Confused about AVCs vs. buying additional pension - help please!

Cardew

I found this thread searching for information on buying additional pension in the Teachers Pension Scheme(TPS) for a friend.


There seems to be enthusiasm in this thread for buying extra pension, but unless I have misunderstood something(perfectly possible - I am an engineer) it seems to me dreadful value.


I wonder if someone could check the following:


The teacher is 45 and 5 months and has a Normal Pension Age(NPA) of age 60. She wants to invest a lump sum of around £20,000 to buy additional pension. The details of costs are in this link:


https://www.teacherspensions.co.uk/members/resources/calculators/additional-pension.aspx


There is an 'additional pension calculator' to download.


Filling in the details to buy an additional £1,500 pa pension would cost a lump sum of £20,220 or paid over 14 years a total of £28,425.


This £1,500 is inflation linked to age 60 and of course after it can be drawn. However it doesn't attract a lump sum like a 'normal' pension.


I have made some calculations and at age 60(15 years) the £1,500 will be worth £1,741 if inflation was a constant 1%. £2,019 if 2% and £2,337 if 3%.


At age 60 when drawing the pension it will be taxed at 20% so the above sums are, £1,393: £1,615: £1,870 respectively.


Drawing that pension for a further 10 years, when she will be 70, the total amount of pension drawn, even assuming inflation had remained constant at 3% for 25 years(from age 45 to 70) would be £21,809. In these days it is unlikely that inflation would be as high as 3% for all those years, in which case the total pension drawn would be far less than the £20,220 lump sum.


£20,220 invested in a SIPP would have a starting value of £25,275 and you can do your own sums with expected returns.


Even £20275 invested in long term ISAs would give a far higher reward.


Please tell me my calculations above are nonsense, otherwise it seems to me that investing in additional years is a disaster.


In this thread people talk of buying 'extra years' in the TPS, I can't see where that is laid down - only extra pension - up to £6,200




P.S.
Come on Jem16 I am counting on you!

jem16

Cardew wrote: »

Filling in the details to buy an additional £1,500 pa pension would cost a lump sum of £20,220 or paid over 14 years a total of £28,425.


This £1,500 is inflation linked to age 60 and of course after it can be drawn. However it doesn't attract a lump sum like a 'normal' pension.

No but it does attract tax relief which you've forgotten to account for. That £20,220 will actually cost £16,176.

I have made some calculations and at age 60(15 years) the £1,500 will be worth £1,741 if inflation was a constant 1%. £2,019 if 2% and £2,337 if 3%.


At age 60 when drawing the pension it will be taxed at 20% so the above sums are, £1,393: £1,615: £1,870 respectively.


Drawing that pension for a further 10 years, when she will be 70, the total amount of pension drawn, even assuming inflation had remained constant at 3% for 25 years(from age 45 to 70) would be £21,809. In these days it is unlikely that inflation would be as high as 3% for all those years, in which case the total pension drawn would be far less than the £20,220 lump sum.

I'll leave you to work out the figures based on the £16,176 or using a higher amount of Additional Pension if she does want to use the £20k. Nearest is likely to be £1750 starting point costing £23,590 which with tax relief is £18,872.

In this thread people talk of buying 'extra years' in the TPS, I can't see where that is laid down - only extra pension - up to £6,200

Added years is no longer available since 2008. You could only use that if you had already started them before that date as I had.

They were much better value than Additional Pension.

P.S.
Come on Jem16 I am counting on you!

Hopefully the above will help.

The main point is that it is not cheap but is guaranteed unlike a PP/SIPP. Some prefer this and others will prefer to take their chances.

The other option is to use a PP/SIPP, take the accrued benefits at age 60 and leave the CARE benefits until state retirement age to avoid an actuarial reduction - need to check if you can do this first as it was mentioned as being possible. The PP/SIPP could be drawn down as needed.

Cardew

jem16 wrote: »

No but it does attract tax relief which you've forgotten to account for. That £20,220 will actually cost £16,176

.

I had looked at that aspect, but couldn't see where tax relief on the lump sum was mentioned.


That is why I put down the cost of the £1500 additional pension over 14 years was £28,425 over £8,000 more than a lump sum. I assumed the large difference was because paying it back by deduction each month would attract tax relief. Even with 20% tax reduction the £28,425 will still be £22,740 which is £2,520 more than the lump sum.


Could you please point me to where it states lump sums are tax deductible, and how do you reclaim the tax.

jem16

Cardew wrote: »

That is why I put down the cost of the £1500 additional pension over 14 years was £28,425 over £8,000 more than a lump sum. I assumed the large difference was because paying it pack by deduction each month would attract tax relief. Even with 20% tax reduction the £28,425 will still be £22,740 which is £2,520 more than the lump sum.

Tax relief when paying it through monthly contributions will receive tax relief at source. The £28,425 is the gross amount and it is dearer than a lump sum payment simply because you are paying it over 14 years as opposed to a lump sum investment. So just like any savings account the last monthly payment would attract less interest than the first payment. (It's not interest obviously but you get the gist).

With a lump sum payment there is no mechanism for a Defined Benefit scheme to add the tax relief so all lump sum payments are gross. To get the tax relief you must claim from HMRC.

Could you please point me to where it states lump sums are tax deductible, and how do you reclaim the tax.

From this application form;

Purchasing Additional pension - https://www.teacherspensions.co.uk/members/resources/forms.aspx

You will normally receive tax relief through the PAYE system if you pay by instalments. You will need to speak to your Inspector of
Taxes about tax relief if you make a lump sum payment.

hugheskevi

Try this comparison instead.

Take a man born on 16/08/69 (so aged 45 and 5 months). He has a Normal Pension age of 60, and buys £1,000 of Added Pension, without any dependent benefits. This costs him £12,520 (from the calculator).

Instead he could put that £12,520 into a personal pension. Using the Hargreaves Lansdown calculator and setting the assumptions such that he has a pot of £12,520 and no further contributions, at age 60 he could take an income (assuming no lump sum) of £527 [assuming 0.5% charges each year, 5% growth, no spouse payment, and 3% fixed indexation to try to replicate the Added Pension as closely as possible]

Of course, he might quite like a lump sum, or think that a 5% growth rate is rather cautious, in which case the personal pension becomes more favourable. If he didn't want to annuitise the expected value would increase further. So it wouldn't be surprising that if he wanted more pension he may choose a combination of Added Pension which is very good at providing income, and personal pension contributions which are very good at providing capital lump sums.

Cardew

The above two posts are extremely helpful, so thank you both very much.


The £1,000 additional pension for £12,500 example in the post above would cost less as HMRC would presumably have no reason to not allow tax relief??


I will show her both options and it is her decision. My choice would be the SIPP. Unless there is huge inflation over the next 25 years it seems to me that the additional pension is poor value and you would need to live to a ripe old age before it started to be advantageous.

jem16

Cardew wrote: »

The £1,000 additional pension for £12,500 example in the post above would cost less as HMRC would presumably have no reason to not allow tax relief??

Only reason would be if she had already used her annual allowance or she didn't earn enough. Can't see any problem with the info you gave on your other thread though.

I will show her both options and it is her decision. My choice would be the SIPP. Unless there is huge inflation over the next 25 years it seems to me that the additional pension is poor value and you would need to live to a ripe old age before it started to be advantageous.

Many people like the security that the Additional pension brings. However she has that plus another DB pension.

I would be thinking of the PP/SIPP if she wishes to retire before state pension age.

dunroving

zagubov wrote: »

<<snip>>The man from the Pru came round and we discussed ways of making up the shortfall by combining three past-added years additional payments to the Teachers Pension and enough AVCs to cover 1 and 1/2 years of pension. I only noted what the total outgoings were without paying attention to the breakdown of which part was which

<<snip>>.

jem16 wrote: »

Now that's the bit I find rather strange to be honest. A man from the Pru would only be there to sell you AVCs as that is his job. Why would he also encourage you to purchase added years as he would make nothing from that?


<<snip>>.

Just to say that Pru is the company associated with AVCs for USS employees also and when they make presentations they also present about buying additional years in USS.

I think it may be that in return for being the chosen AVC provider, they are expected to present employees with all their options.