Take lump sum or not?

frogeyesimon

My wife turns 50 this year. 15 years ago she was made redundant from a large company and as a part of her severence, her deferred pension becomes payable from her 50th birthday.

She has been offered either:-

a) A full pension of £3812 per annum

or

b) Lump sum of £20,057 and a reduced pension of £3008 per annum

Both these pension amounts are RPI linked. In addition there are spousal / children's death benefits.

She doen't really need the income at the moment (she's a non-earner anyway), but that could change in the coming year or so. She's mindful to take the lump sum and reduced pension and to perhaps invest this in our property either by extending or paying down some of our small mortgage.

I'd welcome any comments

Linton

Ignoring all other factors, in crude financial terms taking the lump sum is a bad idea as she is losing £804/year in exchange for £20057. £20057 is insufficient to buy a guaranteed inflation linked income of £804 from the age of 50.

If you paid the £20057 off the mortgage how much interest would you save? How does that compare with £804/year inflation linked for life, currently tax free?

Are the death benefits affected by whether she chooses the lump sum or not?

As the money isnt needed now is there the option to take a higher pension later? This can be advantageous.

jamesd

If she'd go with paying down the mortgage she should forget about the lump sum, take the higher income and use that. It's horribly inefficient to take a higher final salary pension lump sum for that purpose because the amount lost from the pension income is far more costly than the mortgage interest.

If she was to invest the money that has better prospects than the mortgage because the lump sum is equivalent to about 4% plus inflation, while the UK stock market has has historically returned around 5% plus inflation. However, the pension is guaranteed and has the added value of spousal and children's benefits, so it still looks like the better deal.

Take the higher income. If there's a desire to pay money off the mortgage, start to use 0% for purchase credit cards for all possible spending and use the money that would otherwise have been spent to pay money off the mortgage. Get a new card a few months before the end of the deal and repeat to use the money to clear the first card. Repeat until the mortgage is gone and then pay off the cards.

atush

Take the higher income and split between new pension contribs (ie she can put in 2880 per year which is grossed up to 3600 by TR) and the rest in a S&S isa.

kidmugsy

frogeyesimon wrote: »

She doen't really need the income at the moment (she's a non-earner anyway)

Take the higher income: people sometimes argue the other way because the lump sum is tax-free, but if your wife is a non-earner the pension is tax-free too.

While you've got her pondering this topic, get her to get the official estimate of the State Retirement Pension that she could look forward to. Then get her to do it again after the pension reforms going through parliament become law. The first will give her some context for her present decision; the second will let her judge whether it'll be worth buying extra years of SRP.

OurKev

The Comparison between the Lump Sum of £20000 and reduced pension of £800 linked to inflation is not so straightforward....


Let's say she gets a Santander 123 Account and runs it in a way to ensure that she get 3% interest on the £20000 (less £2 per month charges).


Assuming the money is not spent...


After one Year she will have an extra £20576 in the bank if she's taken the lump sum, or just over £800 if she takes the higher pension. So the pension would only be worth say £240 more than the interest


There will be complexities comparing best bank interest rates v inflation, but it would take an awful long time for the higher pension to catch up with the lump sum.


The "risk" of either choice is the unknown future rates of both inflation and interest (and relationships between the 2).


My own decision:-


In a similar position, I took a lump sum because I wanted to have a significant amount of money available "just in case" I or my family had an unexpected need. I haven't dipped into it so far, but it has given me comfort knowing that is it there (and also should something happen to me, there is a good chunk of money to pass on to my children).


No doubt other people would see a secure and growing pension as a better bet in their own circumstances.


Kev

Linton

OurKev wrote: »

The Comparison between the Lump Sum of £20000 and reduced pension of £800 linked to inflation is not so straightforward....


Let's say she gets a Santander 123 Account and runs it in a way to ensure that she get 3% interest on the £20000 (less £2 per month charges).


Assuming the money is not spent...


After one Year she will have an extra £20576 in the bank if she's taken the lump sum, or just over £800 if she takes the higher pension. So the pension would only be worth say £240 more than the interest


There will be complexities comparing best bank interest rates v inflation, but it would take an awful long time for the higher pension to catch up with the lump sum.

........

I have done the calculations assuming £20576 increasing at 3% annually against a pot starting at 0, with input of £804 increasing by 2.5% inflation annually and the whole pot increasing by 3% annually.

The £804 income pot exceeds the lump sum after 28 years when the OP is 78. Her expected age at death is 91. By that age her £804 pot is 45% higher than the lump sum pot.

atush

Our Kev, we are assuming that anyone near retirement has (well they should have) and emergency pot for 'what if'.


So unless you are penniless in that respect, the full pension is preferable. Won't take very long to build up a 'what if' in t he above case where the income is not needed at present.

frogeyesimon

Thanks to everyone for their replies. As I expected it's not a simple decision to take. I suspect that it may be better to go for the higher pension. But of course she's only 50 and it's not beyond the bounds of possibility that she will become an earner at some time in the future, so it would be likely that the pension income would become taxable for a period of time.

We have looked at the Santander account as a example of what could be done, but of course for how long will this deal be available. The cynic in me guesses that once they have captured as many account switchers as they can they will start to reduce the benefits on offer.

As an aside, would anyone know whether, as a non-earning 50 year old, would there be any NI payable on the pension income?

OurKev

Linton wrote: »

I have done the calculations assuming £20576 increasing at 3% annually against a pot starting at 0, with input of £804 increasing by 2.5% inflation annually and the whole pot increasing by 3% annually.

The £804 income pot exceeds the lump sum after 28 years when the OP is 78. Her expected age at death is 91. By that age her £804 pot is 45% higher than the lump sum pot.

In my case the "break even" point was around that age too.


I was happy with that, but wouldn't dispute that many (the majority?) would take the longer term view.


As I said, what swung things for me was the feeling the lump sum gave me of being more "in control" of my medium term finances.


Kev

OurKev

atush wrote: »

Our Kev, we are assuming that anyone near retirement has (well they should have) and emergency pot for 'what if'.


So unless you are penniless in that respect, the full pension is preferable. Won't take very long to build up a 'what if' in t he above case where the income is not needed at present.

We all have different needs and wants. For me there's the "Emergency Fund" and the "Help People Out/Buy Something We Want?" funds...


I considered myself to be in a very fortunate position to have the choice.


Perhaps when I'm 78 I'll look back and wish I'd chosen otherwise, but maybe I'll be glad I had the flexibility when I could benefit my family?