Pensioners who choose to defer their pensions probably achieve a better return for their pension pots than any other investment including the government''s new pensioner bond. That is the central finding of research by Ricky Kanabar and Peter Simmons to be presented at the Royal Economic Society''s 2015 annual conference. The decision to defer, they calculate, will result in investment returns of more than 10% a year.
According to the 2011 Census, 16% of the UK population is aged 65 and over. As of April 2015, these individuals have complete freedom as to how they spend their pension pots – but every one of these individuals also retains the existing option to defer their state pension. There are two options for deferral:
• The first option permanently boosts an individual''s weekly state pension by £1 for every five weeks they defer: equivalent to an interest rate of 10.4% per annum.
• The second option gives a lump sum, consisting of all the missed payments during the deferral period, plus an interest rate 2% above the Bank of England base rate.
Currently the higher weekly income option offers the higher return, partly due to the significant drop in the base rate over the past few years. The authors conclude that making the decision to defer a pension can raise the present value of an individual''s wealth, which will also mean choosing to spend less time in work before retirement.
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Choosing to defer the UK state pension can affect how much an individual chooses to work; this is despite decisions about pension deferral and working being independent.
The study by academics at the Institute for Social and Economic Research and the University of York shows that high interest rates received on the deferred pension, when it is actually taken, raises the current wealth of the individual. Therefore this change in wealth affects the leisure/work trade-off and most commonly leads to a reduction in hours worked.
One of the most important milestones in an individual''s life is reaching retirement. In the UK, this is often at the age at which an individual is eligible to receive their state pension. At this point, should an individual choose to receive their state pension or defer it?
For as long as there has been a state pension, there has been the option to defer. At present, there are two choices available to individuals who opt to defer their state pension:
• The first option permanently boosts an individual''s weekly state pension by £1 for every five weeks they defer; equivalent to an interest rate of 10.4% per year!
• The second option gives a lump sum, consisting of all the missed payments during the deferral period, plus an interest rate 2% above the Bank of England base rate.
For individuals who are not credit constrained, and can spend and borrow as required, the decision to defer receipt of state pension simply depends on the difference in the interest rate they can get from a typical financial product versus what the government is offering. But does deferral affect how much you want to work?
The answer is yes. By offering a sufficiently high interest rate on state pension deferral, when it is actually taken raises the present value of individual''s wealth. If we assume individuals prefer spending more time in leisure the wealthier they are, then the amount of time an individual wishes to spend in work is reduced.
Given that pension deferral is so lucrative, which of the two options is best for a typical pensioner? This study shows that the higher weekly income option offers the highest return; this is based on the current legislation, which assumes an individual lives to at least the age expected for their birth cohort. The significant drop in the base rate over the past few years, which is linked to the lump sum deferral option, means that this result is even stronger now than the estimates reported in this study.
The 2011 Census highlighted that 16% of the UK population is aged 65 and over. Every one of these individuals has the option to defer their state pension and get a return in excess of 10% a year.
Pension deferral is also relevant for individuals who are approaching retirement and deciding what to do with their hard-earned savings. As of April 2015, these individuals have complete freedom as to how they spend their pension pots and it is unlikely many other financial products, even the heavily advertised pensioner bond paying 4%, offer as high a return as state pension deferral.
