Deferred Pension: A Complete Guide to How It Works

There are many retirement planning jargons that look simple at face value but hold deeper meanings if looked into more closely. 'Deferred pension' is one such term that you may have come across during your research on your employer's pension scheme.

We have a complete guide that will explain everything you need to know about deferred pension, including how it applies in the Indian scenario, the situations in which it may be advisable to go for a deferred pension scheme, and some red flags to be wary of while opting for such schemes.

What Is a Deferred Pension?

A deferred pension is a pension benefit that you have earned, but chosen or been required, to delay receiving. Instead of drawing your pension the moment you become eligible, you defer the start date to a later point in time.

In simple terms: you have the right to a pension, but you put it on hold.

This deferral can happen voluntarily, for instance, if you retire early but decide not to start drawing your pension until you actually need the income. Or it can happen as a natural outcome of how a pension scheme is structured, where benefits accumulate during your working years but are only paid out once you reach a specific age or trigger point.

The key idea is that the pension does not disappear. It sits in the system, often growing in value, and is paid out when you eventually claim it.

How Do Deferred Pensions Work?

The mechanics depend on the type of pension scheme involved, but the general principle follows a familiar pattern.

During your working years, you (and in many cases your employer) contribute to a pension fund. These contributions accumulate over time, earning returns through investment or through the guarantee of a defined benefit formula. When you leave employment, whether at normal retirement age, early retirement, or through resignation, you become entitled to a pension based on your contributions and service.

If you choose not to draw that pension immediately, it goes into a deferred state. During this deferral period, the fund or scheme continues to hold your entitlement. In some schemes, the deferred pension grows with interest or inflation adjustments. In others, it stays at the value it was when you left service.

Once you decide to claim it or once you reach the mandatory commencement age, payments begin and continue for the rest of your life (in defined benefit plans) or for as long as the corpus lasts (in defined contribution plans).

Deferred Pension in India

There exist various forms of pension schemes in India, in which the concept of deferral applies. A brief explanation of each can help understand the process better.

1. Employee's Pension Scheme (EPS), 1995

It is the most commonly used pension scheme in India for employees of the organised sector. EPS is run by the Employees' Provident Fund Organisation (EPFO). The EPFO consists of contributions made by both employers and employees for EPF, with a part of the employer's share going to EPS.

A participant in the Employee Pension Scheme attains his eligibility for a pension after serving for a minimum of ten years, and he should have attained an age of 58.

But then again, there is an option for early pension at 50 years of age. However, that comes with a reduction in the value of the pension by 4% for each year the payment is claimed prior to 58.

This is where deferral plays an important part. If the employee does not make the claim for the EPS at 58 years of age, he/she may defer it until the age of 60. Every year that they defer it after 58 increases their pension amount by 4%. In effect, two years of deferral gets an 8% increase in monthly pensions.

This is a relatively simple way of boosting their monthly pensions without any risk as long as they have other means to support themselves financially.

2. National Pension Scheme (NPS)

The National Pension Scheme is a market-linked defined contribution pension scheme which is available for civil servants as well as those working in the private sector. NPS is managed by the PFRDA.

In the case of NPS, the retiree has to purchase an annuity with 40% of the total corpus available after retiring at the age of 60. The balance corpus can be taken out in lumpsum.

However, another feature of the NPS is that annuity purchase may be deferred. Thus, the subscriber who opts out of the scheme at 60 may delay the purchase of annuities till the age of 63 years. This means that the corpus which was meant for the purchase of annuity stays invested in the NPS scheme. And if the market performs well, the pension corpus increases, and hence the amount received by way of pensions increases.

Furthermore, there is an option of delaying the lump sum withdrawal amount for up to 10 years after reaching the age of 60. In this manner, people who are not in urgent need of money can continue growing their investment for a period of ten years in a tax-saving environment.

3. Defined Benefit Pension for Government Employees

The old pension scheme (OPS), which is applicable for central government employees employed before January 2004, offers defined benefit pension for government employees. According to the old pension scheme, the pension payable is a percentage of the last drawn salary.

Deferral, in such a structure, is more based on timing rather than the desire of the individual; it is based on age relative to retirement age. Nevertheless, if the government official has chosen to retire early in schemes such as VRS or Rule 48/48-A schemes, then the pension can be deferred to superannuation age.

4. Difference Between Voluntary and Structural Deferral

It might be useful to know the differences between these two.

• Voluntary deferral involves voluntary postponement of a pensioner from receiving their benefits. In most cases, voluntary deferrals occur if individuals are earning elsewhere in the form of part-time employment, rent payments, husband's pension, etc., and thus do not require pension benefits currently. As a result of delaying the drawing of pensions, they receive larger pension benefits per month during the course of their life.
• Structural deferral is where structural features of a scheme make the pensioner defer their drawing of benefits. For instance, an individual leaving a company after 15 years of service at age 42, may qualify for EPS pension but cannot draw the benefit until reaching 50 or 58 years of age. Deferred not by choice, but by mandate. The participant merely needs to wait till he reaches the eligible age.

Both lead to one common effect, pension payment at a date after which the right to receive the pension is due.

Why Would a Person Want to Postpone his Pension?

There are some logical explanations that may motivate a person to delay his pension.

1. More income from the pension each month

Usually, deferring the pension provides a better monthly pension income. EPS, for instance, offers a 8% higher pension per month after deferral by two years. For NPS, the increased corpus results in a greater annuity. With a life expectancy in excess of 70-80 years, it does not take long for deferral to be economical.

2. Employment income

Assuming that you are still employed, maybe as a consultant or second-career professional, there might be no reason to draw your pension as yet.

3. Tax-efficiency

The ability to defer pension payments might give you better tax management opportunities in the immediate period following your retirement, depending on your other income streams.

Risks and Drawbacks of Deferring Your Pension Payments

Deferring your pension payment is not always the best way to go. Here are some reasons why.

1. Longevity risk

It is only when you outlive the benefits of deferring pension payments that you benefit from them. If health considerations play into your mind, you may need to consider an early pension even if it's somewhat smaller.

2. The threat of inflation decreases buying power

If your deferred pension does not take inflation into account, you risk having an underwhelming pension later.

3. Liquidity requirements

Unforeseen events such as medical costs, personal or family financial situations may come up. Having no other income besides the deferral pension can create liquidity issues for you.

4. Scheme limitations

Not all pensions allow for deferrals. Also, the process of applying and receiving the deferred pension may have age limits attached to it or even procedural requirements.

How to Opt for Deferred Pension Under EPS

If you are an EPFO member and wish to defer your EPS pension beyond 58:

• Do not submit the pension claim (Form 10D) at age 58.
• Continue holding your EPS membership until age 60.
• At 60, submit Form 10D along with the required documents to your jurisdictional EPFO office.
• The pension will be calculated with the applicable deferral benefit (up to 8% enhancement for two years).

It is advisable to confirm the latest procedural requirements with your EPFO office as processes are periodically updated.

Key Takeaways

• A deferred pension is a pension entitlement that is earned but not yet drawn, held back by choice or scheme design until a later date.
• In EPS, pension can be deferred from age 58 to 60, with a 4% annual increase in monthly pension for each deferred year.
• In NPS, both the annuity purchase and lump sum withdrawal can be deferred after the age of 60, giving the corpus more time to grow.
• Voluntary deferral makes the most sense when you have other income, are in good health, and benefit from a higher eventual payout.
• Structural deferral applies when the scheme's rules set a minimum age for drawing pension, common for those who leave employment early.
• Always weigh deferral against personal health, liquidity needs, and inflation before deciding.

A deferred pension is a tool, not a default. Used wisely, it can meaningfully improve your retirement income. Used without planning, it can leave gaps at a time when steady cash flow matters most.