‘I’m receiving the state pension while working – should I defer until I retire to save on tax?’

Dear Steve,

In short, you can stop taking your state pension if you wish and resume it again when you eventually retire fully.

Putting your state pension on pause counts as “deferral”, even if you have already taken some payments. Deferring means you will receive enhanced payments later on, when you decide you want to reinstate your state pension, to make up for some of that lost time. 

However, you can only do this once – you can’t stop and start your state pension payments throughout your retirement.

The deferral rules are different depending on whether you reached state pension age before or after 6 April 2016, when the system changed. 

For those who reached state pension age after 6 April 2016, it’s not possible to get the deferred amount as a lump sum. The only option for post-6 April 2016 claimants is increased payments (and at a lower rate of enhancement than for those who retired before this date).

If you end up living a long time, deferring your state pension can mean you end up with more overall. Under the new system, for every nine weeks you defer taking it, your payments will increase by 1pc-5.8pc a year.

So, if you were to pause taking your state pension for say, two years, your payments would increase by 11.6pc when you resume them. 

If you are currently receiving a full New State Pension of £203.85 a week, two years of deferring would result in an increase in payments to £227.50 a week. 

It could be more than this in practice, because the state pension amount will also have risen over that time period, and so would the enhancement. The indexation of the reward for deferral (known as “extra state pension”) is in line with Consumer Price Index (CPI) inflation.

For argument’s sake, if this figure was 5pc a year for the next two years, then the amount you would get would actually be £250.80 a week when you resume your claim.

So in this illustration, the amount of state pension you would have missed out on over those two full years would be £22,804. 

Once you resume your payments again at the new higher rate, you would at first be receiving £26 more a week on your enhanced payments – or an extra £1,352 a year – meaning it could take you roughly 16 years to recoup the amount you missed out on through deferring.

If you are 68 now, 70 when you resume your state pension payments and you then live until you are 90, then you would ultimately have benefited financially from this decision, without also factoring in any possible tax savings, based on the assumptions used here.

However, your resumed state pension payments would still be liable for income tax once you restart claiming, at whatever your income tax rate is at the time. 

The difference is that because you will no longer be working, the amount of tax you owe is likely to be lower – possibly moving you into a lower tax bracket. 

If, when you give up work, your only income is the state pension plus a modest amount of private pension, so that you are still below the personal tax allowance of £12,570, then you wouldn’t pay any tax at all. 

However if you also have a decent private pension to draw on when you retire, income from which is also taxable, then the tax benefit from deferring could also be reduced.

The longer you defer for, the higher your state pension payments will be and the more income tax you could owe overall. Still, your tax bill is likely to be less this way than it is currently, provided your total pension income is lower than your income from work.

Leaving aside the tax implications, your decision really boils down to whether you think that extra state pension payment is going to be worth more to you further down the road than your current payments are worth to you now. 

The ultimate financial benefit to you depends on your income from work, future pension income and how much tax you end up paying overall, as well as how long you live for. 

As ever, email your questions to pensionsdoctor@telegraph.co.uk