Full Pension or Lump Sum

iarocu · 26 January 2009 at 2:19PM

I can retire this year age 50 with an index linked pension of circa 24000 or alternatively a reduced pension of 18000 and a lump sum of 114000. A commutation rate of 19.

I'm not taking the full pension. After 65 there would be tax advantages in having a pension lower than the point where the age related personal allowance starts being reduced. Currently around 21800 I think.

At the moment I'm planning to take a pension of 20000. In other words reducing my lump sum by 38000 for a 2000 per annum increase. A return of around 5% index linked.
Of the remaining lump sum I plan to pay my mortgage off (20000) leaving £56000 to hold as cash/invest.

Given that I think inflation will increase over the next few years is there any compelling reason to take the maximum lump sum and 18k pension rather than a 76K lump sum and 20k pension?

For more background - I've no other debts or investments. My wife has no pension provision.

dunstonh · 26 January 2009 at 2:39PM

How about funding a pension for your wife so you dont waste her personal allowance when she can start the pension later in life?

What are you future capital requirements going to be?

From age 65, taking it all as pension will wipe out your age allowance costing you over £1000 a year in tax every year. Whilst that is 15 years away, you should be planning now as you can avoid it and it needs to be costed.

I think you need to do some more calculations looking at the figures you have posted.

MikeJones_2 · 26 January 2009 at 3:48PM

Hi iarocu,

I'd agree with dunstonh here in that you need to consider a couple of wider issues too. For example:

(a) what will be the pension increases granted to your pension in payment (this is called 'escalation')?

(b) will the increase apply to the whole of your pension: will different rates of increase apply to different 'slices' of your pension?

(c) Importantly - what will happen to the increases to your pension when you reach State Pension Age?

(d) What happens to the amount of any remaining spouse's (or dependants') pensions on your death once payment has commenced, if you take any cash lump sum?

In (c) above, many defined benefit pension schemes grant escalation on the entire pension if it is paid before State Pension Age and thereafter reduce the pension increases so that certain 'slices' of your pension (such as Guaranteed Minimum Pension) cease to receive increases from the scheme at State Pension Age.

In (d) above, although you're only talking about a relatively small reduction to your pension if you take the greater cash lump sum, this might reduce the amount of spouse's pension payable on your death. Ask the scheme if the spouse's pension is 'pre-commutation' e.g. say 'x'% of your pension whether or not you take a cash lump sum. Could be important - if not to you, then to your wife!

Not everyone benefits from taking or maximising a cash lump sum from their pension - particularly where there a person has more than one scheme. See:

- 10 reasons why you may not want to take that cash lump sum from your pension

Mike

I work in the field of Pension Education and Pension Guidance in the UK. I am a member of the Specialist Pensions Forum as well as being a Voluntary Adviser for The Pensions Advisory Service. I work with scheme members, employers, trustees, scheme administrators and advisers on most things to do with employer sponsored pension schemes. The views expressed by me in this thread are my personal opinions. You should seek professional advice from an appropriately experienced and qualified adviser. I am not an IFA.

EdInvestor · 26 January 2009 at 6:25PM

Get forecasts for your state pensions here: https://www.thepensionservice.gov.uk

The tax free age allowance is going up to 10k per person pa. so you should aim to provide an income ( incl state pension) of 10k p.a for your wife.

Drumtochty_2 · 26 January 2009 at 7:34PM

I tend to disagree with the lump sum at any cost school and reading your original post, I take it you are more measured here. I also think the age allowance trap at over 65 is a problem to be looked at, not avoided at any any cost.

If your pension loss is £2,000 pa less 30% age allowance tax that's £1,400 pa to get the lump sum. If you give the lump sum to your wife and she gets £1,200 a year from that tax free then your income is £200 a year down.

Also assuming long term moderate interest rates, this income will never grow like your employers pension if it is indexed linked.

Rather than take the mortgage money as a lump sum, would the loss of income paid to a mortgage pay it off in 10 years while you have another 10 years to enjoy the rest of the pension higher pension.

Just numbers to be checked before going the lump sum route, not an opinion either way.

dunstonh · 26 January 2009 at 8:18PM

Another consideration is that if you die, your spouse gets 50% of your pension (typically). With no pension of her own and no savings or investments, it leaves her short on her own provision. Hence the need to try and build up a pension in her own name which can be activated only if and when its needed.

So, even if taking more income is the better option if you life, taking the lump sum and funding your wife's provision may be the better option if you die.

Another variable to consider....

jamesd · 26 January 2009 at 10:46PM

Taking the lump sum is the way to increase the overall income and the income for your spouse after your death, if that concerns you. The 25% lump sum can buy a pension for her that is tax free if under her personal/age allowance, while she gets 20% tax relief on money paid into it up to 3600 gross, 2880 net, each year.

Income from investments in ISAs won't count against the age allowance for either of you so that's also likely to put you in a better position over time.

Paying off the mortgage is a concern. Surely you can get a long term lower mortgage interest rate than likely investment returns? The tax relief on pension contributions for your spouse is one easy way to do better than paying off the mortgage - immediate 20% gain with no risk, then whatever investment gains produce long term.

I don't think it's wise to reduce the lump sum. It looks as though you're more likely to be short of capital than income. If you do want more income, it seems better to use the lump sum for pension contributions.

Moving the lump sum into ISA investments at 14,400 a year (two allowances) and paying pension contributions for your spouse of 2880 net seems like a better route to security.

5% index linked but without access to the capital doesn't seem like a good deal at your age when your pension is going to be quite good even without the extra income.

Does the pension you have provide index linking above 5%? Above 3%? It's common for there to be a cap on how high index linking will go. You should also be aware that even full index linking will gradually leave you feeling poor, because wages rise by more than inflation, so pensioners with only index-linking gradually become worse off than the rest of the population.

MieJones,

"You are married and the scheme offers a two thirds spouse’s pension – but only on the pension left over after you have drawn any cash lump sum. Therefore taking the cash will reduce the spouse’s pension. The spouse’s pension is a very important factor in your retirement provision"

I was surprised to see such a statement on that site. 25% of the capital is likely to buy more spousal benefit than is lost by taking the lump sum. Easy basic calculation: 67% of 100 = 67% for the spouse. 67% of 75% + 25% = 75.25% for the spouse.

Fiddly details relate to ages at which annuities are taken, how investments perform and how generous the scheme benefits are but in general I think it's a false statement for most who are actually looking to provide a benefit for a spouse.

MikeJones_2 · 27 January 2009 at 12:03AM

Hi jamesd,

jamesd wrote: »

...25% of the capital is likely to buy more spousal benefit than is lost by taking the lump sum. Easy basic calculation: 67% of 100 = 67% for the spouse. 67% of 75% + 25% = 75.25% for the spouse.

Fiddly details relate to ages at which annuities are taken, how investments perform and how generous the scheme benefits are but in general I think it's a false statement for most who are actually looking to provide a benefit for a spouse.

If the scheme member is only looking to maximise the spouse's pension, then I'd agree with your comment.

If however, the cash lump sum is being taken - as is most often the case - for other reasons (luxuries, debt repayment, etc), then the statement acts as a 'heads up' for people who may not have thought of, known about or even have considered the impact suggested in the text.

It's all about encouraging people to find out the intricacies of what's available from their scheme benefit before making any decisions that are irreversible. Wouldn't you agree?

Mike

I work in the field of Pension Education and Pension Guidance in the UK. I am a member of the Specialist Pensions Forum as well as being a Voluntary Adviser for The Pensions Advisory Service. I work with scheme members, employers, trustees, scheme administrators and advisers on most things to do with employer sponsored pension schemes. The views expressed by me in this thread are my personal opinions. You should seek professional advice from an appropriately experienced and qualified adviser. I am not an IFA.

jamesd · 27 January 2009 at 2:59AM

I don't agree. There's a logical error in your argument. Lets consider the cases:

1. A person who is interested in spousal benefit. For them it's wrong because taking the lump sum, we agree, has an excellent chance of producing a greater spousal benefit.
2. A person who is not interested in spousal benefit. It's irrelevant.

So the only person it matters to - case 1 - is likely to be reading guidance that is contrary to their best interest, which is quite likely to be taking the lump sum and using it for alternative spousal provision.

No problem to say that it'll reduce the spousal benefit from that pension, so using the lump sum to provide some alternative may be sensible. Perhaps better still to say that it can be the best way to provide alternative spousal benefit, giving a good prospect of increased income and diversification away from high reliance on the employer.

MikeJones_2 · 27 January 2009 at 8:57AM

Hi jamesd,

jamesd wrote: »

Easy basic calculation: 67% of 100 = 67% for the spouse. 67% of 75% + 25% = 75.25% for the spouse.

Your calculation works for a money purchase scheme (it assumes the cash is used to protect the spouse - but who's to say it is?) and the statement says:

'You are married and the scheme offers a two thirds spouse’s pension – but only on the pension left over after you have drawn any cash lump sum. Therefore taking the cash will reduce the spouse’s pension.'

That's a fact - isn't it?

How does your calculation work for a defined benefit scheme?

Mike

dunstonh · 27 January 2009 at 10:16AM

I think it just highlights how its not a decision that can be governed by a simple rule of thumb but needs the full facts to be taken into account and then have them married up against the needs of the individual.

Full Pension or Lump Sum

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