Proportionality

edited 30 November -1 at 1:00AM in Pensions, Annuities & Retirement Planning
3 replies 695 views
BazzerPontefractBazzerPontefract Forumite
20 Posts
Funny thing, I've just been reviewing the company pension proposal I received at the time just before I started drawing the pension.
I was offered, and took, the 25% tax free allowance, but what I did not notice at the time was that the pension was reduced by much more than 25% as a consequence of taking the tax free allowance.
Given the way annuities work, and with hindsight, I would have thought that a strict proportionality might apply.
Can anyone explain why this might have been?
Thanks.

Replies

  • ScottyLPScottyLP Forumite
    87 Posts
    Different fund values have different rates applied to them, and by taking the TFC you may have crossed into less favourable rates. For example, fund values bewteen £80K and £100K may rates of x applied to them, and funds of £60K to £79.9K may have rates of y applied to them, and x could be bettter than y.
  • greenglidegreenglide Forumite
    3.3K Posts
    Part of the Furniture Combo Breaker Hung up my suit!
    ✭✭✭✭
    Is it a Final Salary (DB) scheme?

    If so the amount of monthly pension you received will be reduced by an amount stated in the plan rules. This can be hideously expensive.

    If it is a personal pension, stakeholder or other defined contribution (DC), money purchase scheme with a defined "pot" the the 25% comes out of there and the rest can (but generally doesn't have to) be used to purchase an retirement product. Generally the price of this (it may be an annuity) will be roughly tied to the amount of money available.
  • Greenglide is right - it's not so simple for DB schemes. This is because it is 25% of the value of your benefits, which is determined according to a standard HMRC valuation factor of 20 x your pension, whilst the actual rate at which you can commute pension to provide lump sum is determined according to scheme actuarial factors. This mismatch means that usually you won't see a 25% reduction in your pension.

    Easiest way to check that it's been done correctly is to multiply your pension by 20 and then add on your lump sum. Divide that figure by 4. If that figure gives you back your lump sum figure, then you can see that the lump sum is indeed 25% of the value of your benefits - it must just mean that your commutation factor is quite low (so the cost of purchasing your lump sum is quite high).
    I am a Technical Analyst at a third-party pension administration company. My job is to interpret rules and legislation and provide technical guidance, but I am not a lawyer or a qualified advisor of any kind and anything I say on these boards is my opinion only.
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