State pensioners can legally avoid tax on their state pension and gain £727 a year extra in their pension pot by deferring their payments.
Tax Exemption for Some Pensioners
New Prime Minister Andy Burnham has announced support for a policy introduced by former Chancellor Rachel Reeves, which will give a tax exemption to state pensioners who have no income other than the basic DWP state pension.
However, those with even small amounts of income from other sources, like work or savings, will not be exempted and will be made to pay tax to HMRC once they cross the £12,570 threshold.
How Deferring Works
There is a little-known way to avoid tax on your state pension and boost your pension payments in future at the same time: deferring. If you’re still earning money when you become eligible for the state pension - at age 66, or 67 depending on the ongoing state pension rise - you could save yourself from being taxed on your pension by deferring.
If you’re still working, you would pay tax on your state pension at your normal tax rate. For example, if you’re still earning over £50,270, you’d lose 40% of your state pension payments to tax.
Financial Benefits of Deferral
If you defer your state pension - i.e., don’t claim it for a year or more - you’ll add 5.8% to your state pension pot for every year you don’t claim it, which on the full new state pension with a maximum National Insurance record works out at £727.76 a year.
Deferring also means you don't lose any of the state pension income to tax if you're still working, so it could be a double win - less tax now, more money later. Of course, you’d lose your pension income in the year you deferred it, but that extra £727 is paid every year until you die.
So eventually, what you lost in the first year of deferral could be overtaken by what you gain long term - and this would come around much quicker if you already lost some state pension to tax, effectively avoiding that tax entirely and boosting future pension years instead.
Considerations and Expert Views
The £727 amount is based on someone having the full new post-2016 state pension amount, which requires a full National Insurance record of about 35 years. If you had an incomplete record, your total gain from deferral may be lower in cash terms, but it would still represent 5.8% of your total pension allowance.
Financial Advisers Red Dot Group explain: "To make the most of your retirement, consider reviewing your overall financial plan. One of the first steps could be obtaining a State Pension forecast. This free service from the government lets you check how much you’re likely to receive and identify any gaps in your NI record. Additionally, explore options like deferring your State Pension. For each year you delay claiming it, your payment increases by around 5.8%, which may be valuable for those who can afford to wait."
Previously, money expert Martin Lewis spoke about this method. He said: "Defer your state pension, and the maths works out that if you live longer than typical life expectancy, you'll gain; if you live less, you'll lose. Live a typical lifespan and it'll be pretty neutral. So if you're in poor health, it's not really worth considering. If you're in great health with a history of family longevity, deferring could be a winner. Otherwise the real issue is tax – if you're earning or have a decent income now, but'll pay tax at a lower rate later on, then deferring can be very worthwhile."
