Lump sum advice.

agent_orange_2

Hello there, on the 6th of May 07 I took early retirement on medical grounds.
Today, I received figures from my company pension . I have been given the following options

A: pension of £9961 without a lump sum
B: pension of £7247 lump sum of £48315 available.

I am 48yrs old today - my medical condition is not life threatening, I hope to be collection pension for a good few years;)

If my sums are correct, taking the lump sum would cost a reducion of £2714 to my annual pension. I guess I will be paying tax of 20% on that so reducing its real value.

I was wondering, with good investment of the 48k, would I be better off taking the lump sum.

Many thanks for any thoughts.

dunstonh

£48315 @ 5% net = £2415 which is virtually the difference and with tax considered, it is more than the difference.

Lump sum looks attractive.

CLAPTON

it depends a bit on whether the pensions are indexed linked or otherwise yearly increasing.


In reality you need to consider the effects of inflation especially as you a very young to retire.
Lets remind ourselves that 30 years ago you could probably buy a three bedroomed house for well under 30k .. you can't now and you are very likely to be alive in 30 years time.

Currently inflation RPI is running at 4.8% so if you want to preserve the 'real' purchase power of your lump sum 48315 for the future then you need to get a return after tax of greater than 4.8% and only spend the difference above 4.8% so if you can get 5% after tax (quite difficult) then you can only really spend 0.2% or £96 per year. In reality if you want a guaranteed secure savings then you can't really do a lot better than government index linked saving where you get just a bit better than 1% per annum... your best figure for planning.
If you are happy to risk the stock market then you may do better but as they say shares can go down as well as up.
However you do have immediate access to the lump sum if you need it.

agent_orange_2

CLAPTON wrote: »

it depends a bit on whether the pensions are indexed linked or otherwise yearly increasing.

On checking, the pension is index linked (RPI).

I must admit, I didn't take that into consideration.
I'm going to have to give this some thought and book myself an appointment with an IFA. Would I better off using an IFA on a fee basis or commission only?
I also have a smaller avc pension to sort out as well.

Thanks for your considerations.

dunstonh

It is really a matter of opinion and risk.

Personally, I would prefer the lump sum in my pocket. If I passed away, that could continue to be used by my wife whereas the pension would drop to 50%.

However, there are pros and cons with each option.

Would I better off using an IFA on a fee basis or commission only?

On that amount, commission would be better. However, agree a hybrid charge. Thats an increasingly common method where you agree a fee that is paid from the commission with anything above that being rebated into the plan.

carnet

If you take the lump sum, you are foregoing £2714 pa gross pension. If this is subject to 20% tax (as from next year) it reduces to £2171.

If the £48315 lump sum (presumably tax free) was just put on deposit earning interest at 4.4 % net (easily possible) this is £2126 pa.

Thus you would only be "losing" £45 pa.

So, it would take 1073 years before you would be better off foregoing the lump sum (£48315 divided by £45)

Even if the £2714 was not subject to any tax you would be "losing" only £588 pa pension (£2714 minus £2126).

However, it would still take over 82 years before you would be better off by not taking the lump sum (£48315 divided by £588).

Of course these are based on rates as they stand today but, even with RPI increases on the £2714 (if RPI rises dramatically, the likelihood is that interest rates will too), how long would it take before you are worse off ...

....no matter how early you retired ?

And you retain control over a valuable lump sum you would not otherwise have.

IMHO, its a no-brainer.

EdInvestor

It's a no brainer if you are willing to invest the lump sum long term so that the capital and income grow to cover inflation.You don't necessarily have to take high risks to achieve this and it is not difficult to learn how to do it, especially if you have spare time..;)

A more difficult choice if the investor is very risk averse with such a long period of retirement in prospect.

Is this pension the OP's sole source of income, or will he continue to have earnings/other pensions/savings income?

CLAPTON

the one great problem with seeking professional advice (and apologies if i offend any IFA here) is that inflation is rarely taken fully into account. But if you are looking 30 years or more ahead then its pretty essential to do so.

so let redo carnet figures assuming inflation at today rate 4.8% and using his net interest rate of 4.4%.


pension difference now is £ 2,171 pa. at 20% tax and
interest earned is 2126 pa.
so loss is only £45pa

in ten years time and assuming inflation at today rate
pension difference will now be £3,469pa but
interest earned will be still £2,126
so loss now is £1,343 pa

in 20 years time and again assuming todays inflation rate
pension difference will be £5,545 pa but
interest will still be £2,126 pa
so loss will now be £3,418 pa.

in 30 years time etc
pension difference will be £8,861 pa but
interest will still be £2,126pa
so loss will be £6,735pa

Now you really need to set up a spread sheet to work it out properly but the cash breakeven period is about 68 years rather than 1073 years above.

But looking back over the last 30 years we have had long periods where interest rates were lower than inflation and inflation was up around the 20% mark.

Having said all this I personally would take the cash because the potential flexibilty it offers you now but again I dont know your full circumstances (wife, family other savings outgoing, mortgage, plans etc.) But just dont forget about the dramatic effects that inflation has on projection over long periods of time.

I hope you enjoy your retirement even if it is due to medical grounds.

carnet

It's a no brainer if you are willing to invest the lump sum long term so that the capital and income grow to cover inflation

I only commented on this thread because Mrs. Carnet was recently faced with the same option. As a long time investor it certainly was a no brainer to take the lump sum to invest - if I can't make (substantially) more than RPI I better give up. However, not knowing the OP's investing experience, aversion (or otherwise) to risk etc. thought it better just to quote deposit.

in ten years time and assuming inflation at today rate
pension difference will now be £3,469pa but
interest earned will be still £2,126
so loss now is £1,343 pa

Yes, but surely the interest on the lump sum compounds, so that after 10 years at 4.4% the lump sum would be worth £74,316 so therefore the interest being earned would be £3270 ?

dunstonh

the one great problem with seeking professional advice (and apologies if i offend any IFA here) is that inflation is rarely taken fully into account. But if you are looking 30 years or more ahead then its pretty essential to do so.

I got accused in the savings section the other day of making a too big a point about inflation! IFAs do generally harp on about inflation a lot but I do know from my tied agent days that it was never considered then.

CLAPTON

carnet wrote: »

Yes, but surely the interest on the lump sum compounds, so that after 10 years at 4.4% the lump sum would be worth £74,316 so therefore the interest being earned would be £3270 ?

but thats not comparing like with like....if one is going to compound the interest for the lump sum.. (which is fine one ) then you also must assume that the pension difference is saved and not spent and that this money is also invested and the interest compounded.

mine assumes that in both cases either the full pension is spent or that the interest received is spent.

It just shows how you really need to know at lot more about the OPs circumstances... will he need the money for his regular spending or can he save it .. it changes the balance.

anyway very interesting thread