Reduced Pension for Lump Sum

CanaryMike

I know that this subject has been aired before but it is an old chestnut so it will do no harm bringing it up again! I brain is getting scrambled trying to make a decision on my own circumstances so if there is anyone out there with a similar experience who can help me make what is, after all, a rather major decision without having to resort to using an IFA I would be gratefull.
I am 55 years old with an index linked Final Salary pension about to comence. I have been offered a £74,000 Lump Sum with a commutation ratio of 18:1.
Do I take the Lump Sum and invest it - possibly in a small property to rent out - or the full Pension bearing in mind that I will not get my State Pension for at least another 11 years? I already have good savings to take care of capital expenditure and emergencies and a very small low cost mortgage.

dunstonh

Do I take the Lump Sum and invest it

You know your financial circumstances. We don't. So, you tell us if its best or not.

Without the facts of the scheme and your situation and future needs there is no way for us to know what option is best. Any comment telling you which is best is just a guess with 50/50 chance of being right.

richone

As Dunston says its not that simple, however 18:1 commutation rate is reasonable for giving up pension for tax free cash, but whether this good for you depends on factors such as the rate of tax you would pay on the pension income, your life expectancy etc

Also useful to know the scheme details, some will allow you to take tax free cash from the AVC (additional voluntary contribution) pot if you have made additional contributions, and you could potentially top up the AVC before retiring, but without knowing the scheme details its hard to advise.

A good IFA could look in to all this for you, but I would advise looking for one with the ability to look at final salary transfers - not all IFAs can look at these schemes and outsource it , and check they have advanced pension qualifications G60 or AF3 - they will know what this means.

CanaryMike

Thanks for the replies richone and dunstonh. All I am really after here is an opinion on whether, given a commutation ratio of 18:1, I will get more money in the long term by taking extra pension of about £4100 a year or by taking the lump sum and investing it. Does anyone have a similar experience and what decision did they come to based on their own research and advice from others?

Stargazer57

You can get an idea of the value of what you are giving up by seeing how much it would cost to buy an equivalent annuity (including the same terms for increases, widow's pension etc.).
I suspect it will be a lot more than 18:1 even if you allow for tax on the pension (which may not be appropriate if you are going to invest the lump sum and pay tax on the income).
You may earn more from investing the money than you would get from the pension, but only if you take a risk. Whather the return is adequate for the risk is probably a personal decision.

getmore4less

Here is what I would do.

£4100py or £73800 cash

Return needed to keep the £73800 and get £4100py, 5.5% over inflatiion
pension income is taxed so if you can get taxfree say dividends thats 4.4% for 20%

Return needed to draw down £4100 over 30y around 3.75% return 3% tax free after inflation.

If you have enough income and allready have experience with investing you have an idea if these rates are acheavable for you(with the usual risk).

ifyou realy only need to make it last till the state pension kicks in then that is even easier.

Do you want to pass on any cash?

Hows the health that can influence the choice.

jamesd

18:1 on an index-linked pension at age 55 doesn't seem like a good deal. Unless you have some adverse health issues you might plan on half of people living 23 more years. To invest the lump sum in property you might be able to do better if property values go up by more than inflation plus the lost income, particularly if you use mortgages to leverage the investment and get perhaps four times your own money value invested. But this is also quite high risk compared to just taking the pension.

Say you expect £6,000 in basic and additional state pension and want to have that to live on now as well. You could take £6,000 x 10 = £60,000 lump sum and use that to provide the extra £6,000 a year. Your pension income will reduce by about £3400 so you'd instead need to take £9400 x 10 = £94,000 of lump sum. That extra £34,000 of lump sum reduced your pension by another £1900 so you need that much more. Repeat a few times and you'll find you can't fund £6,000 more. I'm ignoring investment income that improves the picture, assuming it's just enough to cover inflation.

Assuming you can get 6% income plus inflation the £73,800 could produce £4428 in income. That costs you £4,100 in pension income so you end up potentially £328 a year better off and have the investment risk yourself.

If you were to buy several properties with 75% mortgages you could perhaps make 6% a year on four times your own investment. That makes the potential gain larger, though with leveraged risk as well.

If you do go the BTL property route do remember that you can get a mortgage on your own property and lend that money to the BTL business, with the business able to deduct the mortgage interest from rental income. This is usually cheaper than using a BTL mortgage so it'll increase your possible profit.

If you like the idea of being a BTL landlord and are going to go for several properties to spread risk, and not newbuilds to avoid overpaying on the purchase price, there's a decent chance that you could be better off with the lump sum. If you enjoy doing up properties you could well do substantially better by buying and after a while selling properties that need work.

CanaryMike

Its time to make the decision as I hit 55 on the 29th June 2010! After reading the advice given, and other similar topics, I am coming to the opinion that with all the uncertainties out in this big bad world at present, and at a relatively young age, I am better off taking a very small lump sum to fund luxury or two and the bulk of the pension. Any final thoughts from anyone before I make the decision?

LindsayO

Mike,
I am 50, on a similar scheme to you (sounds like it anyway). I have health problems that may mean need to stop working quite soon. After looking in to all the options, I think I will go for the maximum pension, with no lump sum. My health problems mean that my life expectancy may be affected, but they also bring cognitive problems, so the thought of having to deal with investments with declining cognitive ability is just too scary

novice-saver

LindsayO wrote: »

I have health problems that may mean need to stop working quite soon.

I would expect that you should get better returns from your pension if you quit work due to long term poor health.

I'm sure someone will be along soon who has more detailed knowledge or experience in this area.