Lump sum or full pension (again!)

Uzima

I know this is an ‘old chestnut’, and that pension decisions depend on an individual’s circumstances and disposition – but…… I would appreciate any advice, as it’s a big decision. What I have read on the forum suggests that with a commutation factor of only 11.88, I should not take a cash lump sum from the company pension that I am about to receive. But my figures still leave me doubtful – which means I may have got them wrong! It seems to me that with the tax advantage of a lump sum, it is only after about 15 years that returns from the full pension exceed the growth of a lump sum - in my case.

The company pension in question amounts to £7317 pa payable from April this year. Seven-tenths of this pension will increase by 5% a year. The other 30% will rise according to CPI up to a maximum of 5% a year. If I take a figure, probably on the low side, of 3% average CPI for this smaller portion, then I would expect the total pension to increase by about 4.4% pa. I will be paying 20% tax.

I am looking, as an example, at two different scenarios. In the first I take a lump sum, say £10,000, and invest it for a return of 5.5% before tax – perfectly achievable (eg in ZOPA.) After tax, this is 4.4%, which turns the £10,000 into about £15,380 after ten years, and almost £20,000 after 15 years.

Taking this lump sum would mean foregoing £842 before tax in the first year’s pension. If I set aside that money after tax – £674 – and invest it at the same 4.4%, and then continue year by year as this portion of the pension increases – eg in the second year investing £703 after tax, and so on – I achieve only £10,350 in ten years. After 15 years, the sum saved will grow to over £19,000. But it is only after this that the returns accelerate beyond – and soon well beyond - those achieved by investing the lump sum.

In those 15 years, I have access to the capital. This would be useful if I became terminally ill and wanted to give some cash out; or if hyperinflation takes off in five or ten years time as some economists expect, and alternative investments – gold, property, stocks, artwork – were a better haven.

A need for instant cash does not influence my decision on taking a lump sum. I have a state pension of over £9,000 (inc second pension). I have £9,000 pa from property and over £50,000 in savings of one sort and another. My wife has a well-paid job and will work for a further 7 years or so. We have paid off the mortgage and the children are independent. So no call for complaint! But I am concerned that I would be going against the advice I have seen in the Forum, and I would like to be persuaded NOT to have the hassle of managing the investment of the lump sum.

Zelazny

Cohort life expectancy for a 65 year old male is about 21.5 years, and as you've pointed out the pension is better in terms of total returns for any period over 15 years, so generally speaking you'd be better off with the pension.

This does not take into account personal circumstances, and if you think that you might need some of the money in the mean time it may well be better for you personally to take a lump sum now.

atush

And any amt lent via ZOPA isn't FSCS guaranteed so you could conceivably lose the lot.

If you take a lump sum (because you have no other savings or you feel your personal LE is lower than 21.5 years) I woud invest it in a safer way personally. Such as Cash and S&S isas, deposits etc among other things.

jamesd

Age allowance seems to be a factor that you need to consider. You're looking at an income of £9,000 state pensions + £7,317 company pension + £9,000 property (I assume after deducting mortgage interest). That's £25,317 a year. This is over £24,000 so some of the higher £9,940 personal allowance that those over 65 get will be eliminated, giving you an effective income tax rate of 30%, not 20%.

This suggests that there may be some benefit to you from taking a lump sum to reduce the work pension income by £1,317 or some more as safety margin to allow for other taxable income like savings interest and the likely use of fiscal drag by governments to reduce the benefit of the age allowance. Then you can invest the lump sum in a S&S ISA and get tax free income from that which doesn't count towards the age allowance test.

With an 11.88% commutation rate your target investment income starts at 8.5% to deliver the income, plus inflation plus the value of any spousal benefits. That's overly ambitious except for the effect of the age allowance reduction which reduces the target a bit.

It appears that you may have some experience investing and that there is a reasonable chance that you will be better off by taking a lump sum due to the tax effect. However, this is a pretty marginal situation due to the low commutation rate and whether it's worth doing depends to a large degree on how keen you are on having the capital available from day one.

If you are after reduced hassle factor I suggest that you consider an alternative approach. Take the full pension income because that's hassle-free for as long as you live. Split ownership of the rental property with your spouse if you haven't done that already, to get below the age allowance reduction level. Then to lower hassle, stop letting the property and sell it when you feel the inclination to have a simpler life. This gets you the nice protected pension income for life without any hassles and an easy way to further reduce hassle later when you no longer want to deal with tenants and voids.

There's no real reason to use Zopa for this, the returns are lower than you can get tax free inside a S&S ISA using a wide range of funds that have some FSCS protection. A little use of Zopa or any other high risk investments at a maximum of 5% each would be OK for diversification, though, even though Zopa itself isn't likely to come anywhere near to paying out enough to meet the investment return that you need to break even.

Uzima

Amazed to see so much good advice so quickly. There is no other place on the web to get this sort of support.

As I stopped crunching numbers and read more, I realise that this - as everyone advises - is a very personal decision. I am prepared for some long-term cash loss in taking a lump sum in return for flexibility. I have been diversifying part of my savings out of sterling because fiat currencies are under threat - hence the high gold price. My pension is capped at a 5% pa rise. A period of inflation such as that the UK experienced in the 1970s would destroy pensions. And western governments are relying on inflation as the only way out of debt - without inflation, it is hard to see how UK and USA will not default. And it is a great stealth tax - the building societies still alk about a 1% or 2% fall in house prices, without ever factoring in 4-5% inflation! Less polemically, longevity is also not brilliant in my family!

Agreed about ZOPA - I am keeping 4% of my cash savings there and won't go much higher. But I support the principle. Thanks for advice regarding age allowance which does affect me. Especially since we don't know which way tax rules will move: an increase in the tax threshold to 10,000 GBP may se other allowances frozen or worse. Re JamesD's suggestion, thanks - but my wife and I normally keep our finances separate these days! - different savings outlooks. And she would pay higher rate tax on the income. I wouldn't sell this retail property at the moment - it generates 18,000 pa for no hassle (half for me, half for my sister), and at this rent the sales value would be little more than 200,000. It has paid for itself twice over in the past 25 years. Best investment I ever had.

In conclusion I think I'll take half of the lump sum and give up about 1000 GBP a year pension (after tax), which keeps me safe on the age allowance. I will say again that we owe a lot to people who are always on the MSE Fora to advise. I come here to read and learn and ask on occasion, but I have never found the commitment to look to provide help in the areas of my expertise. I will try harder! Thanks.