By Ian Lowes

WHEN you reach state pension age you don't have to claim your state pension straight away and deferring it could be the best "investment" you ever make.

If you can afford to defer your state pension, then, depending on how long you hold out, there can be significant financial advantages when you do ultimately claim. Your options when you decide to take it are either an additional pension, your normal state pension or a one-off taxable lump sum, which you can use however you choose.

If you defer and later opt for an additional pension, you build up extra state pension at one per cent of your normal weekly rate for every five weeks you put off claiming (this is equivalent to about 10.4 per cent extra for every full year you defer). The extra state pension you receive, when you do claim, is calculated by adding up all the extra state pension accrued, but at 10.4 per cent it amounts to about an extra £1 for every £10 of pension. However, the extra is not compounded, although it is increased each April in line with increases to your state pension. The extra state pension is paid on top of your normal weekly state pension from when you start claiming it, and continues for as long as you receive it.

If, instead of additional pension, you opt for a lump sum payment, you must defer claiming for a continuous period of at least one year. The lump sum is a oneoff, taxable payment based on the amount of normal weekly state pension you would have received, plus annual interest of two per cent above the Bank of England's prevailing base rate.

When considered against deposit accounts and bearing in mind that it would effectively be a Government-backed deposit arrangement, this rate of interest is extremely attractive. You receive the lump sum when you start claiming your state pension, which is then paid at the normal rate.

There's no maximum on how long you can defer your state pension, but you can only do it once and you must normally be living in the UK.

■ So which is the best option?

THE problem with choosing an increased pension is that it may take years to recoup the pension you could have received had you not deferred it. What's more, should you die, the state pension dies with you, although your spouse may receive the extra.

If you elect for a lump sum, when you receive it, you can use it as you wish, eg invest it to provide a tax-efficient income. Also, a sizeable lump sum can accrue even after a few years. In an example used by the Pensions Service, if you defer your weekly state pension of £105 for three years you would get a taxable lump sum of around £18,000 on top of your normal weekly state pension. This assumes £105/week attracts interest of 6.5 per cent for the whole deferred period, although the actual the amount depends on the state pension and Bank of England base rate.

On death, during the period the state pension is deferred, your spouse or surviving civil partner may be entitled to extra state pension or a lump-sum payment when they claim their own state pension.

If you had already claimed your state pension and had chosen extra state pension prior to your death, your widow, widower or surviving civil partner will get extra state pension added to their own state pension. If you had chosen a lump sum and then subsequently died, any amount you still had left would form part of your estate. However, a woman who is widowed before her state pension age wouldn't get extra state pension or a lump-sum payment based on her late husband's contributions if she remarried before reaching state pension age.

Extra state pension counts as income for tax purposes in the same way as your normal state pension, so you will pay tax if your total income is above your personal tax allowance.

Lump-sum payments count as income for tax purposes in the year received. However, the lump-sum payment is not added to the rest of your income to work out your total income for tax. Instead, the tax due on your lump-sum payment will be at the highest rate of tax that you pay on your other income, ignoring any of the special rates of tax that apply to any savings or dividends you might receive. Other income' also includes any weekly state pension you get once you have started to claim it.

What if you're already claiming state pension? You can defer it for a while to earn extra state pension or a lump-sum. But if you're a married man and your wife gets a state pension based on your NI contributions, she must agree to deferring as her state pension will also stop, apart from any state pension she is entitled to on her own NI contributions.

Deferring state pension is a complicated area. If you would like more information, a guide is available from the Pensions Service on 08457-313233.

* IAN Lowes is managing director of Newcastle-based Lowes Financial Management, one of the UK's top 100 Independent Financial Advisors. He is one of the few individuals in the UK to posses enough financial services qualifications to earn the accreditation Fellow of the Personal Finance Society as well as Chartered Financial Planner. Ian presents seminars all over the UK. To find out more, visit www.lowes.co.

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