Early retirement - pension reduction

wagnerite

Hi everyone.

I'm new around here, so pardon my financial illiteracy (which is of a fairly high degree!).

I'm hoping to retire at 55, in a couple of years. I've got an NHS pension which I can take at that age, and I understand about "actuarial reduction" which will reduce it to about 2/3 of the value it would have if I keep working till I'm 65.

However, I also have three small private pensions with a major provider which have been running since 1987, and which I'd also like to access when I'm 55. Two of them were single-contribution pensions - transfers in from other work-related pensions - and they seem to be ticking over quite nicely. The third is an AVC which I'm due to keep paying in to till I'm 65. As I say, I'm actually hoping I can access all of these when I'm 55.

My problem is, I assume my private pensions will also have an "actuarial reduction" attached, or something analogous, but I can't seem to find even a rough estimate of how much the reduction will be. Will I get 20% of the currently estimated pension? Or 33%? Or 50%? I'm only looking for rough numbers at the moment - can anyone help?

jamesd

I'm assuming that the private pensions are defined contribution types, where there's a range of investments within them that you could change if you wanted to. That's what they normally are.

The value is normally the current value of the investments, so there's no reduction in that if you take a lump sum at age 55. If you wanted to buy an annuity with them you would get less income for your money at a younger age than at an older age. That's effectively the same sort of thing as an actuarial reduction. You don't need to buy an annuity, you could instead leave the money invested and take an income from it.

However, before deciding what to do with these pensions, it's good to know more about them. For pensions of that age it is quite likely that they have something called a guaranteed annuity rate as part of the product. That guarantees to pay an annuity at a certain age that is typically now several times what the open market for annuities would produce. Taking money out of such a pension could cost substantial future income if there is a GAR.

It was also not uncommon for investments in pensions of that sort of age to use with profits funds as the investment. Those can have a reduced value if taken out, called a market value reduction, but it's unlikely to be substantial at the moment.

Ignoring the possibility of a GAR what I'd generally want to suggest is taking a lump sum and income from the private pensions to delay taking the NHS pension for as long as possible. That's because the actuarial reduction gets lower the longer you wait and it's usually a much better deal to reduce that as far as possible than to keep the private pension money for longer. Simply,. the longer you delay taking it, the more you'll get from the NHS pension.

The effect of an actuarial reduction is also sufficiently large that it can pay to do things like extending or taking out a mortgage to borrow money to live on for a while until you can take the pension with a lower reduction. Or if not that, something as straightforward as getting a 0% for purchases credit card and using the money for that to live on for a while can be helpful.

Bad ideas include things like using savings or income to overpay on a mortgage leaving you with reduced savings that cause you to have to take the pension with a larger actuarial reduction than you could have done otherwise.

There is a change probably coming in April 2015 that is expected to allow people to take all or any part of the money out of a personal pension (meaning private) at once, with the 75% that isn't the tax free lump sum being added to normal taxable income. This feature may make it possible to draw on the assumed personal pensions rapidly to provide money to live on while you delay the NHS pension for as long as possible.

I've also assumed that the NHS pension won't make you a higher rate tax payer, not even when the state pension is added to it. A transition to higher rate tax for some of the income can sometimes change the best choices.

The key next step for you is to find out more about the features of those private pensions.

wagnerite

Thanks, jamesd, for that extremely helpful and detailed answer.

Just to expand a bit on my circumstances - I'm mortgage-free and have no dependents. I want to take early retirement because I want to concentrate on things I'm currently doing that aren't earning me any money, such as (voluntary) working in the arts sector.

I don't need a lot to live on - I calculate about £13k a year at today's prices should be enough to maintain my current lifestyle. My work pensions, plus my personal pensions, plus my current savings, should easily see me through from 55 to state pension age at 67 or 68, at which time the state pension plus my pensions should be more than enough.

I've had a look at the original pension documents, which in the late 80s were with Refuge Assurance. The two single-contribution pensions are a "with profits pension transfer/protected rights" with a guaranteed pension rate per £100 of £5.64, and a "with profits pension transfer/non-protected rights" with a guaranteed pension rate per £100 of £8.61. The third is a "with profits free standing avc" with a guaranteed pension rate per £100 of £8.61 - I've been paying the princely sum of £50 a month into this since 1987.

Obviously, all of these were originally intended to run till I'm 65. I've also no idea whether the original terms and conditions survived Refuge's changes of ownership over the years.

I'm pretty sure my sums add up, but the most uncertain term in the equation is the value of these personal pensions.

kidmugsy

wagnerite wrote: »

The two single-contribution pensions are a "with profits pension transfer/protected rights" with a guaranteed pension rate per £100 of £5.64, and a "with profits pension transfer/non-protected rights" with a guaranteed pension rate per £100 of £8.61.

The third is a "with profits free standing avc" with a guaranteed pension rate per £100 of £8.61 - I've been paying the princely sum of £50 a month into this since 1987.

Obviously, all of these were originally intended to run till I'm 65. .

That guaranteed annuity rate of 8.61%p.a. is pretty attractive nowadays: you'd need a pretty good reason to give it up. But maybe you have one: as jamesd said, allowing yourself to delay taking the NHS pension might be one such reason.

The other things to check with With Profits are (i) Might you be sacrificing a terminal bonus? (ii) Would you have to pay a Market Value Reduction/Adjustment? If there were no MVR/MVA when you reached 55, it might be tempting to cash them in just in case there is one later on. In that case, you'd want to find out how long they'll hold to a promise of no MVR: e.g. if you instruct "crystallisation" on a day when there is no MVR, do they promise to honour that irrespective of how long the paperwork takes?

jamesd

As kidmugsy wrote, the guaranteed annuity rate is impressively high. The current market rate is more likely to be around 3% for an inflation-linked annuity or around 6% for level. I don't know which that 8.61% is but it might well be the more valuable inflation-linked type. The GAR will have a limited range of ages when you can take it so you should find out what that is for each of them.

Given the use of a with profits investment, kidmugsy is right that there could be a significant terminal bonus. In such a case the current value is likely to be lower than the true value.

Much of the value of those pensions is now in the GAR and possibly a terminal bonus.

What happened is that back when you took these out the annuity rates and growth expectations were higher, so guarantees were made that turn out to be expensive today when life expectancies have increased and investment returns and inflation are lower.

The actuarial reduction of the NHS pension is still probably more valuable than the GAR so if you must choose it would still be better to delay the NHS pension by spending the other money.

The AVC is probably the best target for taking a lump sum, perhaps all of it gradually over time so you can delay the NHS pension for as long as possible.

If you care to say more about your asset values it'd be possible to give some idea of what sort of income might be sustainable and for how long. A very rough rule of thumb if the money is invested is 4% for life or more if you can drain capital, depending on how long you need to drain it for - the target then is to work out the highest safe income that can be taken given how long the money has to last.

chucknorris

Part of me thinks that I should retire next year (at 57), from a financial point of view I certainly should, for some reason I am quite reluctant. I am just wondering if others who retired early can identify with that feeling? It is hard to explain, because when you look at it logically, it seems crazy to want to carry on working when you don't have to. I may go for something in between and try to drop down to a 40% fractional position (from 80%).

brewerdave

@chucknorris - if you are employed in a job which you enjoy -carry on working!

I was fortunate to be employed for 33 years in such an industry -when I suffered a 2nd redundancy at 56 I was forced into a job that I didn't enjoy -that came to an end after two years and I quickly realised that job satisfaction was paramount and took early retirement -much less money -but also much less unhappiness and stress!!

wagnerite

Thanks again, everyone. Obviously this is all more complicated than I thought. I contacted Royal London last year for a pension forecast, and they provided estimates for an assumed retirement age of 65. However, the person I dealt with said they couldn't give me an estimate for early retirement.

What do I need to be looking at, either in the estimates I got, or in my annual pension statement, to give me a clue as to what these things might be worth in two and a bit years when I'm 55? That retirement date, as far as I'm concerned, is the one non-negotiable point in this whole thing!

kidmugsy

wagnerite wrote: »

What do I need to be looking at, either in the estimates I got, or in my annual pension statement, to give me a clue as to what these things might be worth in two and a bit years when I'm 55?

I can suggest two things. First, see if they will allow you to change your retirement age without penalty, and how much notice they'll want. (My wife has a With Profits pension that allows a change of retirement date as long as they get many months notice.)

Secondly, find out if they will let you transfer free of charge to a non-With Profits pension, either with themselves or some other provider. Because then you could invest in cash so that there's no risk of it losing value (except against inflation) before you crystallise it.

wagnerite

Armed with some of the very perceptive points people have made here, I've now contacted my pensions provider, asked a few questions, and they're going to send me some forecasts. If I take the pensions at 55, I will lose the GAR, but they're going to give me forecasts for level-rate and inflation-linked annuities.

Chucknorris - retirement is a bit scary. I've no particular problem with the job I'm in, but there are other things I want to do more. The problem is, they don't have any money attached to them.

chucknorris

wagnerite wrote: »

Chucknorris - retirement is a bit scary. I've no particular problem with the job I'm in, but there are other things I want to do more. The problem is, they don't have any money attached to them.

Well to be honest we have got the money completely wrong, but at least the right way, I just can't see how we could spend it all. My dilemma is that I quite like my job and would like to continue but the money I earn from now (and also going back a little way) will end up going to our fav charities (not that that is a bad thing of course).