Questions to ask an IFA?

1echidna

dunstonh wrote: »

I don't know. Why don't you enlighten us as to what you think?

Sorry I just don't know either, you lot just baffle me with technical terms. I can't see the wood for the trees.

GeorgeHowell

Retirement options is one area where use of an IFA can potentially be beneficial, provided it is a good one who knows what he is talking about. Pensions and all that go with them are fiendishly complicated and it is difficult for the average layman to grasp all the salient issues and nuances unaided.

However where to be cautious with an IFA is if the decision is made to release some of the pension fund buid-up in the form of a cash lump sum. People at or close to retirement age should be extremely cautious about putting their money into anything where the capital is at risk (beyond inevitable inflation risk). It is all too easy to lose a substantial portion with limited possibility to get it back. So one key question to ask an IFA under these circumstances is, "Are you going to advise me to put my money into anything capital risky, and if so why ?" If the answer is the same tired old mantra about the stock market historically having done better than anything else etc (not proven since 1999 by the way), then some of the points made above about crystal balls and hindsight and "(un)suitable investments" come into play. It's then time to look for another IFA, or better still don't use an IFA in terms of where to put the money.

chris1

GeorgeHowell wrote: »

However where to be cautious with an IFA is if the decision is made to release some of the pension fund buid-up in the form of a cash lump sum.

Is it always better (mathematically) to take the 25% cash lump sum?

dunstonh

Is it always better (mathematically) to take the 25% cash lump sum?

No. There are times when it is not best to take max lump sum

chris1

dunstonh wrote: »

No. There are times when it is not best to take max lump sum

When would that be the case?
Would it always be the case in a standard defined contribution scheme with no guaranteed annuity rate?

dunstonh

chris1 wrote: »

When would that be the case?
Would it always be the case in a standard defined contribution scheme with no guaranteed annuity rate?

Effectively that would be the only case. Although enhanced annuity rates giving a particularly stronger rate than say a purchased life annuity (net of tax) or alternative that would be used with the lump sum could theoretically apply.

GeorgeHowell

chris1 wrote: »

Is it always better (mathematically) to take the 25% cash lump sum?

The issues to consider are :- the cash lump sum is essentially tax free whereas pension income is taxed; if the fund goes pear-shaped that money is already in the bag; should the pensioner not live long into retirement that money (if unspent) cannot be lost to dependents; if the pensioner has debts at relatively high interest rates some of that money can be used to pay them off. Conversely given actuarial life expectancy the additional pension income gained in the absence of taking the lump sum may work out at more than the lump sum (including accrued interest in both cases).

Using an IFA to help dimension all that is not necessarily a bad thing. The things to guard against are firstly an unscrupulous IFA weighting the argument in favour of lump sum in the hope of gaining work from managing the investment of it, and secondly an IFA recommending potentially unsuitable capital-risky investments to people of pensionable age.

srcandas

George just to add to your excellent summary, obviously the 25% becomes much less valuable the better the annuity rate (AR) you have.

From my calculations starting at 60 if I spend the pension amount each year

with a 9.3% AR I run out of the lump sum aged 75
with a 4.5% AR I run out of lump sum aged 101

So where I have a Guaranteed AR my decisions are very different. But even a 1% difference would equate to about 5 years :beer:

ps very rough calcs of course but I believe good ball parks

chris1

srcandas wrote: »

George just to add to your excellent summary, obviously the 25% becomes much less valuable the better the annuity rate (AR) you have.

From my calculations starting at 60 if I spend the pension amount each year
with a 9.3% AR I run out of the lump sum aged 75
with a 4.5% AR I run out of lump sum aged 101

So where I have a Guaranteed AR my decisions are very different. But even a 1% difference would equate to about 5 years.

I'm struggling to set up a spreadsheet for these decisions, particularly level versus increasing annuity -

Example: Level annuity rate 5.221% and increasing at 3% annuity rate 3.385%, £50K pot, basic rate taxpayer.
Option 1 (level) gives £2088.40 p.a. after tax (Pensioner L)
Option 2 (escalating 3%) gives 1354 p.a. after tax in year 1 and increases by 3% p.a. (Pensioner E)

Let's say Pensioner L can live on the same amount as Pensioner E and puts difference each year into a bank account paying say 2.4% after tax.

According to my spreadsheet, the monthly income would equate in about year 15, but Pensioner L would have saved up (with interest compounded) £7862. From here Pensioner L then has less income and uses savings pot to make up the difference. According to my spreadsheet, the pot doesn't run out until Year 31!

The figures are even worse for 5% and RPI - I must be doing something wrong, at this timescale no-one would do this! What have I missed please?

srcandas

Chris I think you are ignoring that the lump sum invested is entirely tax free. It consists of the lump sum and interest after tax (in your example).

The pension assuming you will receive a state pension plus a pension on the 75% left after the lump sum is taken means the pension will almost certainly be taxed ??

So I think your break even point should be nearer a little over 40 years.

Of course you may do better than 2.4% after tax. You could for instance put £10000 in a five year fixed ISA using the extra £2500 to pay the pension for those first five years.

I haven't got time at the mo to do a precise calc. however:

A suggestion. Ignore the 75% of the pension on which you have no choice. So take the pensions as £522.10 and £338.00. Then reduce allowing for tax. Thus £417.68 and £270.80. So now you have after tax pension.

You can see that the £12500 lump sum would give you 24 years of flat rate without any interest.

Remembering the interest in year one would be £300 even at your very conservative 2.4%.

Hope that helps but please do not sign your life away on my figures until I have time to do detailed checking. I'm no IFA

Of course if your pot is £50000 and you have nothing else accept state pension you may not be paying tax on the pension?