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Half a million workers pay unnecessary tax on state pension

Written by: Danielle Levy
Half a million people over 65 and still in work could be paying unnecessary tax on their state pension, research shows. 

This is because they claim their state pension as soon as they can rather than deferring it, which means the whole of their state pension is being taxed, in some cases at 40%.

Insurer Royal London said that of the 1.1 million people in the workforce aged 65 or over, roughly 950,000 continued to work while drawing a state pension. And around 520,000 people earnt enough to take them over the tax threshold. This means the whole of their state pension was taxed.

In contrast, those who defer their state pension can get an extra 5.8% per year on their pension for the rest of their life for each year that they defer, according to Royal London’s analysis.

The insurer compared an individual who draws their state pension immediately and continues to work with someone who waits for a year until they have retired before drawing their state pension.

They found that a man who defers for a year and has an average life expectancy at 65 of 86 will be around £3,000 better off during retirement in comparison to someone who takes their state pension immediately and pays more tax.

Meanwhile, if a woman with an average life expectancy at 65 of 88 defers for a year, Royal London concluded they will be around £4,000 better off. As well as the tax advantage, they can also enjoy two extra years of pension at a higher rate.

What to do if you already take your state pension

If you have already made withdrawals from your state pension and have continued to work, you have an option to ‘unretire’. To do this, you need to tell the Department for Work and Pensions (DWP) to stop paying your state pension and then start to draw it again at a higher rate once you stop work.

Steve Webb, former pensions minister and director of policy at Royal London, advises anyone who earns enough to support themselves to consider deferring taking their state pension to ensure that less of it disappears in tax.

“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 government should be doing more to alert this group to the option of deferring, as current publicity is clearly not working,” he explained.

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