Which way would you jump?

Goldwing1

I'm looking at taking my BT pension. They have sent me a number of options. Some are "no brainers" and I'm left with two options.

Option 1.
Lump sum (How much is not really important)
£18K pension. The pension rises with RPI and has risen an average of 2.9% each year over the past ten years.

Option 2.
Extra £15,921 lump sum.

Split pension
£8,008 which increases with RPI as above, plus
£11,335 which is fixed and will never increase.

Depending on how you calculate it and depending on RPI, it could be 15 - 20 years before I become worse off.

Is option 2 too good to be true?

TMFTP

Assuming 3% inflation, option 1 will start to pay the same as option 2 after just 5 years.

After 20 years, option 1 will be paying 6k per year more than 2, and will have paid a total of c. £40k more over the period.

Can you invest the £15k to match that level of income? Do you need that level of income? Do you expect to live more than 5 years in retirement? Have you got a "no negative RPI" guarantee?

If it was me, I'd be thinking option 1 was too good to be true. The power of compound interest....

Goldwing1

According to my spreadsheet and asuming 3% increase pa (Which won't happen next year at least) and ignoring the lump sum I don't lose money until year 10.

Including the lump sum and investing the money it's year 17 before I'm out of pocket.

Option 1 was always the one I assumed I'd be getting.

Goldwing1

Reading deeper into the application form I've found an option that the paperwork didn't talk about.

Based on option 1 at the start of this thread,this option allows me to exchange my lump sum for more pension. I've called the help line and I now have to wait for someone to call (Could be five days).

Given that I intend to take my pension six and a half years early which results in around a 30% reduction in my pension, can anyone give me some idea what would be a reasonable exchange rate?

Goldwing1

Looking at other posts perhaps I should have used the term commutation rate?

Does it work backwards?
ie: exchange 12 pounds of lump sum for 1 pound of pension?

I've taken the 12 pounds from another thread. I'm still waiting for the helpdesk to contact me.

zygurat789

Goldwing1 wrote: »

According to my spreadsheet and asuming 3% increase pa (Which won't happen next year at least) and ignoring the lump sum I don't lose money until year 10.

Including the lump sum and investing the money it's year 17 before I'm out of pocket.

Option 1 was always the one I assumed I'd be getting.

I'm glad we've got that sorted.

MrChips

If you are taking it early, you must be in your 50s I assume?

The younger you are, the bigger the commutation rate should be as you are giving up a longer expected pension income for cash. A rate of 12 to 1 is more common at age 65 (and even then it is a bit stingy). I would hope for at least 16 to 1 if I was in mid to late 50s.

Goldwing1

MrChips wrote: »

If you are taking it early, you must be in your 50s I assume?

The younger you are, the bigger the commutation rate should be as you are giving up a longer expected pension income for cash. A rate of 12 to 1 is more common at age 65 (and even then it is a bit stingy). I would hope for at least 16 to 1 if I was in mid to late 50s.

I'm 53.
Full pension would be payable at age 60.
16 to 1 would seem to make the exchange very expensive (If I'm doing it right).

MrChips

No, the bigger the commutation rate, the more favourable to you.

For example, taking a £40k lump sum from a £10k pa pension.

Commutation factor of 12 leaves you with a pension of £6,666.67.

Commutation factor of 16 leaves you with a pension of £7,500.

For a 53 year old, I would want a commutation factor nearer to 20! In theory, the commutation factor should be equal to the value of £1pa for the rest of your life, so being so young (and with investment yields so low) this should be quite a high figure. I can post the theoretically correct figure when I get to work.

Is the spouse's pension in the event of your death a percentage of your pension before or after it is commuted for lump sum?

Goldwing1

I just put the phone down on the helpdesk and then read your post. Damn!

They tell me that £1000.00 of lump sum buys me £50.00 pension pa.

Didin't ask the spouse question as I hadn't read it then.

MrChips

Very roughly, for your age a fixed pension of £1pa is worth about £17.

An index linked pension of £1pa is worth about £29.

Obviously these numbers are very theortical and assume average health and current bond yields etc. These are the value of a single life pension and ignore any additional spouses benefits. They also ignore any tax implications.

Purely on this basis option 1 is more valuable.