According to Money Management magazine (quoted in The Sunday Times 3/7/11) deferring the state pension by five years would increase annual income from £5,311 to £8,072.

This, says the highly respected magazine, is equal to a return of 8.7% a year compound – highly attractive in today’s low-interest-rate climate.

Of course, you have to live for at least nine and a half years after starting to take the pension in order to benefit, but with so many of us living longer than previous generations, this could appeal to many.

Why would you wish to defer the state pension?

Although many people wish to retire as soon as possible, others feel that they will be able to work well beyond even the increased state retirement age (which will reach 66 for both men and women by April 2020). Between April 2034 and April 2036, the state retirement age is set to increase to 67, affecting anyone currently up to their mid-40s. Then between April 2044 and April 2046 it rises further to age 68 – so anyone currently in their mid-30s or younger is hit.

To find your expected retirement age, please click here.

What if you need the income

Whatever your individual state retirement age, the potential rate of return available could make a decision to defer taking the basic state pension by half a decade potentially attractive.

Of course, this might not appear to be practical for everyone, although the flexibility allowed under current legislation makes it easier than previously to make a gradual transition into retirement by starting to draw a private pension while still in part time (or even full time, if you wish) employment.

For those who do not wish to work longer, but are still attracted by the idea of delaying their basic state pension, making personal provision to ‘fill the gap’ is by no means impractical. One method could be by building up an additional pension plan intended to generate an income for the five years between starting their occupational or other personal pension plan (provided it generates at least £20,000 a year) using the new flexible drawdown facility, which would enable them to utilise the entire additional fund over five years.

This option is not available to those whose guaranteed income is less than £20,000 a year, although they could still put aside sufficient money into a personal pension to generate an additional income between the ages of, say, 65 and 70, but this would require a larger fund as the income is limited to 100% of the level that could be purchased as an annuity at the time. However, after the basic state pension starts, the income drawn under basic drawdown could be reduced to zero, with the balance of the fund rolling up for future use.

An alternative approach

Another way of funding for the ‘five-year gap’ might be to use Individual Savings Accounts (ISAs) which can generate an income. Unlike pensions, there is no tax relief on the money you put in, but ISAs do grow largely free of UK taxes on income and capital gains and there is no tax on the money you take out.

It is important to seek independent financial advice before making any decision regarding your finances. The value of investments is not guaranteed; you may get back less than you put in.

NOTHING CONTAINED IN THE ARTICLE SHOULD BE CONSIDERED AS GIVING INDIVIDUAL FINANCIAL ADVICE. PLEASE NOTE THAT THIS ARTICLE IS BASED ON OUR CURRENT UNDERSTANDING OF LEGISLATION, WHICH CAN BE SUBJECT TO CHANGE IN FUTURE; THERE MAY BE VARIATIONS FOR THOSE LIVING IN SCOTLAND AND NORTHERN IRELAND.