Lump sum vs Pension: Help me understand

bigbigmamamoo

I will soon be retired on medical ground I have a final salary pension that will either pay me based on my years to date, or on years to 65, depending on whether they deem me to be incapable of doing my own job, or incapable of doing any job

I have no idea what to expect. It is clear to me that I can't hold down a job, but that doesn't mean they will see things that way

I have a mortgage on my flat and I expect to still owe £93k when I retire. I have an offset account linked to the mortgage

So I am dealing with 2 potential scenarios

Scenario 1: I am granted only a partial pension. Then I could receive a maximum lump sum of approximately half what I owe on my mortgage. I could put this in my offset account and use that to reduce my monthly payments to an amount that was affordable given the monthly income I would receive. If I took no lump sum and hence an increased monthly amount I would not be able to afford the higher mortgage payments. So I really have no choice under this scenario. I take the maximum lump sum, reduce my monthly payments and live on a reduced income

Scenario 2: I am granted a full pension. The maximum lump sum in this case matches almost exactly the amount I owe on my mortgage. So I could take that put it in the offset account and start paying my monthly payments out of that and still have a reasonable monthly income, sufficeint to meet all my current outgoings and to save or afford a few small luxuries

If I took no lump sum I could afford to make the monthly mortgage payments out of the increased monthly income I would receive and possibly even over pay a little bit, and once the mortgage was paid off I would have a higher disposable income than if I took the maximum lump sum

I consulted a financial advisor and he advised me to take the maximum lump sum in both cases. Now I don't want people here to second guess him. What I am looking for help with is my own thinking which is not at all clear due to my disability which includes cognitive problems

I was thinking that I would be better of in Scenario 2 (full pension) if I took half the maximum lump sum and put that in a the offset and used the increased income to put monthly amounts in the offset account. I figure that in three years I could have enough in the offset to match what I owe on the mortgage, and so would be in the same position as if I have taken the full lump sum but with a higher monthly income

I feel I must be missing something.
The monthly income is index linked, but with the slightly worrying clause that the index linking for the supplimentary part is not guaranteed.
I am on a not very good by today's standards 5.99% mortgage fixed for 7 more years
It would take me 20 years to earn back the lump sum. I am 51 and expect to retire within 6 months

My medical condition does carry a reduced life expectancy of 6-11 years, but that is an average made up of people who either go downhill fast and die young, or people who deteriorate more slowly and live a longer life with high care needs, so I can't really use that as the determining factor.

vbm

Do you know the schemes commutation factor ?

This determines the amount of pension you have to give up for cash. This can is usally expressed as 9:1 or 15:1. That is the most useful guide when calculating the value of the lump sum.

If it is 9:1 that represents very poor value, if it is say 20:1 (very rare) then that would represent excellent value.

bigbigmamamoo

vbm wrote: »

Do you know the schemes commutation factor ?

This determines the amount of pension you have to give up for cash. This can is usally expressed as 9:1 or 15:1. That is the most useful guide when calculating the value of the lump sum.

If it is 9:1 that represents very poor value, if it is say 20:1 (very rare) then that would represent excellent value.

I believe it is 18:1. I took the maximum yearly income (YMax) subtracted the minimum yearly income (YMin) to arrive at the difference (YMax-YMin). I then divided the maximum lump sum (LSMax) by that difference
LSMax/(YMax-YMin)=18

I also redid the calculation using the incomes after tax and it came out at 22:1

kittybuttoon

I was in almost exactly the same position as you a couple of years ago, waiting to learn how ill I was so that the pension people could determine whether I got more or less money. Talk about a double-edged sword!

Anyway, I got the higher lump sum and paid off all the mortgage. I decided not to insist on a copy of the medical report which said how long I have to live, as no-one can put a firm date on it,anyway.

One thing that nobody told me about, and which I want to make sure you know about, is Disability Living Allowance. If you are terminally ill, you are entitled to fast-tracking and when filling in the online application, make sure you tick the box. It says six months but as I've said, no-one can put a firm date. What happens next is that you ask your GP to send them a form to give more details about your health. You can see it if you want, but I got my doctor to send it off as I didn't want to be unnecessarily frightened!

It only took about three weeks to be notified that my doctor's report qualified me for the highest rate, and they backdated the payments to the date when I completed the online form. I get about £115 pw paid into my bank account. The benefit is not means-tested. There are lesser amounts available if you are not quite so ill.

Of course, this makes a huge difference to me financially as it means that if I am not feeling so well I can take taxis, etc. Also as I am on higher-rate DLA I applied for, and got, a free bus pass from the local authority, which means I can use any bus in the country for nothing. This saves me money too, of course. And all this is very important if you can't work any more through no fault of your own.

The website has said I am not allowed to post a link as I am a new user, but for the information about DLA, go to the directgov website, and put Disability Living Allowance into the search. It is in the section 'Help for Disabled People'. The process is very simple and only takes half an hour. I think you need your national insurance number handy before you start. Good luck!

bigbigmamamoo

kittybutton,
thank you so much for your kind and helpful post. I thankfully do not have a terminal condition, just a progressive one. I feel that the most likely outcome for me is not much of a reduction in lifespan but a increasingly disabled old age, but who knows, and I can't really be sure if that is wishful thinking (of a sort) on my part. I am in receipt of DLA, just doing my renewal in fact, but it is good information for anyone else reading this post

Chorlie

Earlier this year I finished work on ill health ground and like you wasn't sure if I'd be granted part or full pension, I get the full pension.

I didn't have a mortgage to pay off but was unsure about the tax free cash lump sum. I selected to take the max lump sum and put it all into high interest account and that gave me more (after the tax) than if I'd taken a full pension, the down side is the annual increase will be less but the interest on the lump some and having cash in the bank made it a no brainer for me.

The mortgage adds another angle, but mortgage free and debt free as early as possible has to be the best, your mortgage is off set so the interest difference is less of an issue. All you can do is the maths over the length of your mortgage, what's the difference between paying it off or letting it run and than taking that difference and working out how long it's takes in the higher pension to get that difference back; if it's only a short time then take the pension but if it's a long time take the lump sum.

I also get DLA have done for years and since I've retired I'm getting a small amount of ESA, which is something else you might look into but your pension will effect that so the smaller pension was a bonus for me with the ESA.

bigbigmamamoo

Chorlie wrote: »

The mortgage adds another angle, but mortgage free and debt free as early as possible has to be the best, your mortgage is off set so the interest difference is less of an issue. All you can do is the maths over the length of your mortgage, what's the difference between paying it off or letting it run and than taking that difference and working out how long it's takes in the higher pension to get that difference back; if it's only a short time then take the pension but if it's a long time take the lump sum.

thanks Chorlie, I'm still trying to get my head around this. You are so right mortgage-free and debt-free as early as possible is a big goal, but then so is maximimizing income.

supposing I get the full pension
If I take the maximum lump sum and put it in the offset, and then make my mortgage payments out of that, I am essentially mortgage free, but I am also taking the lowest possible income. So that maximises one goal but minimizes the other

If I take no lump sum, I maximize my income but have to make mortgage payments till I'm 65 (which should be affordable out of my increased income) so I don't really get the advantage of the maximized income till I'm 65

I I take a lump sum half way between 0 and the max, then I get an increased income, and I can afford to pay extra into the offset every month, so that I should reach my goal of having offset savings equal mortgage due in about 3 years

So it seems like the third option is the best: It takes me 3 years to be essentially mortgage free, and although I don't have the maximum possible income I have an income half way between the min and max possible, and I have access to it in 3 years rather than 13 (when I'm 65)