Final Salary Scheme transfer - justified?

Smiffy7

My father was intending to work until his 60th birthday (scheme retirement age) but would like to consider early retirement on his 55th birthday in 18 months time. As an accountant, I have a reasonable grasp of the concepts involved but am worried about him making a bad decision that he'll regret in his later years

Whilst a lump sum redundancy payment is on offer (which he would use clear his mortgage and to purchase a 2nd home abroad), there is no enhancement to his pension and he would suffer a penalty of 25% if he chooses to release benefits 5 years early

He could take a pension of approx. £27k pa at age 55, index linked for life with 50% widows pension - but this would not provide him with sufficient income to maintain his current standard of living.

He has full entitlement to State Pension and whilst the index linking and State Pension will ensure he is extremely comfortable in his later years, he wants to be able to have a better income now and not have to wait until he's 65 to benefit from State Pension and effectively when he's 75 or 80 to benefit from the index linking on his FS Scheme. In effect, he's considering coming out of the FS scheme to take level, rather than increasing, benefits (which we have estimated would be circa £38k pa using the scheme transfer value and current GAD drawdown rates) in an attempt to increase his starting income, knowing that in 10 years or so, he'll be eligible to receive State Pension which will re-establish the spending power of his pension income at that time.

Does "a bird in the hand" have any place here or is he being foolhardy? I can see his point - being unwilling to scrape by for 10 years whilst he has the health and energy to live a very full life, in exchange for knowing that he'll have more money than he actually needs when he reaches his 70's.

Any opinions out there before he seeks professional advice?

jamesd

He's being foolhardy. As you have summarised, his plan is to deprive himself of income he knows he needs in the future to fund a second home purchase and an unwise paying off of a mortgage.

But this does not necessarily mean that he cannot retire at 55.

He has some quite straightforward options available. One is to increase the mortgage and then invest the capital to provide income through a mixture of investment income and capital drawing. This money can provide a bridging income until the 60 normal retirement age of his work scheme.

Once he reaches NRA he then can consider whether to take the lump sum or not. Key here will be commutation rate. Some have very poor commutation rates, as little as £12 (or even 8!) of capital per Pound of annual income foregone. Some have more decent rates but none I've seen have an actuarially neutral rate of about 28:1 except the Pension Protection fund.

Next stop, state pension age. By this point he will have been living on his work pension and I will assume that this income is adequate for his needs. This means that the state pensions income is available to start to pay off the mortgage at a higher rate. It's the optimal time to do it to maximise early retirement income. Less optimal would be taking a lump sum at 60 from the work pension but that is also possible.

It's quite possible that the state pensions will not provide sufficient additional income to clear the mortgage by say age 85, a few years before life expectancy for males who make it to 65. That can be addressed by using a portion of the difference between pension income now and work pension income at NRA.

It will be mandatory for an IFA to make a recommendation to transfer. I don't see a high prospect of an IFA being willing to make that recommendation, given the existence of a less painful alternative. The IFA ends up on the hook to pay redress for a plan that makes their customer worse off and so far as I can see the IFA is going to be on the hook with his plan. The purpose of the IFA requirement is to protect people from making mistakes where they over-value current income or capital and under-value future income and capital.

Highly favourable things for him are time (that can be combined with life assurance to protect others) and well protected and known future income levels from the work and state pensions. So treat it as a cash flow problem with highly stable future cash flows. As an accountant you can do the cash flow analysis so I won't try to put together one in this case.

In the event that he does continue with his poor plan, do be sure to let him know that age 55 is far too young to get a decent annuity rate, that annuity rates at the moment are poor anyway and that income drawdown is an alternative.

Smiffy7 wrote: »

He has full entitlement to State Pension

That's possible, but unlikely. Full entitlement is about £250 a week once the maximum SERPS and S2P Additional State Pension entitlements that could be accrued are added to the Basic State Pension entitlement. I'm being pedantic in part because he may have a higher state pension entitlement than you and he expect if he hasn't factored in the Additional State Pension. Around £190 a week isn't uncommon.

He's planning to purchase a second home. Does he still need the first home? Does it need to be as large or possibly costly as it is, if he plans to use the second home extensively? Another possible option is to downsize and keep a mortgage on the downsized property. This has the advantage of reducing running costs and debt levels for a property he might not use much in the future.

xylophone

Around £190 a week isn't uncommon.

But not where a person was contracted out.


The OP's father would probably have started working for the company in around 1978-81 - it is likely with a DB scheme that he was contracted out of SERPS.

If he was born in April 1960 then he'll reach SPA when he is 66 in 2026 - by that time the single tier pension system could have been in operation for 10 years.

https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/210299/single-tier-valuation-contracting-out.pdf

With regard to transferring out of his FS scheme, the OP's father might find that an IFA is unwilling to sign off the transfer.

http://www.fca.org.uk/firms/financial-services-products/investments/pension-transfers

atush

All talk of a second property should be abandoned (and perhaps revisited int he future if they downsize their current home). That is an unwise use of pension funds.

What savings and investments do they have outside the pension/family home? Does his OH (your mother maybe) have a pension? Does he NEED the LS to pay off his mtg? What rate is it?

We'd need to know more to give sensible suggestions really.

I know James' reasons for the whole extending t he mtg to invest thing, but I am not a fan esp if your father is not savvy in the ways of investments. But I do agree wasting capital on a holiday home is unwise if it would mean he can't live on his current pension income projected. Plus a second home has costs, and will restrict them int heir holiday choices.

If he wants to retire that early, I would consider 1 phased retirement (ie getting a PT job or consultancy perhaps). Living on his projected ret income now, and banking the rest in S&S isas or PP.

What will his pension be if he reduces the LS to take out the holiday home pruchase?

jamesd

xylophone wrote: »

The OP's father would probably have started working for the company in around 1978-81 - it is likely with a DB scheme that he was contracted out of SERPS.

If he was born in April 1960 then he'll reach SPA when he is 66 in 2026 - by that time the single tier pension system could have been in operation for 10 years.

Agreed. It seems more likely in his case that he'd initially be eligible for a reduced flat rate pension but could then buy additional years after the work pension NRA to get to a £144 a week state pension.

atush wrote: »

I know James' reasons for the whole extending t he mtg to invest thing, but I am not a fan esp if your father is not savvy in the ways of investments.

Worth noting the time span for this: five years from 55 to NRA. That implies little use of investments and mostly relying on savings and capital drawing from them because of the usual five year minimum guidance for standard investments.

atush wrote: »

All talk of a second property should be abandoned

I don't think it has to be abandoned but do think that more work on funding it in less damaging ways and possibly use of a mortgage and downsizing the existing home to ensure sufficient income to enjoy it is available should be considered.

Smiffy7

Dad is waiting to hear from pension company as to what his max lump sum is and what effect this will have on his pension income if he draws benefits now. He was hoping to be able to release enough pension cash lump sum to more or less repay the mortgage and use the redundancy to purchase the holiday home, which would leave the endowments & ISA (see below) as a buffer to top up their pension income / protect against inflation if needed. His thinking was that as the endowment and ISA monies started to dwindle over the next 10 years, the state pension would kick in and provide a boost. We've just applied for a State Pension forecast but Xylophone is right, he was contracted out.

Mum's pension is non-existent, apart from what I assume will be a nominal state benefit. She's a year younger than dad.

Never thought about increasing the mortgage and using this to help bridge the income gap until age 60 but can't see his lender being in favour of extending a mortgage (approx. £60k interest only - std variable rate - 2.99%) to someone without an income? He has an underperforming endowment which matures in just under 2 years time and this should give him +/- £40k. They also have ISA savings (not sure of value but I'd guess around £30k at the moment). The ISA's were set aside from cash savings a number of years ago when it became apparent the endowment would not be likely to repay the mortgage. Cash savings are now minimal (circa £15k and mainly tied up in Premium Bonds - I know don't event say it, he won't listen!!)

Sounds like sensible option would be to park the holiday home idea & revisit once TFC released from pension at age 60? He had anticipated £70k purchase outlay from net redundancy pyt of circa £90k. This could leave him free to use the redundancy money to live off until Co Pension kicks in at 60.

Downsizing not really an option as house value is modest.

This all really kicked off when we worked out that the "loss" of income in early years to make up for cost of indexation in later years is quite staggering for a 55 or 60 year old as the annuity rate more or less doubles without indexation. He doesn't see the point in being at his wealthiest (as far as income is concerned) just before he pegs it and would like to be able to enjoy more income now in the full realisation that every £1 he spends now will be £1+ that he won't have available when he's 80 or 90. He doesn't see a problem with this and I must say I can see where he's coming from. Trouble is, to take more up front and less in the future, he needs to transfer his pension benefits and everyone is telling him not to do this.

atush

Well, it certainly sounds as if he is not a very wise investor. Money in PBs, thinking of buying a holiday home he can't afford AND retiring early.


Take him to see an IFA who will explain as we have why his plan is very unwise. As he seems to not listen to you (intimated over the PBs).

xylophone

Mum's pension is non-existent, apart from what I assume will be a nominal state benefit. She's a year younger than dad.

Your mother too will be affected by single tier proposals- seehttps://www.gov.uk/government/uploads/system/uploads/attachment_data/file/181235/derived-inherited-entitlement.pdf

jamesd

Smiffy7 wrote: »

This all really kicked off when we worked out that the "loss" of income in early years to make up for cost of indexation in later years is quite staggering for a 55 or 60 year old as the annuity rate more or less doubles without indexation. He doesn't see the point in being at his wealthiest (as far as income is concerned) just before he pegs it

All indexation does is preserve the real value to try to keep up with the way inflation reduces buying power. It doesn't increase it.

What it does do is make it easier to overpay on a mortgage as he gets older, because the amount owed doesn't increase with inflation, while the number of Pounds of income does.

It's not a case of £1 now reducing his income by £1 when he's 90. Assuming inflation of 3% a year a Pound now costs him £2.81 at age 90 and less or more for each year before and after that. Or more generally, a pound of spending today takes about £20 to replace because it takes about £20 to generate a Pound of ongoing income for life (assuming income drawdown and 5% investment return).

Smiffy7 wrote: »

Never thought about increasing the mortgage and using this to help bridge the income gap until age 60 but can't see his lender being in favour of extending a mortgage (approx. £60k interest only - std variable rate - 2.99%) to someone without an income?

He has an income at the moment and should do any remortgaging while he has one. Via the work pension he also has available quite a large income in retirement, so he may well be able to get a repayment mortgage with a term that ends at age 85, from one of the limited number of providers who offer those. That guaranteed pension income is one of his biggest assets that should make it possible to get a mortgage that extends into retirement, because it will be affordable in retirement.

Better than repayment would be interest only well into retirement but I don't know of any providers who offer that for a useful ending age.

Smiffy7 wrote: »

Sounds like sensible option would be to park the holiday home idea & revisit once TFC released from pension at age 60?

Yes, unless he can release capital somehow, using his future income to repay the borrowing.

It seems that he has about £85k available now and during the next five years. What is their minimum spending requirement per year assuming a holiday place is not purchased? And if one is? Ignoring interest or investment returns, £85,000 can produce £17,000 of tax free income just from the capital. If he waits one year that rises to £21,250. Eventually it'll get to the point where it's doable. Just a case of when.

Smiffy7

They'd like around £2,500pm net and a bit of capital behind them assuming mortgage is repaid. ISA's are no longer being contributed to and mortgage is only costing £150pm so makes no real difference whether he pays it off or not. Holiday home idea was borne out of "what income could I get by investing £60k of my redundancy?" versus "what would I save by not having to pay for holiday home accommodation" (they'd like to spend several months a year out of the UK). He doesn't see this as a permanent arrangement, just something they'd like to do whilst they are relatively young and will probably treat it as a longer term investment as well as something to enjoy in the meantime

They've been using surplus income in last few years to help my brother out of a financial hole so don't have much short term capital apart from the ridiculous premium bonds. Dad has had a couple of promotions in last few years which has led to him effectively having a pension income that isn't far off what he was earning just 5 or 6 years ago so he knows he can enjoy a life of leisure within this budget as long as he has some capital set aside to pay for ad-hoc expenditure, the biggest thing of which will be buying and running a car.

I'll get him to speak to a reputable IFA to see what his best options are to meet his expenditure needs over the next 5 years without disturbing his pension until age 60. I had a chat with him tonight and he has no appetite to seek employment and tells me he has already made the decision to stop work. Life is too short and all that! Bang goes my inheritance then !! Thanks to all for the posts - you've been a great help and given us lots of food for thought

jamesd

So a target of £30,000 a year. That's two years and some more saving away unless he releases capital. For the second property he should really look into the market for long stay winter breaks. There are some great deals aimed at the pensioner market. No capital cost so it's a good deal less risky.

Getting more creative than the standard mortgage or equity release there are credit cards with life of balance 5-7% interest rates that might work decently for this purpose. Up to half of his current income in unsecured credit may well be doable assuming he has an excellent credit record. But this isn't quite as nice as the mortgage or maybe equity release option, just another potential tool.

You'll still end up with some inheritance, probably. The value of the property. Well, unless they go for equity release and decide never to pay it off...