Best thing to do with Pension Lump sum

Seumas

My Mum has recently retired after 40years of teaching and has taken the maximum lump sum and a reduced annuity. The lump sum she received was approx 100k and the annuity is 32k per annum. She has 72k left on her mortgages with 5 years remaining to pay it off. Her monthly payments are quite high so she wants to pay her mortgage off completely. This would only leave her with 28k cash to enjoy her retirement. Is this the best thing for her to do or are there any other options she could take that would allow her to keep more of her lump sum so she can do some of the things she's always wanted to do in her retirement. Any ideas would be much appreciated.

CLAPTON

it's unusual for a teacher to get an annunity; they usually get an indexed linked pension

if the interest rate being paid on the mortgage is larger than the interest (after tax) she can earn on the lump sum then pay off the mortgage: she can then save up the mortgage amount if she wishes
otherwise then save the limp sum
I'm assuming there are penalties for early repayment of the mortgage

jamesd

It'll almost certainly make her substantially worse off to pay off the mortgage. It's one common way that retiring people make themselves poorer than they could otherwise be.

It's easy to get 5%+ tax free income from investments, with less cautious investors perhaps using 6% instead. Capital values will vary over the years but on say a 5% income target there's enough margin so that they should also increase by more than inflation.

If she's looking solely at being better off then investing the money and using the investment income to make the mortgage payments is the way to go.

It looks as though she has £14,400 in capital repayments and I'll assume 4% interest for initial interest payments of 5% for around £18,000 total mortgage payments. £18,000 on £100,000 of investments is too high to do just from normal investment income but high yield investments paying 8-10% plus use of £10,000 of capital a year will do the job without tying most of her money up in the property. Keeping lots of free capital generally beats having it all tied up in a property, since capital is more flexible than property equity.

Or she could change the mortgage term to say 15 years and cover the payments with investment income alone. In this case part of the money might be placed into an investment bond that lets 5% a year of income be taken tax free (regardless of how well the investments do, they can go up and down). The remainder in stocks and shares ISA investing and top up payments to cover the remainder of the mortgage payments. With repayments and interest of around £8,400 a year over 15 years the investments could cover the whole repayment cost and leave her with the capital still available at the end, instead of tied up in the property.

Even if she is cautious about investing, an option is to switch to an offset mortgage and stick the money in the offset account. That eliminates interest payments on that much money, leaving only the capital payments to be made.

Taking the maximum lump sum was probably also a bad decision for her wealth, unless she's some reason to believe she's likely to die young. It's more likely that taking the higher income and using that to pay off an increased mortgage over say 15 years would have left her better off. The mortgage provides the lump sum, then the higher pension income pays off the mortgage and at the end of the mortgage she'd have the higher ongoing income for the rest of her life.

Have a read of "lump sum or pension" for some worked examples of how mortgages can increase flexibility and make people better off in retirement.

Seumas

Thank you for your replies.

CLAPTON - I probably used the incorrect terminology. What you said makes sense though

Jamesd - Thank you for your post. An offset mortgage is the thought I had but I will take your advice on board and pass it on to my mum.

Thank you both again for your post it is very much appreciated

CLAPTON

Seumas wrote: »

Thank you for your replies.

CLAPTON - I probably used the incorrect terminology. What you said makes sense though

Jamesd - Thank you for your post. An offset mortgage is the thought I had but I will take your advice on board and pass it on to my mum.

Thank you both again for your post it is very much appreciated

do bear in mind that 'capital values may vary' means, in English, that your mother may lose lots and lots of her capital.

jamesd

Seumas, one of the more interesting ways to use an offset mortgage is to note that half of all 60 year olds can expect to live at least 28 more years. So she could start out with a 25 year mortgage term, offset so she pays no interest, then initially set the payment level clear the capital over 25 years. But instead of sticking to 25 years, increase the payments as her income increases due to inflation, while the mortgage balance just declines gradually over time as she repays. Then she'd end up clearing it in 15 or so years, without cutting her income much when she's young and most able to be out and about and enjoying her retirement. This sort of plan is nice and safe because her income is guaranteed and it would start out only taking £2,880 of her income a year, £240 a month. If she is concerned about inheritance, the money in the offset account clears the mortgage, so the house is protected.

Though coming out of her income isn't quite right, since each Pound she pays off decreases the amount needed in the offset account by the same amount, so that the money comes from there and doesn't really affect her pension income at all. Meanwhile she retains instant access to the money in the offset account if she wants it or needs it or can get a better rate outside the offset account.

Clapton, capital values may vary over 28 year terms means that unless you buy at the peak of one of history's great boom markets or sell at a bust, you're going to come out no worse than even, even once you've allowed for the effect of inflation. The only historic 25 year terms where people lost money were those buying at the peak of the market or selling in a deep drop times. We aren't in a massive bubble at the moment.

There still will be variations over the short term, though. As investments gradually increase in value over time the number of years when those variations take the value below the initial value will gradually decline. You still can't rule out something new but it's not very likely and diversification is how you manage that risk.

getmore4less

Its a relatively simple trade off the end result is the same
Total in, is income and lump sum.
Total out, is living and debt

Pay off the debt and live of the income.

Don't pay off the debt, have a reduced income but capital to do stuff and potential earn more income than the debt cost


One thing to consider is the house suitable long term?
I think the move the final home should be done long before it is needed to give time to settle.


5% return is easy on paper but not so easy in real life without risk to capital.

Investing with borrwed money, (which is what is being proposed) for someone just retiring must be top of IFAs guidance.

The security of a mortgage free and index linked pension has significant attractions for someone that has no interest in managing investments

One question is why comute the pension are the rates on the teachers pension worth while, might have been better off taking the bigger pension especialy if they are curently healthy.

bendix

Seumas wrote: »

My Mum has recently retired after 40years of teaching and has taken the maximum lump sum and a reduced annuity. The lump sum she received was approx 100k and the annuity is 32k per annum. She has 72k left on her mortgages with 5 years remaining to pay it off. Her monthly payments are quite high so she wants to pay her mortgage off completely. This would only leave her with 28k cash to enjoy her retirement. Is this the best thing for her to do or are there any other options she could take that would allow her to keep more of her lump sum so she can do some of the things she's always wanted to do in her retirement. Any ideas would be much appreciated.

Congratulations to your Mum and all that, but I can't think of a better thread to highlight the kind of public versus private sector pensions inequities that this government is seeking to address.

£100k lump sum and £32k per annum income! Back of the envelope figures suggest that would need a private retirement fund pot of £600,000 or more - something totally beyond the scope of possibilities for a private sector employee working in a similarly paid job.

jamesd

getmore4less, investing with borrowed money isn't what is being proposed. Investing to pay off borrowing with investment income is something that's been proposed. The difference is that the borrowing was already there and the decision being made is how to pay it off.

annie_tanks

Bendix, quote.."Congratulations to your Mum and all that, but I can't think of a better thread to highlight the kind of public versus private sector pensions inequities that this government is seeking to address."
It makes me so angry that because I worked in the private industry I cannot enjoy the same benefits as those from a public pension.The company like most private industries stopped all final salary pensions,years ago,because they were seen as unaffordable;so why do they persist in the public sector.And dont give me that old chestnut about the public sector being on a lower wage..

CLAPTON

bendix wrote: »

Congratulations to your Mum and all that, but I can't think of a better thread to highlight the kind of public versus private sector pensions inequities that this government is seeking to address.

£100k lump sum and £32k per annum income! Back of the envelope figures suggest that would need a private retirement fund pot of £600,000 or more - something totally beyond the scope of possibilities for a private sector employee working in a similarly paid job.

public sector pension are very very good deals

but
lets say she earns 65k (which would be needed if she gets a pension of 32k plus a large lump sum)

lets say some-one puts 20% of their income into a pension for 40 years

65k x 20% x 40 years = 520,000

ok I know the obvious limitations of my calculation but if people were realisitic about what is needed to be invested in pensions then people can make reasonable provision for their old age.
so not beyond the scope of possibility but nevertherless a lot.