It’s becoming increasingly commonplace for people to reach state pension age and still be earning an income, whether through choice or necessity. Almost 1.5mn people aged 65 or over were employed or self-employed in June 2022, according to the Office for National Statistics — a record high.
State pension age has now risen to 66, but there is no indication that the trend towards later or phased retirement is going into reverse. It raises an interesting question for many still in work: if you are state pension age or older and still earning enough to live comfortably, what should you do with your state pension, currently worth around £11,500 a year?
As Nick Onslow, chartered financial planner at Progeny, points out, the state pension is paid gross but is taxable if you’re paid enough — and that extra cash may have broader tax implications.
“It can be a particular problem for those whom the additional income could push into a higher tax bracket or over £100,000 — at which income level they start to lose their personal income tax allowance of £12,570,” he explains.
One option is to defer taking it until you’re earning less. Deferral comes with a “reward” from the government in the form of an uplift in the amount of pension you eventually receive. That uplift used to be worth 10.4 per cent per year of deferral, making it a very attractive proposition; but it was almost halved to 5.8 per cent in 2016.
As a consequence, you now have to live much longer to recover the value of each year’s deferred state payout. Assuming no change in the current value of the state pension, it would take more than 17 years to recoup a year’s deferral through the additional uplift received.
“For people suffering from ill-health or with a history of family illness, deferral could be seen as a risk not worth taking, especially over a number of years,” adds Onslow.
He therefore advises many clients still earning to take their state pension when they become eligible and invest some or all of it into their workplace money purchase pension scheme or a personal pension or Sipp, rather than keeping it as savings.
Such a move may sound counterintuitive; but if you don’t need the money and are still eligible to contribute, it’s the most tax-efficient strategy.
That’s because until you reach age 75, you can pay up to 100 per cent of your earned income, or £60,000, whichever is less, into a pension each tax year and get tax relief on the contributions. (That annual allowance is progressively reduced for very high earners.)
Relatively few people are normally in a position to fund their pension fully, so the state pension income stream can be effectively used by many as a pre-retirement pension booster.
“If you were to contribute your state pension to a private pension, you would receive income tax relief at source of 20 per cent,” explains Michelle Holgate, divisional director of financial planning at RBC Brewin Dolphin. Higher-rate taxpayers receive a further 20 per cent relief when they complete their tax return.
Contributions can then be invested and grow tax-free within the pension wrapper, and there is also the ability to withdraw up to 25 per cent tax-free.
Additionally, pension contributions are a useful way to avoid tipping over into a higher tax bracket as a result of taking the state pension.
This is a consideration for anyone whose earnings are approaching the higher or additional tax thresholds, and also for those with income in danger of tipping over £100,000 (at which point their personal allowance starts to be progressively reduced by £1 for every £2 earned above the threshold).
Ian Cook, chartered financial planner at Quilter Cheviot, stresses that while he often suggests higher-earning clients should use their state pension to bolster their pension, it’s highly dependent on personal circumstances and considerations such as the current value of their pension pot.
“For instance, if a client’s pension value was approaching the lump sum and death benefit allowance [£1,073,100, replacing the lifetime allowance], it wouldn’t be a good idea,” he says.
In practice, Cook stresses, people will not necessarily pay the state pension directly into their personal pension, but rather look across their income and assets to decide on the best approach.
“Most clients are employees, so [after starting to receive their state pension] they might increase payments from their salary into their company scheme — not necessarily the whole state pension value, but whatever worked for them,” he said.
Many people access their pension savings to supplement a reduced income as they wind down from work. The annual allowance for pension contributions is much reduced once they start taking a taxable pension income, but provided they’re earning at least £10,000 a year, they can still put up to £10,000 of state pension into their personal or occupational pension.
Even if you’ve retired completely, it’s worth making use of the annual gross allowance of £3,600 that can be paid into a pension, says Tom Kimche, head of advice at Netwealth.
He gives the example of two clients, a married couple who don’t need their state pension to live on. “They have sufficient other pension income and cash, so they use it to top up their personal pensions by £2,880 each year. This is grossed up by 20 per cent to £3,600 within the pensions,” he explains.
Not only are they benefiting from £720 of tax relief, they are moving funds out of their estate, reducing the future IHT liability. “They have made the four grandchildren beneficiaries of their personal pensions, so they will receive a tax-efficient beneficiary pension in the future,” adds Kimche.
State pension is a crucial element of retirement planning for many older people. But if you don’t actually need it to pay the bills, using it to boost your personal pension may well be a sensible planning move for you.