it into their 90s and beyond have more to gain. For them to be as well off by deferring, Gad calculated they required a return of 5.7 per cent this year and next, rising to 5.8 per cent the year after and 5.9 per cent by 2020.
In other words, the only people who will get fair value are women who retire this year
or next and who are expected to get that telegram from the Queen – quite a small subset of the population.
There will still be individuals who choose to defer for tax purposes, or who are desperate for the index linking that the state pension provides. But advisers will have to look much harder at their client’s overall position before ticking the deferral box.