Why delaying your pension makes sense

Find out how putting off taking your pension for a few years could boost your income in retirement.

Pension fund values can really take a hit when a UK listed companie runs into trouble. Take the recent crisis at BP for example. The massive oil leak into the Gulf of Mexico has caused untold damage to the environment, but it has also caused the BP share price to plummet which has had a negative impact on the value of UK pension funds.

If you're getting ready retire and nursing a depressed pension pot, it may be a good idea to think about delaying taking benefits from it for a while. After all, state pension age is rising and many of us will continue working beyond 65.

Of course, in an ideal world, you probably want to stop working at the earliest opportunity, but delaying retirement doesn't have to be as disastrous as it seems. Here's why:

Shorter retirement equals more income

In principle, if you put off taking benefits from your pension for a time, it should provide you with a higher level of income later on. What's more, if you continue to pay contributions into your pension fund during these extra working years, you could significantly boost the value of your scheme.

Stock market recovery

The stock market has had a pretty rough ride, even over the relatively long-term. In fact, the FTSE 100 Index has generated a disappointing annual total return of just 1.4% over the last decade. If your pension was heavily invested in the UK market over this period, no doubt its value has dropped off significantly.

But, I'm confident once the economy has strengthened, shares prices will climb higher. So, there's a strong argument for delaying retirement to allow the value of your pension to recover. This, in turn, will provide you with a better income in retirement.

Of course, this comes with one important caveat: no one knows what's going to happen to share prices in the future. I'm confident prices will go up, but I could be wrong. So you'd obviously be taking a risk: the stock market could deteriorate further between now and your eventual retirement, and you could find the value of your pension has fallen even further.

In other words, staying in shares is a gamble. If you're uncomfortable with that, you could consider moving your pension fund into lower risk assets such as fixed-interest gilts (government debt) and corporate bonds (company debt), or cash. Although, it's probably a good idea to consult an independent financial adviser before carrying out a major overhaul of your pension investments.

Better annuity rates

An annuity converts your pension fund into an income when you retire. Quite simply, a higher annuity rate equals more income. And, luckily, annuity rates increase as you get older.

Annuity rates are higher for older people to compensate for paying out income over a shorter period. Since there are fewer years left until you reach average life expectancy, you'll benefit from a more generous rate.

For example a man, age 65, could get an annuity rate of 6.82% if he chose today's most competitive standard annuity.* This means a pension pot of say, £100,000 would payout an annual income of £6,820. But, if he delayed buying the annuity until he reached 70, the rate would shoot up to 7.73%. This would give him an annual income of £7,734, and make him £914 a year better off.

In this example, I've assumed the pension pot stays constant at £100,000, but if there was some capital growth over the five-year period, the annuity income could be even higher.

But remember, because you don't take benefits until you reach 70, you'll have sacrificed annuity income during the five years you delay retirement. You're unlikely to make up this amount even by taking a higher annuity rate later in life, although - as you're working - your finances will benefit from your ongoing salary instead.

Annuity rates and the economy

As well as your age, annuity rates are also based on prevailing interest rates and the yields on gilts and corporate bonds. In the beginning the credit crunch was good for your pension, giving annuity rates a temporary boost as bond yields rose sharply.  But as interest rates fell, annuity rates were dragged down too. Even worse, quantitative easing - or printing money as it is more commonly known - proved to be bad news for pensioners. It forced gilt yields to drop, reducing annuity rates even further. And worse again, annuity rates have recently hit an all-time low.

There has been downward pressure on annuity rates for quite some time. But, in simple terms, when interest rates start to rise again - which is inevitable at some point given that the base rate is already as low as it's ever lgoing to get - annuity rates should improve too. But, again, we have no way of telling how quickly - or indeed slowly - interest rates will climb over the next few years, or the impact it will have on annuity rates.

Boost your state pension

If you do decide to delay your retirement beyond normal retirement age, it makes sense to think about deferring your basic state pension too. You then have two choices:

1) Take the missed income as a cash lump sum (plus interest of at least 2% above the base rate), or

2) Take a higher weekly income later on which is based on how long you wait before claiming your pension.

If, for example, you put off claiming your state pension for five years and you chose the second option, you would get an extra £54.60 a week - or £2,839.20 a year - for the rest of your life. (Assuming you would have received £105 a week if you hadn't deferred the state pension.)

If you reach average life expectancy, you should get more money overall by deferring and taking a higher income, than you would by claiming your state pension at normal retirement age at the lower rate.

Read Boost your pension by 52% to find out more.

* Annuity rates are based on a standard level annuity without a guarantee period.

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