Evaluating Annuity vs Drawdown

kidmugsy

Surely if deferral of the state pension to get extra pension is not worthwhile, no purchase of an index-linked annuity can be other than disastrous?

Be that as it may, a member of my extended family deferred SP to avoid 20% income tax and has started drawing SP + extra pension at an income tax rate of 0% (until she is widowed). Now that must surely be advantageous?

jamesd

kidmugsy, breakeven between level and index-linked tends to be too long to make sense. Ends up better to take the level and invest some of the extra income, though it depends on the specific situation. Deferring the state pension has better payback.

DCF_Evaluator

hold everything!

jamesd - I am indebted. There was an error in the state pension deferral algorithm! In fact the break even for 1 year deferral is close to your figure - I now get around age 77. With (eg) a 3 year deferral the break even is around 79. If one does get to 88 the net gain is indicated to be (eg) about £5k on a 1 year deferral, 12k on a 3 year.

These ages obviously will flex with different discount rates and assumptions re annual inflation-related increases to the state pension.

jamesd

The increase from deferring and the additional state pension also don't get the triple lock so perhaps you should assume 1% higher inflation increase for the basic station above RPI. That's because long term employment earnings increase by about RPI+1%.

If reaching state pension age after 2017 the current plan will cause any amount above the £144 amount to increase only with CPI. The £144 core will get the triple lock, so RPI+1% if using employment income increases.

kidmugsy

DCF_Evaluator wrote: »

hold everything!
... There was an error in the state pension deferral algorithm!

Ah!

Anyway, here's a wrinkle that might be new to you. My wife deferred her State Pension and, lo, her Final Salary pension was increased for the duration of the deferral (by about 10% of the pension forgone). This was something to do with a period of non-contracted out employment and the corresponding Additional Pension component of the SP. (She had once transferred a different pension into her occupational scheme.)

kidmugsy

What about 'inheritance' of extra pension by a widow? For us it'll be (if I understand it correctly) 100% of the extra based on the Basic Pension component, and 50% of the extra based on Additional Pension component. Did you include that?

DCF_Evaluator

kidmugsy

Re inheritance of widows' pension. The model currently only looks at a single individual. But this is a good point, I will have a look at the implications. Be in touch shortly.

DCF_Evaluator

jamesd

I will have to look into triple lock. In the meantime I tested the model with different annual state pension increments. This has no effect, I think because the basic state pension with or without annual increments is common to both the deferral and non-deferral scenarios. Incidentally, the £13.93 in your example above is fixed.

DCF_Evaluator

kidmugsy

I had a look. As I said the model looks at the individual only. I am not too familiar with the wife/inheritance but can see straightaway that it would give a 3D outcome(!) ie deferral years/individual survival years/spouse survival years which would become dead complex and beyond the scope of what I was planning to do here.

DCF_Evaluator

jamesd

Thanks for your posting as it has made me find out what Triple Lock is ... the highest of the three below:

• The rise in average UK earnings.
• The rise in inflation (as measured by the Consumer Price Index).
• A standard rise of 2.5 per cent.

I so I was working on RPI (Jan 2013 = 3.3%), CPI (Jan 2013 - 2.7%) or CPI+1% would be better. However, I tested it with all of these figures, it makes no difference to the deferral gains or losses at all because I think the core pension value is common to both the deferral and non-deferral scenarios.