Commuting in 40% band

digdog

Hoping to get some help in working this through, financial advisor says commute, financially very savvy family say MADNESS- don't touch it. I will be retiring next year( not financially savvy) from final salary scheme with a 1:12 commuting rate with a pension pa which is close to 60K. If I commute I will lose 12k per year which after tax is a difference of £590 per month. I understand that to equal the loss of pension I will have to get an investment return of 8.3%ish return. What I don't understand is (a) is this the same in the 40% bracket? I will be in that bracket what ever I do as I will go on doing some work after retiring. (b) how does the index linking of the pension if I take that in full equate to what I would have to earn in investing? I know that you can't guarantee but is it likely that investing 120ishK will get this sort of return. I am in my middle 50s, in pretty good health with no (hopefully) obvious physical difficulties. I would really appreciate any thoughts about this as I have read the other threads but still remain unclear.
Many Thanks

jamesd

A 1:12 commutation rate is bad. Is that financial adviser an Independent Financial Adviser (IFA), all three words? If so, the recommendation should have come with a detailed description of why it is better to commute than not. Knowing in detail what alternative the adviser recommended and why would be very helpful.

The index linking increases the required investment return by inflation. So instead of requiring 8.3% (1/12) you'd need more like 10.3%, which is quite high compared to guaranteed safety.

The tax situation reduces the target if your alternative is tax free or taxed as dividends, say. That 10.3% target would be more like 6% in a tax free alternative.

Assuming a lump sum of £144,000 it'd take perhaps 5-10 years to use the ISA allowance of two people to get it into ISAs. Not too bad. But 6% is still a bit high as a target for many people. Entirely doable, though.

It's also worth wondering whether you need to take the pension now and how bad the penalties for taking it in the mid fifties is compared to whatever the normal retirement age is.

I think it is possible that long term you'll be better off commuting and putting the money into investments within an ISA, if you're content to take the investment risk.

digdog

Thanks jamesd, I should have said I could have retired at 55 on close to a full pension but am staying to maximise pension until next year, so I suppose that gives a sense of needing to maximise the money coming in.
When you say that 6% is doable but a bit high as a target for many folk do you mean you would need a high risk strategy to gain it? Recent risk planning questionnaires put us as 5/10, so not very risk happy. My pension will be the main income for us two and we have no dependents.
I think the IFPA is totally independent- not commission based. We have not had detailed discussions yet about commuting but he has said that he generally advises folk in my position to commute

jamesd

Not high risk. 6% is entirely achievable. But 4% allows more safety margin to allow meeting a target after a large stock market drop just before you retire. Mainstream stock markets like the UK's FTSE All Share will drop 20% in routine bad years, 40-50% in uncommon ones. For emerging markets that increases to 70-80% or so. Commercial property and bonds have lower drops in the 10-25% range.

dunstonh

I think the IFPA is totally independent- not commission based.

What is IFPA?

he has said that he generally advises folk in my position to commute

Pre 2006, that was the case. Now you would expect it to be closer to 50/50. (financially in isolation of other issues, you would expect more to be told to take income rather than lump sum. However, when you factor in personal issues then more would take lump sum to around the 50/50 mark).

Linton

From my reading of your situation I would suggest the decision is not primarily a financial one. After HRT is taken into account the poor cummutation rate becomes less of a factor.

Some questions you could consider - How much income do you need for the type of life you want in your retirement? All the 60K? If you had a large lump sum do you have something you really want to use it for? An early bequest? A rather nice sports car? Upsize or renovate the house?

digdog

Thanks for all replies.

Dunstonh, sorry meant IFA not IFPA. Can you expand on the financial/personal issues that would shift folk towards taking either lump sum or pension?

Jamesd, is this a right reading of what you say? If I don't commute I could invest in risk5 rated investments and get a return equal to index linking on the full pension? Am I right in thinking this is only the case in tax protected products like ISAs and not in other investments? Sorry but I really don't know my way around this and want to have some sense of being able to talk the same language as the IFA- or at least be able to evaluate his advice.

Linton, if index linking can be matched by investment- you raise I think the fundamental question i.e. how much do we need to go on living in a way which is right for us? I don't feel "retired" whatever that means so don't want to do pipe and slippers but don't have a mega project in mind.

jamesd

Commuting is the act of taking a lump sum instead of some ongoing income from a pension. So the potential is that by commuting if your investments did well you might get more income than taking the pension.