Point at which you start losing with a lump sum...
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wookie6
Posts: 277 Forumite
Hi,
I've just done some maths based on the following assumptions:
1) Your conversion rate from annual pension to cash lump sum is 12:1.
2) You would have to pay the 20% basic tax rate on the full amount of any cash lump sum you don't take if you leave its as part of your annual pension.
3) You don't ever touch the amount converted to a cash lump sum and earn 2% interest per year on it with interest paid monthly.
4) The full amount of the cash lump sum if left in the annual pension would have increased by 2.5% each year.
Looking at the full annual pension you would have each year if you don't take any cash lump sum (including yearly increases on the lump sum figure) minus the the interest earned on the cash lump sum and the yearly basic rate tax saved on the cash lump sum that you would have paid on it, it looks as though you start to lose out around 22 - 23 years after the start of your pension.
Can anyone verify that this is roughly the case based on the assumptions above?
I've just done some maths based on the following assumptions:
1) Your conversion rate from annual pension to cash lump sum is 12:1.
2) You would have to pay the 20% basic tax rate on the full amount of any cash lump sum you don't take if you leave its as part of your annual pension.
3) You don't ever touch the amount converted to a cash lump sum and earn 2% interest per year on it with interest paid monthly.
4) The full amount of the cash lump sum if left in the annual pension would have increased by 2.5% each year.
Looking at the full annual pension you would have each year if you don't take any cash lump sum (including yearly increases on the lump sum figure) minus the the interest earned on the cash lump sum and the yearly basic rate tax saved on the cash lump sum that you would have paid on it, it looks as though you start to lose out around 22 - 23 years after the start of your pension.
Can anyone verify that this is roughly the case based on the assumptions above?
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Comments
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That sounds about right to me. When I took my pension @ 55 I didn't take any additional lump sum due to still being a relatively young retiree. Had I been 65 or older though, I may have taken the additional lump sum.0
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Actually what I haven't considered in my initial list of factors is that if you don't take any cash lump sum you can then start to save that amount each year.
so adding the following factor:
5) You save the monthly amount that you could have converted to a cash lump sum each month and don't ever touch it and get paid 2% interest per month on it.
I now make the point at which you would start making a loss between 13 - 14 years.0 -
Actually what I haven't considered in my initial list of factors is that if you don't take any cash lump sum you can then start to save that amount each year.
so adding the following factor:
5) You save the monthly amount that you could have converted to a cash lump sum each month and don't ever touch it and get paid 2% interest per month on it.
I now make the point at which you would start making a loss between 13 - 14 years.
Ball park break even figure (for 1:12 commutation rate ) is indeed about 12 to 14 years for a standard rate tax payer.
However, that doesn't take everything into account. For example, if you took the maximum tax free lump sum and used it to pay off your mortgate X years early, how much interest would you save over that period?0 -
Silvertabby wrote: »Ball park break even figure (for 1:12 commutation rate ) is indeed about 12 to 14 years for a standard rate tax payer.
However, that doesn't take everything into account. For example, if you took the maximum tax free lump sum and used it to pay off your mortgate X years early, how much interest would you save over that period?
Sure, I appreciate there are other factors that could increase the years before you start losing (mainly paying off of high interest debts if you have any).0 -
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I took the cash lump sum when I took my main DB pension 18 months early @ 59. I got a commutation rate of ~ 20.
At the time, my fag packet calculation gave me a breakeven point of 83, so I decided the "gamble" was worth it to ensure that we had a comfortable cash buffer for future emergencies. Not sure I would have gone for the lump sum on a lower comm. rate tho'.0 -
I make it just over 14 years on those assumptions. Basically you are saying the choice on commuting £1000 of pension is a) £800 a year indexed income (post tax) or b) £12,000 invested at a real rate of -0.5% pa from which you draw that indexed £800. Simple sum if you do it all in today's money. Unless you have a reduced life expectancy it sound like a very bad plan indeed.
If, on the other hand, you invest in an equity heavy portfolio and make say 3.5% real then the breakeven is about 22 years so more likely to be worthwhile.
If you can't stomach the risk of investing in anything other than cash then you are probably better off sticking with the pension.0
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