When is it worth taking DB early - Actuarial Reduction)

mark55man

I am just reviewing my pension spreadsheets against the new rules (only 50 now). I believe they will allow me to smooth my income before my and my OH DB's kick in, and allow us to retire 3-4 years earlier than I could have afforded to using current drawdown regime. I would also gain a smoother income balance between before and after retirement day albeit at a lower (but reasonable) average income from retirement day onwards.

One thing I have noticed is that if I wait until Scheme retirement age (65) and assuming current rate of fiscal drag will continue so that Higher Rate tax bound increases slower than Inflation then I will quite quickly have to pay HR tax on some of my DB+State and all of any DC income

In these circumastances, and to help reduce the rapid reduction in my DC pot from retiring ahead of scheme retirement age what are the pros and cons of taking my DB 2-3 years early at the cost of some actuarial reduction to keep the DB + State total under HR tax band. 5% reduction p.a. would be applied - so I can work the numbers which given neither OH or I come from long lived families I am comfortable with

My concerns are more about robustness of arrangements - eg maintaining some DC buffer may be wise in case I shuffle off this mortal coil earlier as my OH would then have my DC funds/pension income of mine transferred to her in full rather than just the half DB pension

What are people's experiences and decisions in this area?

(For clarity 1 - my OH has some DB provision about £10K a year so comfortable if a bit tight - but about 1/3 of the way into the BR tax band.)

(For clarity 2 - owing to earlier recklessness and having 4 kids our ISA savings are insignificant for retirement planning and are mainly for emergency planning)

kidmugsy

i) I suggest you do the calculations on taking DB early while therefore allowing you to do phased drawdown of DC. That way if you pop your clogs early your wife will get 100% of the uncrystallised DC money tax-free.

ii) Anyway, if the terms for drawing the DB early were genuinely actuarially neutral, it shouldn't matter whether you take some early - indeed, your knowledge that you are both from short-lived families may stack the gamble in your favour, unless the general effect is allowed for in the actuaries' calculations.

ii) Long shot - check whether your DB scheme allows "allocation" whereby you surrender some of your pension so that your widow eventually gets a bigger widow's pension from the scheme. It sounds as if that could be tax effective for you both.

mark55man

Thanks kidmugsy

To answer your ii) I believe that 5% is quite standard but is suboptimal for early leavers (in purely cash / actuarial terms) because the trustees mandate is to protect the full termers and therefore any concession will be cautious in their favour (and to my detriment).

However if by doing so I can accrue benefits elsewhere such as robustness, flexibility or peace of mind for OH then I may do so - I certainly would like to retire AEAP (I enjoy my job and I'm good at it, but enough's enough!!).

If I have gathered one thing from this forum through is that there is always another way of looking at things - possibly involving other investment types or other lifestyle choice, or simply something obvious I haven't considered


in terms of iii) - I will check - that might help a lot!!

atush

Did your non long lived families engage in LE risky behaviour such as smoking, drinking and eating poorly?

My parents died youngish (57-68) but they both smoked like chimneys

Triumph13

I think the only things that you can do are (i) run the numbers through a spreadsheet; and (ii) discuss them with your OH.

The correct answer will depend on a huge number of factors, not just the size of the various DC and DB pots. You basically need to model the income with both living to a ripe age and with either of you dieing early for each combination of retirement date and DB commencement date to see what the survivor would be left with after losing the other person's state pension and half their DB. That only gives half the picture though. What would happen to the survivor's spending patterns? Would they downsize to a smaller house? Run less cars? Would you have to spend more on household maintenance without your wife's DIY skills? Would she spend more on ready meals without your culinary expertise?

It needs a whole lot of thought, but the goal is probably to first ensure a reasonable situation for either survivor and then to weigh up trade offs between what's better if you both live and what's better if one or the other dies.

And as atush alludes, just because your family haven't been long lived, doesn't mean you won't be. Not only are there lifestyle issues, but medicine is making huge strides all the time - viz the fact that the drug that keeps me alive was only discovered about 7 years before I needed it.

PenActuary

Hi I have been a scheme actuary for a number of years. The early retirement factors are usually derived on a best estimate assumption in order that they are generally cost neutral, although they are only usually reviewed every 3 years so can drift away from cost neutral as market conditions change. 5% seems a bit penal.

Another option, which isn't obviously for everyone, is to consider a transfer from the DB scheme. Transfer values can have a bad name and obviously carry more risk but for those close to retirement they usually offer good value because of how they are calculated, but it will obviously depend from scheme to scheme. Given the new freedoms in the DC world, generating an income with any TV can now be very flexible and you can easily design an income which incorporates the state benefits in later life when these kick in for you.

If you are worried about higher rate tax on your pension when state benefits kick in (nice worry to have) you could draw down more early on to allow you to retire now and less when the state pension kicks in to stay underneath this threshold or retain more pot to pass on when you die.

The other benefit of course is if you were to die early before your wife could use the whole of the remaining pot, which would still be large at that point.

jem16

PenActuary wrote: »

Hi I have been a scheme actuary for a number of years. The early retirement factors are usually derived on a best estimate assumption in order that they are generally cost neutral, although they are only usually reviewed every 3 years so can drift away from cost neutral as market conditions change. 5% seems a bit penal.

5% is certainly normal for Public Sector pensions.

Another option, which isn't obviously for everyone, is to consider a transfer from the DB scheme. Transfer values can have a bad name and obviously carry more risk but for those close to retirement they usually offer good value because of how they are calculated, but it will obviously depend from scheme to scheme.

A DB to DC transfer would have to be signed off by an IFA and you would be hard pushed to find an IFA willing to do such a transfer as 99/100 it is the wrong thing to do.

Could you explain more about the calculations closer to retirement that would make this a good thing to consider?

Given the new freedoms in the DC world, generating an income with any TV can now be very flexible and you can easily design an income which incorporates the state benefits in later life when these kick in for you.

There is already talk of banning Public Sector DB to DC transfers and I suspect the private sector would follow suit on this one but you never know.

PenActuary

Hi - 5% is quite penal on a cost neutral basis on current market conditions but it depends on the schemes benefit basis as well. That's only my view, I don't know what the factors are for public sector schemes but I've set plenty of private sector scheme factors before.

Transfers usually use a post and pre retirement discount rate split, the post retirement rate is usually linked to gilt yields so will be quite low. The pre retirement rate will usually be based on growth asset returns so quite high.

Therefore a TV right at retirement can offer very good value, whilst one at 25 years old is likely to offer far less value.

Plenty of IFAs will sign off a DB to DC transfer if its right for the individual and meets a yield test. In many cases it makes sense if you are for example single, or in poor health,smoke or prefer a higher flat rate pension or are comfortable in drawdown and want more flexible income design which you can now integrate with the state benefits.

Of course it doesn't make sense if the TV offers poor value, but as I say in many cases close to retirement that isn't the case.

The Government is banning transfers in the public sector because most schemes are unfunded (except the LGPS and some small others) and if many desired the new flexibility (which I am sure will be popular) in the DC world they would need to find a lot of money quickly to pay these TVs.

They are considering banning these in the private sector and are taking consultation. Personally and its only my opinion I don't think they will because

- In many cases it can be the right choice as I have highlighted above especially with the new flexibility of the DC world.
- Some people transfer because they don't believe the private sector employer will meet the promise and the scheme may end up in the PPF. Stopping people from transferring forces them to take this credit risk. If it goes wrong, I know who they will blame.
- It will boost the economy as many private sector employers will remove a lot of pension liability at an affordable price.

This is all only my opinion. I came here to read people opinions on all the new changes and noticed the original post so made a reply.

Teaandscones

What would be a fair actuarial reduction for someone who takes a pension at 60
compared with a NRA of 65? The LGPS has 25% which seems penal to me particularly as my mother's side of the family tend to go on and on and on.

sandsy

Have you considered a phased approach on the DC scheme?
By taking the maximum tax free cash over a period of years, chrystallising the DC pension gradually, and using it to invest in an ISA and for income during the bridging period, you can create a tax free income for the fiture o which will reduce your liability to higher rate tax and perhaps negate the need to take the DB scheme benefits early.

It will depend on the relative sizes of your DBand DC pensions though.

mark55man

Thanks all. Food for thought with some room for optimism.

Atush my parents were old to have me and served in ww2 and smoked!!

The more technical suggestions I will model eg creating tax free income.

Interesting debate on reduction rates if 5% is penal (ie disadvantageous relative to full termers) then I might try and minimise the number of years

Also interesting about late transfer but I think Ienjoy investing DC because I know I have dB to back it up

eDIT. I suppose as well if I am going to pay hrt eventually i may as well take enough to fill our isas early and then take income tax free later is pay 40 earlier on drawdown or save 40 later as isa income