What to do with pension lump sum

Orwell

OK, I am 50 and about to get a £19k payable final salary pension due to redundancy. In addition I have an AVC fund (£100k) which could be converted to additional pension in the scheme at a rate of 4% (i.e. an additional £4k pa).

The pension payments are LPI (RPI) indexed to 5% max, with a 66% widows pension (my wife is aged 52). I am in reasonable health (ditto the wife). There is a 5 year guarentee on the pension as well.

Any additional pension would of course be taxable, so should I take the lump sum as cash? (I can take almost all of my AVC fund as tax free cash due to it being about 25% of the combined value of the main pension and AVC in cash terms).

In other words - what's best? £4,000 p.a. (LPI to 5%) or £100k tax free now?

I currently work and pay higher rate tax, but hope to fully retire (or work part-time) at 55 and would then pay BRT at that time. If I took the lump sum I could buy a purchased annuity - would this be a better route? This is a once only option so appreciate any guidance!

EdInvestor

What else have you got in the way of liquid savings/investments?

Presumably you own your home outright?

Orwell

Yes, no mortgage. No other debts.

I have about £20k in other cash investments and a SIPP of about £15k and my new employer money purchase pension plan of £15k. I intend to save about £20k pa into the money pension plan from now on.

I have 2 kids going to Uni in the next 2-3 years so may need some dosh for that.

EdInvestor

In that case I'd say take the cash as you are retiring very early and have yet more taxable income in pension format.

I would also suggest you stop saving in pensions (unless there is free money from an employer) and start keeping extra savings in stocks and shares ISAs.

You will already be likely to lose your old age tax allowance from age 65 as your income is too high after state pension kicks in.

You need to maximise tax free (ie non=pension) investment income.

Alternatively put any new pension saving in your wife's name to use up her full tax allowance if it isn't already in hand.

Orwell

Thanks.

What I was really getting at is whether the conversion rate from AVC to pension is attractive or not (i.e. is it ahead of market rates)?

It used to be 50% higher in the scheme which is why I saved AVCs but the !!!!!!s cut the rate last year.

Workng longer is not always possible, I work in IT where most large employers are busy transferring jobs to India (if they have not already done it) or hiring people 20+ years younger than me.

When Governments tell us to work to 70, I have to wonder what planet they are on - I have never known an IT worker be hired after age 55 and yet many are laid off.

Appreciate the point about age allowances, but predicting the tax regime 15 years from now is not easy. I am addicted to the HRT tax relief on pensions really.

We need transferable personal tax allowances - I suffer from being taxed at HRT whilst my wife is well inside BRT, people who earn the same, but more evenly, pay much less tax as a family.

dunstonh

I suffer from being taxed at HRT whilst my wife is well inside BRT

So, why are you considering taking the pension?

All you are going to do is suffer penalties and receive and income which you have to pay 40% tax on.

Orwell

But I won't be a HRT once I stop working, or go part-time in a few years time.

Short term I appreciate it's 40% tax on it, but long-term it may be my only income.

I was speaking to someone (not an IFA) but involved in personal finance and they suggested that long-term with inflation, the pension income was more likely to be useful (e.g. when you're 80 years old).

I must admit to not understanding the IFA passion for ISAs - the tax breaks are minimal (if you don't currently have any capital gains liability), and ultimately the only reason to have them is to increase your retirement income - but isn't that what pensions are for?

jem16

Orwell wrote: »

But I won't be a HRT once I stop working, or go part-time in a few years time.

Short term I appreciate it's 40% tax on it, but long-term it may be my only income.

I think Dunstonh is wondering why you are taking it now when you clearly don't need the income from it now. Why not simply defer it till you do need it? Would there be penalties involved if you don't take it now but leave it till you are ready to retire? ( I ask because you mention redundancy)

I was speaking to someone (not an IFA) but involved in personal finance and they suggested that long-term with inflation, the pension income was more likely to be useful (e.g. when you're 80 years old).

Assuming you reach that age. However I would not have thought it would make much difference as final salary pensions normally increase each year in line with inflation whereas a level term annuity won't.

I must admit to not understanding the IFA passion for ISAs - the tax breaks are minimal (if you don't currently have any capital gains liability), and ultimately the only reason to have them is to increase your retirement income - but isn't that what pensions are for?

I can't see where this passion for ISAs from IFAs come about. Dunstonh is usually advocating a pension as the best for providing an income in retirement. However as he has said frequently it's usually a mixture of both that is best to maximise income.

Up to £10k should come from pensions as you have your personal allowance which gives tax-free income. You then start to pay 20% tax so this is where ISAs are useful as the income from them is tax-free. However if you have pension income above the personal allowance you have to be careful not to get into age allowance territory (starts at £22,900 for this tax year) as you start to lose that increased personal allowance by £1 for every £2 above the limit.

Orwell

As I mentioned the £4k extra income would also be RPI indexed to 5%, it is not a level annuity.

Reasons to act now - in case the AVC conversion to extra pension rate is further reduced in my scheme. Also If I were to take the full lump sum it's better now because I can take 25% of the combined total value of the pension fund and AVC fund tax free even when the funding for that lump sum comes only from the AVC portion. This is possible only when taking the pension and AVC at the same time.

I am taking the pension now because I get it without age reduction due to redundancy and so deferring it would simply throw money away.

I thought share ISAs were now taxable on dividend income or it that just for higher rate taxpayers?

Aegis

ISAs vs Pensions:

ISAs are flexible, you can take as much out of the wrapper as you like whenever you like. Pension capital is effectively tied up for the rest of your life until the amount drawn down exceeds the capital that you built up.

Aside from this they both grow tax free (or as near as it gets), so both can be extremely good choices for an investor. For example, someone investing £100k as a lump sum and doubling their money in 5 years could be looking at a capital gains tax bill of around £16000. By selling £7200 each year (£14400 if using a spouse's allowance as well) that capital gains bill can be reduced significantly or completely removed depending on the volatility of the investments over the term. By investing directly into an ISA, the possibility of Capital Gains Tax never comes up even if the returns are phenomenal.

As an ISA rarely costs more than a standard mutual fund account, there's every reason to use the ISA wrapper fully and no reason whatsoever to ignore the potential benefits. Yes, they might not actually be necessary in the long run, but you don't lose anything either.

jem16

Orwell wrote: »

I am taking the pension now because I get it without age reduction due to redundancy and so deferring it would simply throw money away.

I assume you will lose 5% p.a. by taking it early? Taking it now loses 40% on tax. Have you worked out what is better in the long term?

I thought share ISAs were now taxable on dividend income or it that just for higher rate taxpayers?

Dividend income comes with a 10% tax credit for everyone regardless of tax status. A higher rate taxpayer would have an extra 25% tax bill outside of an ISA but nothing inside an ISA.