Converting part of teachers pension to lump sum

DeeB_2

I am considering converting part of my teachers pension to lump sum. I think that this is a good idea as the lump sum is tax free whereas my pension will be taxed at source and again if I put any of it in a savings account. Also think that the amount I will sacrifice a year (about £1700) in exchange for £21000 extra lump sum would take me around 10 years to make up and hopefully the lump sum would be earning some interest. However in the current financial climate I've no idea where to invest my enhanced lump sum. Has anyone taken enhanced lump sum and am I right in thnking it's a good option or would the bigger pension be better? I am becoming very stressed about this as I need to decide soon (only 26 more full-time working days to go - hooray!!)

jem16

Personally I would not take the enhanced lump sum as the commutation rate at 12:1 is poor. You will not manage to get any savings rate at 12% to make up for the lost income which is index-linked.

However much depends on your circumstances as to whether a lump sum or income is the better option.

mikemoate

It really depends upon personal circumstances and then a careful consideration of the swings and roundabouts. I'm about to retire at 60 and am considering the options. In my case I'm not in the best of health, a heart condition and some other circulation problems, so am considering converting some pension in to lump sum as I think I should enjoy some of the extra funds made available whilst I can. My pension is a local government one.

The way I am looking at it is there are pro's and cons, dependant, as I said, upon personal circumstances. For example, and using round figures for convenience, if I give up £1,000 pension I will get £12,000 lump sum tax free. Now whilst that is 1 to 12, because I will continue to pay tax, I would only get £800 of the £1000 pension so it is actually 1 to 15. Now lg pensions are uplifted in line with RPI, afaik. So obviously I will miss out on the uplift on the £1,000, but RPI is very low at the moment and an ISA or other saving vehicles may well be a more attractive proposition. Who knows what will happen with RPI and interest rates in the future, but again if the investment market is near it's low point at the moment, it may be that a lump sum invested now will out perform RPI uplifts in the future.

It may also be worthwhile paying off high interest debts, such as credit cards or personal loans, with converted lump sum.

If you feel that you are looking at a long and active retirement and want peace of mind and total security then converting a lot of lump sum may not be a good idea.

For me I doubt I will be here in 10 years time so the extra flexibility and spending power the cash provides in the here and now is an attractive proposition, particularly as the conversion doesn't impact upon the survivor pension paid, it's paid at the same rate whether or not you convert to lump sum.

DeeB_2

Thank you for your replies. Like you Mike I can see the logic in taking a lump sum that will not be taxed at source and using it hopefully to attract interest that will more than make up for reducing my pension. Also as you say we don't know how long we will have to draw a pension, a sobering thought but true. I am still trying to get my head around the options (almost wish there wasn't this particular one, which is relatively new!) I have e-mailed a former colleague who recently retired to canvas her opinion, so will feed back. Thanks again.

Sobraon

DeeB please look again at the post by Jem16 above. For the interest to "more than make up for reducing my pension" by my calculation you need to generate a return of about 10% above inflation (before tax)*. Apart from Madoff's schemes I don't know anywhere that can produce this type of return. But I would be very happy to find out!

* 1/12 commutation rate = 8.33%, tax 20% requiring 10.4%, pension is RPI linked so return required is 10.4%+RPI

mikemoate

Sobraon wrote: »

DeeB please look again at the post by Jem16 above. For the interest to "more than make up for reducing my pension" by my calculation you need to generate a return of about 10% above inflation (before tax)*. Apart from Madoff's schemes I don't know anywhere that can produce this type of return. But I would be very happy to find out!

* 1/12 commutation rate = 8.33%, tax 20% requiring 10.4%, pension is RPI linked so return required is 10.4%+RPI

I don't really understand how you have arrived at those figures. The commutation rate is not 1/12 but 12/1, i.e. you give up £1k pension and get £12k lump sum. Now using round figures, ignoring the tax personal allowance and assuming tax paid at basic rate, it would work out as follows. 2 people have a pension of £11k, one A converts £1k to lump sum and the other B doesnt. Person A therefor has a pension of £10k minus tax = £8k. They invest £11k in a 3% net ISA and draw down the other £1k out of an easy access savings account through the year (we'll ignore the paltry interest on that). At the end of year 1, they have spent their £9k and have £11,330 to invest. If RPI is 3% their pension is uplifted to £10,300. Person B's pension is £8,800 after tax and they spend this, but their pension is uplifted to £11,330. So starting year 2 they will have £834 more pension income than person A, as against £800 at the start of the previous year, but in the previous year actually had £200 less to spend. Now it is true that the lump sum will eventually disappear but by no means as quickly as your figures suggest and there is a good chance that persons A and B will be gaga by then.

As I said earlier it's more about personal preferences and circumstances and the economy, especially RPI and interest rates. RPI is very low at the moment, 0.1% was the last figure I heard mentioned. The benefits of additional lump sum are that it does give added flexibility, and of course if gradually drawn down, or if indeed left intact, doesn't disappear on death, as does the personal pension. That latter is ignoring the lump sum paid on death within the first 10 years of drawing the pension, and as I said in my earlier post the survivors pension is not reduced by the taking of a lump sum any way.

Sobraon

Thanks Mikemoate, this commutation question is critical to me as I will be in nearly the same situation as DeeB so I am trying to keep an open mind on this matter and I will take professional advice. I personally would not draw down on the LS as I would seek to preserve it to bequeath. So my analysis preserves the LS in real terms hence the significant difference.

I started to type a long reply, but briefly for me the key issue is the 'effective' annuity rate the pension scheme is 'notionally' offering of 8.3% (£12 LS for £1 reduction in pension) .

If the issue is simply income then to buy an RPI linked pension the annuity tables on "This is Money" (best buy M 60, F 60, 50% spouses pension) shows a rate of 3.49% (Norwich union) or a cost of £28 for each £1 of pension. Now I accept that tax relief (both on contributions and LS) complicates things a little but on this basis I find a 12:1 (LS:Pension) commutation rate personally insufficiently attractive....

.....but I am hoping to be convinced that I am wrong and taking the LS is a good deal!

Oblivion

This decision is a bit of a flutter on the old roulette wheel of life ... how long do you think you'll live after retirement, what might the future prospects be of making a steady return from a lump sum invested etc.

I retired two years ago now and as a member of the LGPS, I opted to convert the maximum I could from pension to lump sum at the 12:1 conversion. But my decision was influenced by personal factors. Like Mike, my health is poor and I've already cheated my doctors who thought I'd never make it past 50 (I was 60 last weekend).

So I figured the best thing for me was to take as much money as possible and run ... well a sedate stagger anyway. :rolleyes:

As Mike has pointed out, it may be 12:1 but when the tax-free status is factored in it's really 15:1 and I doubt I'll last 15 years, so my estate is likely to be quids in. I've had 2 years (ok that's now over) of high interest rates to boost my LS so it's now even more that 15 years to the break-even point.

As Mike has also pointed out, my decision to convert has not reduced my wife's entitlement when I shuffle off, so it's win-win.

There was also another factor niggling away at me, even two years ago. I could see the way the economy was going, and I could see that pension funds were going to be under increasing strain. I wouldn't put it past the present or any future government to introduce legislation to curb pension payouts, even those already being paid. That's why I took the money and ran.

Dave.

DeeB_2

Thank you all for information and opinions. I'm still considering what to do and am awaiting an accurate figure for my pension from Teacher's Pensions - I spent my first year teaching in a private school which is calculated at a different rate. I also had 13 years out of teaching producing 4 children followed by several years of part-time teaching so the pension won't be great, but at least I have one!