Half a million people paying ‘unnecessary’ tax on state pension, study finds

An average male worker could gain around £3,000 by deferring for a year, while a female worker, with a longer life expectancy, could be around £4,000 better off after her retirement

People do not have to draw their state pension as soon as they are eligible (PA)

Around half a million older workers may be paying “unnecessary” tax on their state pension, analysis from a mutual insurer has found.

Large numbers of people in this age group could be paying tax on their state pension when they may not need to because they have failed to take up the option of deferring their state pension until they stop work, Royal London said.

The insurer found more than half a million people who are working past pension age are earning enough to pay tax and have not deferred their state pension.

An average male worker could gain around £3,000 by deferring for a year and a female worker, with a longer life expectancy, could be around £4,000 better off after her retirement, Royal London said.

People do not have to draw their state pension as soon as they reach the age when they are eligible for it – and they can defer it in return for receiving an enhanced payout when they do start to take it.

Those who defer their state pension can potentially get an extra 5.8 per cent annually on their pension for the rest of their lives for each year they defer.

Some people working past retirement age may find they would be better off deferring their state pension for a while if they are still earning a significant income, and then drawing a larger state pension when they actually retire, when more of their pension may be covered by their tax-free personal allowance.

But employees would need to work out whether deferring their state pension is right for them, depending on their own personal circumstances.

In 2017, around 1.1 million people in the workforce were aged 65 or over. Of these, roughly 950,000 were combining paid work with drawing a state pension, Royal London said.

Out of this 950,000, more than half, at around 520,000, were earning enough to take them over the tax threshold – meaning their state pension could be taxed.

Sir Steve Webb, a former pensions minister who is now director of policy at Royal London, 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.”

Comparing someone who draws their state pension immediately while continuing work with someone who waits for a year until they have retired before drawing their state pension, the research found:

* A man who defers for a year and has an average life expectancy at 65 of 86 could be around £3,000 better off after retirement than someone who takes his state pension immediately and pays more tax

* A woman who defers for a year and has an average life expectancy at 65 of 88 could be around £4,000 better off

Sir Steve said more should be done to raise awareness of the option to defer the state pension. He said those who have started to draw their state pension do have the option of “unretiring” – they can tell the government to stop paying their state pension and then resume receiving it at a higher rate when they stop work.

Sir Steve said: “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 analysis was based on the UK government’s Labour Force Survey and Family Resources Survey.

PA