lump sum or pension

gamston

hi all
keep reading threads on this subject, but still no not sure.
in 2 years time i expect to be made redundent,
i'll be 55yrs with 3 young children, no mortage.
i would expect a redundance of £60k
i can take a pension (without adding the redundance) of
£29k per year & £8k lump sum or
£19K per year & £100K lump sum

i expect my kids to be with me for 15 more years,
i'm in good health
do i take a big lump sum or should i get the maximum pension,
do'nt like the idea of give tax man my hard earned money
as i have 2 years there is time to think about it

bendix

Do you have any other savings or pension provision?

jamesd

gamston, the first thing to consider is the commutation rate, how much lump sum you get for each Pound of ongoing income you get. In your case it's 92k lump sum from giving up 10k of income, a 9.2:1 commutation rate. That's a horrendously bad commutation rate that suggests that you're likely to be better off keeping the higher pension in less than ten years.

A decent to good commutation rate would be getting you more like £200k for giving up 10k of income.

So in your case the general answer is extremely easy: the commutation rate is so horrendously bad that you shouldn't consider it.

You could consider some other factors:

1. Is the employer a financially sound company? If not, you should read about the Pension Protection Fund limits.
2. It's possible to get a lump sum quote from an employer for possible transfer to a personal pension. It would be necessary to get advice from an IFA about this since the critical yield - income from investments - to match the pension income you have guaranteed by your employer is a key factor in whether it's a good or bad idea. It's usually a bad idea for those with little experience of investing for themselves. In your case it might be a good idea if you have some great need for the lump sum but it's probably not a good idea anyway.

From the numbers you've given you shouldn't really consider taking the lump sum. Better to take out or increase a mortgage or seven year or longer term personal loan to get a lump sum and use the £10k a year higher income to repay it.

Don't be tempted to take the lump sum to repay a mortgage. That's a way to make yourself poorer because you can't hope to save as much in mortgage payments as the lost income.

If you were to invest a 60k lump sum you might reasonably expect to be able to take 6% income without much long term decrease in value. The capital value will go up and down continuously, that's just what investments do. So the 60k might get you an extra £3600 a year of income, taking you to around £32,600. The income from the 60k can gradually become tax free because you can put it into a stocks and shares ISA, at 10.2k per person per year.

Part of the redundancy will be taxable so for part of it at higher rate tax there might be more to gain from putting part into a pension if it's still possible to get higher rate tax relief on pension contributions. You could then immediately start taking a 25% lump sum from the pension and an ongoing income.

gamston

thanks jamesd
my figures were rough figures
we get £1000 per year pension for every £12000 lump sum.
I'm in the rail industry

but you have given me a few ideas to look at, as its 2yrs or so i have time on my side a little

CLAPTON

you haven't really said so I'm guessing........
that:-
you have a final salary pension scheme
the pension will be indexed linked to RPI
at 55 you can give up 1,000 pa pension is exchange for .... 12,000 or 9,200... your post is a bit unclear
can you divert some of your redundancy money into the pension so you avoid paying tax on it? if so what rate will you get?
will you actually need a lump at 55, especially as you say you are mortgage free?

jamesd

gamston, 12:1 still isn't good enough to be worth taking.

If you wanted a lump sum, mortgage and repay is still a far better deal.

Say you went with a mortgage and borrowed £96,000, equivalent to giving up £8,000 of pension income, with the Yorkshire Building Society 10 year fixed term mortgage at 5.29%. The monthly repayment over ten years would be £1,030, £12,360 a year. So that leaves you out of pocket for the first ten years, then getting the extra £8,000 plus inflation changes in pension income for life. For other terms here's how it works out:

10 years: £1,030 or £12,360 a year
15 years: £772 or £9,276 for ten years then variable rate
20 years: £648 or £7,776 for ten years then variable rate

So starting at a 20 year term would get you the equivalent to the pension lump sum but after that you'd continue to get the income instead of losing it. It doesn't really take this long because at 3% inflation after ten years the £8,000 becomes £10,751 in income while the mortgage balance doesn't change. So you effectively end up making ever-increasing overpayments each year that clears the mortgage faster. Here's how the £8,000 in kept income changes with 3% inflation:

start: £8,000 a year
after 5 years: £9,274 a year
after 10 years: £10,751 a year
after 15 years: £12,463 a year

So you'd really only take around 13 or 14 years to clear the mortgage before getting that ongoing income free and clear for the rest of your life. Starting at 55 that would mean around 14 years of the lump sum but no extra income, then at average life expectancy (30.7 more years for men aged 55 in 2012) another 17 years with the extra income. Or you could start with a 25 year mortgage term and £577 a month/£6924 and get an extra £1,000 of income at the start (£8,000 pension, paying out only £6,924), using the inflation-linked increases to clear the mortgage more quickly.

I'm assuming that YBS is happy to do a mortgage for these terms and ignoring cheaper shorter term deals. This sort of thing is more risky than just taking the income but it's a way of getting the lump sum and income together. It's also essential that you have life assurance to clear the mortgage!

Better not to take the lump sum if you don't need it. This is just an alternative way of doing things if you do need it for some reason, that's less costly for you than commuting part of the pension.

exil

When considering a similar set of options I bore in mind that until my state pension comes in I will need a rather higher income - for example (not real figures)

retire at 55, state pension at 65

10 years with a pension of 10,000 until state pension starts = 100,000

or

10 years at 8,000 with a lump sum of 40,000 (commutation rate 20 to 1) = 120,000

OK in the long term you lose out but the break even point is at age 75 or so....

CLAPTON

exil wrote: »

When considering a similar set of options I bore in mind that until my state pension comes in I will need a rather higher income - for example (not real figures)

retire at 55, state pension at 65

10 years with a pension of 10,000 until state pension starts = 100,000

or

10 years at 8,000 with a lump sum of 40,000 (commutation rate 20 to 1) = 120,000

OK in the long term you lose out but the break even point is at age 75 or so....

it's a difficult issue as you really need to consider the effects of inflation

so the 10,000 per annum would have grown to 13,400 if inflation averaged 3% or 16,000 if inflation averaged 5%

and the 100,000 would be 115,000 (3%) or 125,000 (at 5%)

of course we can't predict the future inflation but its worth thinking about

novice-saver

CLAPTON wrote: »

it's a difficult issue as you really need to consider the effects of inflation

Not forgetting the moving target of when the state pension starts.

It won't be 65 for anyone retiring in a few years time, 68 maybe, or even higher.

If you're working it out to within a few £1000's you will run short of cash, or have to significantly alter your lifestyle, if you expect to live 20, 30, or more years into retirement.

Just consider what you were earning 30 years ago, or your first pay packet...

gamston

lots to think on
my trouble is i want the cake and the 1/2p

i'm worried if i take the lump sum i'll live +13yrs so i'll lose out on not taking the higher pension, or i'll take the bigger pension and kick the bucket after a few years and so missed out on the big lump sum.

jamesd

It's very likely that you'll live more than 13 years. It takes another 17 years beyond that before half of men aged 55 in 2012 can be expected to have died.

What do you want the lump sum for? Extra spending money while kids are in your care? You can get that by taking out an offset mortgage and putting the whole pot of money from the mortgage into the offset account. Then gradually withdraw it over the years. You'll have to start paying it back eventually, of course, or lose the house, so you'd need to carefully plan how much you could afford to take out and to ensure that you'd be able to handle the gradually reducing income as the amount withdrawn increases, then again once you switch back to fully repaying it. This sort of option can be a good one for people who need a higher income just until the state pensions start. Then they can use the extra state pension income to pay off the mortgage. Need to ensure that the repayment plan will repay in a reasonable time.

The following numbers are approximate to give an idea of how it works. They aren't grossly wrong but aren't perfect.

Keep the full pension income, no lump sum.
Take out an interest only offset mortgage for £70000 at say 6% interest rate and put the money into the offset account.
Start out taking out £300 a month plus the monthly mortgage payment.
When the children leave home stop taking out the extra and just take out the mortgage repayment.
When you get the state pensions, use that money to repay the loan as fast as you can.
If you were to take out for ten years the £300 and the monthly interest amount amount you'd have borrowed about £69,000 with only £1,000 left in the offset account, with the withdrawing to cover the £300 and interest being about £630 in the last month. Interest on that would be around £329 a month. £583 a month assuming a state pensions total of £7,000 a year would gradually start to repay the borrowed money but it'd take something like 15 more years.

This gets you that extra £300 a month of income for raising the children, at the expense of losing the state pension income for a while as you clear the mortgage. Hopefully you wouldn't want the extra income for ten years!

Again, life assurance is vital to get the mortgage repaid.