ill health retirement - lump sum

maisie1

i would be grateful for advice on my situation. i had a stroke in 2010 and returned to work but have since had to retire on ill health grounds and will finish work in may. I am 51 years old.I have a 25 year mortgage and still have 22 years to pay back. the outstanding balance is £139,000 and interest rate on the mortgage is 4.69%.
I have a local government pension and have the option of taking a pension of £21,000 and a lump sum of £32,000 or a pension of £15,200 and a lump sum of £101,500. The lump sum would be tax free. Would it be wise to take the max lump sum to pay off a large proportion of my mortgage or take the max pension.
I am in relatively good health so would expect to live a normal life span. My wife works and earns about £15,000.

Just_Some_Guy

You've got two options - give yourself a pension of £15k and a 22y mortgage of £40k or a pension of £21k and a 22y mortgage of £110k (because you'd chuck the £30k at the mortgage right?).

Now some back of the envelope calculations show that you'd only save about £5000 a year in mortgage payments when you reduce your pension by £5800 a year. So it looks a bit dumb to take the maximum lump sum. But that's not the whole story. As interest rates go up the amount of mortgage payments you'd avoid increases, so if interest rates become 6% or so you'd break even. Also you will probably pay tax on your pension, so by reducing your pension by £5800 a year you reduce your tax bill by about £1160 a year as well so you only lose out on £4640 of cash a year hitting your bank account. So it looks like a good idea already. But don't forget about inflation.

If you have a normal life expectancy then you have three to four decades left. So if you reduce your pension by £5800 this year then you will reduce your pension by £5800 x three to four decades of CPI inflation when you get to the end of your life. The extra cash you receive later on could more than compensate for the extra cash you have to chuck at the mortgage now. But maybe not.

With a history of stroke you may have a normal life expectancy but your care requirements towards the end of your life may be higher - would a higher pension at that point in time be more useful than reducing the mortgage more now?

What are your wife's pension arrangements like? Could her lump sum pay off the mortgage in full when she retires? What do you both want to do with your retirement anyway - would a higher pension income make that more achievable or would the maximum lump sums do the job? Would your smaller pension income be enough to support both of you in retirement? What do you get in terms of State pensions? What about other State benefits?

Also, do you have any kids or any other plans for the house when you are both gone? If so then it makes reducing the mortgage ASAP more attractive so that if the worst happens there is more equity in the property to pass on. But maybe having a higher income allows you to help your kids out more.

So in summary: lots to think long and hard about. Your retirement will last you the rest of your life so don't make any rash decisions just because it makes sense for this decade.

jamesd

That's an increase of £69,500 in the lump sum for a loss of £5,800 in ongoing income, which will increase with inflation. Ignoring the inflation increases it's a commutation factor of 12:1 or an interest rate of 8.3% to break even. First thing that tells you is that paying off a mortgage at only 4.69% is a lousy deal and you shouldn't remotely consider doing that because taking the income and using it to pay the mortgage gains you more.

That 12:1 commutation and 8.3% plus inflation investment return needed to break even if you took the lump sum and invested it is too high for taking the lump sum and investing it to be sensible.

So on those figures the option that leaves you financially better off is clear: keep the mortgage and take the lower lump sum and higher ongoing income with its regular inflation increases.

Looking at the mortgage and the lower £32,000 lump sum the pure financial decision is again easy. You can get 6-8%+ tax free without inflation growth inside a stocks and shares ISA without much trouble so it's a better idea to invest the money and use the tax free income to pay the mortgage over time than use the lump sum to reduce the mortgage.

maisie1

thats helpful thanks - i think i probably will take the maximum pension and minimum lump sum. i would like to draw up a spreadsheet of future years but im not too good at doing the maths.

elsie777

Hmm not sure I follow the advice above. Perhaps there are some key points that could be discussed further...

Firstly as your lump sum payment from your pension is tax free, but your pension income is not, many people take the maximum lump sum they can, I certainly did following financial advice after my ill health early retirement and I'm younger than you.

Secondly, it's easy to say you should get 6-8% income no problem from a stocks and shares ISA, but you could also lose e.g. 6-8% or more any given year, so I wouldn't rely on that income as all but guaranteed to happen if you need access to it for paying bills like your mortgage etc.

You are also of course limited by the amount you can put in ISAs, so is any tax free income you might make going to be enough to pay the things you need it to do. Most other investments would be liable to tax, and of course inflation needs considering when looking at your options, as do any mortgage repayment penalties if you have them.

I'm actually in a quite similar position following ill health retirement. I've taken the max lump sum I was allowed as I mentioned above, and Im now wondering whether to pay off all of my repayment mortgage which is a similar amount to yours with a similar interest rate, or perhaps keep paying the mortgage and invest say £140k and hope it makes enough regular income to justify the decision, because I can't afford to tie up that money long term, pay off the mortgage each year with other money, and also live on further money.

Currently im erring towards paying off the mortgage, and wiping out the big monthly repayment totally, because at least that's guaranteed to happen and I know I can live fine then with the pension income. I'll also use left over lump sum money to place in stocks and shares ISA(s). However if anyone thinks this plan is crazy I'm all ears if they say what they'd do instead with mortgage money and why

jem16

elsie777 wrote: »

Firstly as your lump sum payment from your pension is tax free, but your pension income is not, many people take the maximum lump sum they can,I certainly did following financial advice after my ill health early retirement.

How much pension did you give up for what amount of lump sum?

I'm actually in a very similar position having taken the max lump sum in that Im wondering whether to pay off a repayment mortgage of a similar amount to you with a similar interest rate or keep paying the mortgage and invest say £140k and 'hope' it makes enough regular income to justify the decision, because I can't afford to tie up that money long term, pay off the mortgage each month with other money, and also live on further money.

Why were you advised to take the highest lump sum yet no real decision on what you were going to do with it?

elsie777

As I said above I was advised (by more than one person) to take the maximum lump sum because it was tax free and the pension income is not. What you then do with it doesn't change that fact.

I was given a number of options and advice with what to do with the lump sum, but I've yet to decide and as I also said above I'm leaning towards paying off the mortgage. I personally think I might prefer to do this due to the risk of any significant investment given it is money I cant really afford to risk as I need it for the rest of my life ill health retired. I also can't tie it up without access medium to long term as I might be moving abroad and will need it to buy a new house if I do, and there are a few other reasons.

My lump sum was 200-250k and it dropped my pension around 8-10k

jem16

elsie777 wrote: »

As I said above I was advised (by more than one person) to take the maximum lump sum because it was tax free and the pension income is not. What you then do with it doesn't change that fact.

I'm afraid it does matter though.

If you take the extra lump sum with a view to spending it then great it is the best option.

if it's to pay off a mortgage, then for some it is the best option as they want to be mortgage free. However for others it won't be the best option.

However if you take the extra lump sum but still need to create an income from all or part of that lump sum, then it may not be the best option at all.

My lump sum was 200-250k and it dropped my pension around 8-10k

Is that lump sum, the extra amount that you got or the total amount.

If it is the extra amount then it is a commutation rate of 25:1 which is brilliant and well worth taking.

In the OP's case however it's only 12:1 which is dire.

elsie777

My primary objective was covering the mortgage and ideally I wanted to pay it all off unless there was a better alternative, which made me money and allowed the mortgage to be covered. Plus I wanted to use the left over to invest e.g. stocks and shares ISAs etc.

The lump sum is the total amount I got for a drop of 6-7k (I just double checked)

jem16

elsie777 wrote: »

The lump sum is the total amount I got for a drop of 6-7k (I just double checked)

Can't really check your rate unless you give the extra amount of lump sum gained rather than the total amount.

elsie777

Sorry I wasn't given 'an extra amount'.

The only illustrations I was given from my company were the option of max lump sum and salary, or just salary. I never considered alternative lump sum amounts as all the advice I received said to take the maximum I could.