Commutation of Army Pension - Is it worth it?

soldier_sam

I retire from the Army next month after 22 years service and will receive a full pension. I will also have a commutation option of an additional (tax free) £16,761, but if I accept it, my monthly pension drops by £170 per month! I return to my full pension on reaching the age of 55. My question is, should I take the extra money and pay it off some of my mortgage or take the full pension (all of which will be taxed) then increase my monthly mortgage payments? I worked it out that for the £16,761 they are offering, they actually take over £30,000 from me over the 15 year period! Which option would be best??

Cardew

To enable the financial gurus amongst us to formulate advice it is pertinent to point out that soldiers can retire at 40(or with 22 years service) with an immediate pension. That pension is fixed until they reach age 55 when it is enhanced by inflation over the preceding 15 years. From that age it is inflation linked in the same manner as most government pensions.

The prevailing wisdom was that if your pension plus new salary put you well into the higher tax bracket, or the mortgage rate rose above 6% the ‘safe way’ was to take a lump sum and pay off your mortgage.

For a standard rate tax payer and mortgage rate below 6% it was less clear cut, and depended on what return you assumed was possible when investing that element of the pension(£170 monthly for the OP)

The other option considered was to invest the £170 in a second pension.

soldier_sam

Thanks for the input, you have explained it a little better! The reason I have asked this question is, with the new increase in interest rates today I feel that it may be worth taking the money and running but who knows whats around the corner... having a nice larger sum every month is certainly appealing!

Cardew

soldier_sam wrote:

Thanks for the input, you have explained it a little better! The reason I have asked this question is, with the new increase in interest rates today I feel that it may be worth taking the money and running but who knows whats around the corner... having a nice larger sum every month is certainly appealing!

I don’t think there is a single Serviceman who hasn’t faced this dilemma as they approach the end of their pensionable service. It was an even worse dilemma for officers who had the option to commute part of their pension for life!

In your position I suspect that there will not be a huge difference whichever path you choose at the end of 15 years; although new rules on investing in another pension may make this a more attractive option.

However there are some real experts on here who hopefully will give you the benefit of their wisdom.

soldier_sam

Hopefully someone on the forum will offer advice over the next few days, if not, then I will call an independant financial adviser to see what they say...

Thanks

JACKLX_2

I went in for commutation when I qualified for pension after 22yrs in 1977. I consider I was swindled. I was told I would have £75.00 deducted from my annual pension to pay for a commutation sum of £1000.00. This seemed quite fair as interest rates were high at this time. I assumed that when I reached age 55 and the pension would be increased I would continue to be £75.00 per annum worse off than someone who had not commuted. This was not the case, the £75.00 contribution was effectively increased by the same as my pension resulting in losing £220.00 per annum, a figure which is effectively increased by RPI each year. This was not made clear at the time I decided to commute, I would suggest that anyone considering commutation should confirm how much the deduction will be when reaching 55.

moonrakerz

JACKLX wrote: »

I went in for commutation when I qualified for pension after 22yrs in 1977. I consider I was swindled. I was told I would have £75.00 deducted from my annual pension to pay for a commutation sum of £1000.00. This seemed quite fair as interest rates were high at this time. I assumed that when I reached age 55 and the pension would be increased I would continue to be £75.00 per annum worse off than someone who had not commuted. This was not the case, the £75.00 contribution was effectively increased by the same as my pension resulting in losing £220.00 per annum, a figure which is effectively increased by RPI each year. This was not made clear at the time I decided to commute, I would suggest that anyone considering commutation should confirm how much the deduction will be when reaching 55.

This sounds like "Life Commutation".
The OP is referring to Resettlement Commutation, to quote from the MoD website:-
"If you leave the Armed Forces before reaching the age of 55 ..................... you may apply for resettlement commutation. There will be a compensating reduction in your pension, which will be restored to its original value at the age of 55."

The differences between the two types of Commutation were always very well explained - hence the poor take up of Life Commutation. Life is being/has been phased out.

System

I took full commutation when I left in 2005 (30yrs RAF). I worked it out that I would be better off by putting that money in a high interest account in one lump sum.

johng_uk

soldier_sam wrote: »

I retire from the Army next month after 22 years service and will receive a full pension. I will also have a commutation option of an additional (tax free) £16,761, but if I accept it, my monthly pension drops by £170 per month! I return to my full pension on reaching the age of 55. My question is, should I take the extra money and pay it off some of my mortgage or take the full pension (all of which will be taxed) then increase my monthly mortgage payments? I worked it out that for the £16,761 they are offering, they actually take over £30,000 from me over the 15 year period! Which option would be best??

Sam,

I'm in RAF and having served 8 years so far, I cannot pretend to be a pensions expert.

Many people I have spoke to, who are nearing the end of their sefvice are commuting the maximum. The rationale behind this is that you do not pay any form of tax on this lump sum when you take it out. If you receive this as a monthly contribution you will pay either 20% or 40% dependent upon your circumstances.

Of course if you did take it all out you would have to be careful not to spend it all!!!

greytroot

I left with the last redundancies, RAF, and took full commutation as i was using it to purchase a house (btl). Remember you have up to 1 year from discharge to do this. It really is a personal thing and down to what you want/need the money for. You will pay roughly twice back what you borrowed but no tax on your repayments or your lump sum.

johng_uk

greytroot wrote: »

I left with the last redundancies, RAF, and took full commutation as i was using it to purchase a house (btl). Remember you have up to 1 year from discharge to do this. It really is a personal thing and down to what you want/need the money for. You will pay roughly twice back what you borrowed but no tax on your repayments or your lump sum.

Shows how much of an expert I am, I didn't even realist that you payed the lump sum back?

Also Sam, you may wish to post a similar thread in the pensions board. All the financil experts hang out there (inc. some financial advisers). You may get an additional, informitive response from there.