Retirement pension options.

ukmike

I have been offered early retirement(58 years old),in a final salary scheme.Options are annual index linked pension of £9,500,or tax free lump sum of £40,000 plus annual pension of £6,000.Am i right in thinking i'd have to get more than 10% before tax(impossible!) on the £40k to make it worthwhile?Any advice welcome.

CLAPTON

the figures look a bit surprising but
you would need 8.8% plus fully index linked on the 40k to match the higher pension .. there are no products that offer than of course

however in depends upon whether you need cash now.

EdInvestor

How much state pension are you expecting?

If you can keep your total pension income around the age tax-free allowance of 10k p.a , there could be advantages in taking the tax free cash apart from the fact that you have the capital free and accessible. Depending on how you invest it income can be tax free too.

MrChips

Assuming you are in fair health, the extra pension is the better deal, even after allowing for tax. However you may feel the lump sum is more useful if there is something you'd like to spend it on.

MrMicawber_2

There's a general rule of thumb which says not to take the lump sum from a final salary scheme - largely because of the index linking. You'd need to make 8.8% in the first year if you took the lump sum but say your pension rose by 3.5% per year then after 10 years it would need to make 11.9% and after 20 years it would need to make 16.8%. You could offset this by eating into the 40k but that rather defeats the object.

So, unless you desperately need the cash and you have every reason to expect a long and healthy retirement the maths says don't take the lump sum. (However please get someone to check my sums just in case).

If you wanted a lump sum and felt you could live on a starting pension of £6,000 then saving the £3,000 would give you a lump sum of £36,680 after 10 years at 4% or £38,600 at 5%.

ukmike

Don't need the cash,will be getting normal retirement pension when 65.Hope to live a bit longer than that!

EdInvestor

ukmike wrote: »

will be getting normal retirement pension when 65.

There's no such thing as a "normal" state retirement pension.Everyone gets different amounts.This is because there are two state pensions and the second one is earnings linked. Many people do not seem to know this.

If you have been "contracted out' of the second one (eg into a company pension) all your working life since 1978, and have been paying NI for the full 39 years required (for a man) then it is possible you would get the basic state pension (90.70 a week) only, but even people like this usually have some variation, so they get a bit more or less than the basic.

EdInvestor

MrMicawber wrote: »

There's a general rule of thumb which says not to take the lump sum from a final salary scheme - largely because of the index linking.

Not quite so cut and dried for many people. For instance tax can play a big role - a person who took the larger pension pushing his income over 21,800 could see his age allowance clawed back at 33% tax equivalent.Ouch! That might reduce the needed investement return.The fact that the pension income will be taxed and the tax free cash will not can be quite important to people who are near the tax bands.

Many people will also prefer to have additional capital for emergencies or extra spending or which they can pass on to beneficiaries. For married people, if the spouse pension and/or life expectancy is not great , being able to pass on capital may be a better deal.

Also these days you can often get the tax free cash via an AVC without touching the main pension.This is the best of both worlds if available.

robnoblewarren

Yes: but the figures are so much out of the ordinary that I would get them checked. I would have expected £52,000 lump sum for that much reduction. It's not 10% before tax, of course, the pension is taxed as income, and the income from your investment lump sum is taxed as income. But it is 10% after inflation, in other words you have to make 10% + ~ 4% inflation guaranteed, and it is the guaranteed part that you can't match. This one is close to a no-contest, take the full pension (although you understand that's not advice, just a first reaction based on the figures given). What a professional would do is to check the figures given, check the widow's pension, look at the pension accounts, make a judgement as to whether they would default, then create your own financial model, and test it to see which of your options worked out better for you [cost £250]. There is a fuller answer with another example at
http://www.fee-only.net/sample/samplepage.asp?article=1291

EdInvestor

robnoblewarren wrote: »

the pension is taxed as income, and the income from your investment lump sum is taxed as income.

As I've indicated before this may not be so.Investment income can be tax free. Tax aspects can increase or decrease pension income.Do not ignore this aspect as it can make a big difference.

MrMicawber_2

To Edinvestor - you say "Not quite so cut and dried for many people" - You are of course right and as I said ".......a rule of thumb......." and a rule of thumb is just that, namely "not cut and dried".

There is of course another saying which is 'don't let the tax tail wag the investment dog'.

I do take your point entirely though and would only suggest that those who are in this position see an appropriately skilled IFA.

As an interesting aside I've often wondered what value people put on peace of mind as opposed to maximising theoretical financial efficiency.