is a bigger lump sum the best option?

coyler

Hi,

I'm trying to help my parents decide which is the better option for them and would love some input if you would be so kind!

My father is now unable to work and is about to take his ill health retirement pension.
He can take a lump sum of £14.5k with an annual pension of £7.3k or there is also the option that he can reduce his annual income to £5.4k for a larger lump sum of £36.5k (is this taxable?)

Just to give you a little background info my parents have just finished paying their mortage off around 6 months ago so don't have to worry about that.
They are also in their early 60's.
We would greatly appreciate any of your thoughts and what you would do if in their position!


thanks in advance!

jamesd

That's a commutation rate of just £11.58 lump sum per pound of income given up, which is a poor deal unless he has a good reason to believe that he will die within the next twelve or so years. Normal life expectancy is to around 86 years for 60 year old men.

If there's some prospect of dying then how much pension your mother will get becomes part of the picture. If it's a typical workplace defined benefit/final salary scheme she'll end up with a 50% or more pension and that would also help to make it a bad idea to take the higher lump sum.

He'd need to make 8.7% interest from investments to make it worth taking the lump sum and that's not likely enough to be worth doing unless he's a skilled investor.

If for some reason they did want the money, a cheaper way to get it would be to take out a mortgage for £22,000 and repay it with some of the extra pension money. That would only cost about 3-5% in interest, less than the 8.7% he's getting in effect by not taking the bigger lump sum. And once the mortgage is clear, the whole extra pension amount is his for the rest of his life. If he took this option he should also ensure that he has enough life assurance to clear the mortgage if he does die before it's paid off.

Loughton_Monkey

The easiest way to look at it is to take the high lump sum quote as a 'base'. So that's £36,500 cash (tax free) and £5,400 annual income. If they need £36,500 then this is fine, but if you just assume most of that cash would just be invested (but not in any high risk/potential reward equities at their age).

So looking at the alternative quote, he is being offered to exchange £22,000 in return for an additional £1,900 per annum. That is an "annuity rate" of 8.6%. This is exceptionally good for a "healthy" 60 year old who would normally receive 6% or less.

However, my main concern is reference to "ill health". Whilst there are conditions that can prevent working, but do not materially affect longevity, he could (for all we know) have an illness that might severely affect longevity. You should try (if possible) to understand the 'gamble' involved here. If he were to live only for a few more years, then the high lump sum would turn out to have been the better option.

lilac_lady

Bearing in mind that your father's health is not good I think the larger lump sum/smaller pension may be the best choice for him. Remember to ask an IFA about an enhanced annuity. This pays out more to someone with medical problems.

coyler

thanks for your replies.

I'm going to be looking into this a lot more this weekend (oh the joy!) and try and contact an old friend who is an IFA and find out more about the enhanced annuity.

you've been a great help on my first-ever post, cheers!

Andy_L

Is that pension "level" or does it include some degree of inflation indexation?

zygurat789

If there is a possibility of your father not lasting much longer do not forget to find out what the spouce's pension would be.

jamesd

Loughton_Monkey wrote: »

So looking at the alternative quote, he is being offered to exchange £22,000 in return for an additional £1,900 per annum. That is an "annuity rate" of 8.6%. This is exceptionally good for a "healthy" 60 year old who would normally receive 6% or less.

Note here that exceptionally good means exceptionally bad to take the lump sum.

Impaired life annuities might be able to pay out more than this if his health really is poor from a life expectancy perspective. Something an IFA could check, comparing the best available market option for £22,000 with the probably inflation linked and high spouse benefit work pension. I doubt the IFA could do better unless life expectancy is really low, though.

Life assurance, mortgage and the extra income used to pay off the mortgage is the easy way to come out ahead here.