The UK has the lowest state pension in Europe. The basic state pension is currently only £87.30 a week. Many retired people receive additional benefits through Serps or the state second pension but the total state pension for average earners who retired last year was equivalent to only 30 per cent of preretirement earnings, against 60 per cent in the rest of the EU, according to AON Consulting. However, you can boost your state pension – by deferring it.

Normally pensions start automatically for men when they reach 65 and women at 60, even if they are still working. But if you do not need the income, it could be advantageous to wait. Since April 2006, state pension deferral has become a more attractive option because you now accrue a larger increase in your pension if you defer. Alternatively, you can take the deferred pension as a lump sum with added interest. You can defer for as long as you want, though you only clock up extra pension benefits after five weeks and the lump-sum option is available only after a minimum deferral of one year.

You can postpone both your basic pension and any graduated, Serps or state second pension. All will be increased by the equivalent of 10.4 per cent a year if you decide to use your deferral to build up extra pension benefits. If you prefer a lump sum you will receive the pension you have deferred plus interest, calculated in line with bank base rate plus 2 per cent, giving a current return of 7.5 per cent. You do not have to decide between taking an enhanced pension or lump sum until you eventually come to take your pension.

Both the extra pension and the lump sum will be subject to income tax. But to prevent the lump sum from pushing lower-rate taxpayers into a higher tax band, there is a special rule that the lump sum, however large, will be taxed at the same rate as the rest of your income.

If you decide to take an increased pension, it will take several years to claw back the income you have missed. An example provided by the Department for Work and Pensions (DWP) shows that if your total state pension is £100 a week and you deferred for two years, you wouldreceive an extra £20.80 a week, or £1,080 a year. But during the deferral period you will have missed out on payments totalling £10,400, which means that it will take about ten years to get that back. So a woman who defers from 60 to 62 needs to live until about 72 to break even.

However, the higher pension will be payable for life. The average life expectancy of women reaching 60 is 84, so they could gain much more than they forgo. When you die, your widow, widower or civil partner benefits from the extra basic state pension you have accrued, though they can inherit only 50 per cent of the increase in any additional state pension.

So is deferring a good idea? If you do not need the income now, it is worth considering. Tax is an important consideration. Paul Willans, chief executive of Mazars Financial Planning, says: “For a higher-rate taxpayer who will change to the lower rate after retiring, there is an argument for deferral.”

If you are a basic-rate taxpayer and likely to remain so after you retire, there is no tax advantage. But if you do not need your pension now, what will you do with the money? You could save it, but Tom McPhail, of Hargreaves Lansdown, the independent financial adviser (IFA), thinks that you would be hard pushed to match the return offered by the DWP. He says: “If you invest it, you would do really well to achieve that rate of return risk-free, whether you take a lump sum or extra income.”

When you eventually take your pension, should you go for an enhanced pension or a lump sum? Mr Willans says: “If someone is in good health, then the income option is likely to be better.”

But Graeme Mitchell, of Lowland Financial, another IFA, points out that the lump sum can be tax-efficient. He says: “If you can afford to defer the start of any other pension for a year, so you have no income apart from your state pension, this is likely to fall below your personal allowance at 65 making you a nontaxpayer. So you won’t have to pay any tax on the lump sum.”

For further information, go to www.dwp.gov.uk.

CASE STUDY

Sue Sullivan, of North London, decided to postpone her state pension when she turned 60 on the advice of a friend. She still works part-time as a special needs teacher three and a half days a week. Mrs Sullivan, above, says: “I felt I had made a mistake when I was made redundant from a previous post at 50 by taking my teacher’s pension early, so it is a relatively small amount. I was, therefore, very interested in increasing my state pension as much as I could. “I am planning to defer for about two years, which should give me about £80 extra each month. That doesn’t sound a lot when you are working but every penny counts when you retire, and it will be index-linked.”

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