take the tax free element or not....

balbs

I have a DB scheme worth £8.5K starting next year when I hit sixty - I was thinking of taking the tax free element, but as the pension increases by RPI each year Im beginning to think this is not a good idea - in addition if I defer taking the pension it is uplifted by 6% a year - call me naive but why would taking that 6% a year be any sort of deal compared to 'losing' that £8.5k income - Im sure I can get my head round both issues but where should my thinking start? I have another DB that kicks in at 65 for roughly the same amount plus about £120K in other pension savings.

Your_Hero

balbs wrote: »

I have a DB scheme worth £8.5K starting next year when I hit sixty - I was thinking of taking the tax free element, but as the pension increases by RPI each year Im beginning to think this is not a good idea - in addition if I defer taking the pension it is uplifted by 6% a year - call me naive but why would taking that 6% a year be any sort of deal compared to 'losing' that £8.5k income - Im sure I can get my head round both issues but where should my thinking start? I have another DB that kicks in at 65 for roughly the same amount plus about £120K in other pension savings.

What is the commutation factor? i.e. 12:1, 15:1 etc? Normally it's quite poor value to commute your pension, so if you don't need the lump sum don't take it and have a higher pension for life.

kidmugsy

balbs wrote: »

I have a DB scheme worth £8.5K starting next year when I hit sixty ....in addition if I defer taking the pension it is uplifted by 6% a year - ... why would taking that 6% a year be any sort of deal compared to 'losing' that £8.5k income

If your pension isn't index-linked you'd break even in roughly 17 years. Is your health poor? Are your family short-lived? If the answer to both is "no" then your life expectancy at 60 is 24 years or better, so on average someone in your position would end up in profit. But if the pension is index-linked - which being DB it will be - then you're likely to be in profit far quicker. I'd say that the pension scheme trustees must be cursing this rule, except that probably most retiring members are too dim to exploit it.

Two caveats: first, if you mean not that deferring adds 6% but instead that deferring it and continuing working and contributing adds 6%, then it's a bit less attractive, since presumably you actually want to stop working. Secondly, there's always tax: does taking it at 60 have any tax advantage for you?

balbs

Ive rolled the two very useful comments together for my reply...
Two caveats: first, if you mean not that deferring adds 6% but instead that deferring it and continuing working and contributing adds 6%, then it's a bit less attractive, since presumably you actually want to stop working. Secondly, there's always tax: does taking it at 60 have any tax advantage for you?
The pension is frozen from previous employment – if I defer each year 6% is added. No tax advantage as I will be still be working I hope in present employment.

What is the commutation factor? i.e. 12:1, 15:1 etc? Normally it's quite poor value to commute your pension, so if you don't need the lump sum don't take it and have a higher pension for life.

The calculation is 20x the DB figure, plus £26k of AVC and I can take 25% of that total as tax free if if that doesn’t exceed AVC

jamesd

I'm assuming that you are in normal good health in this reply.

If it's still possible the best deal is to pay more into the AVC then take all of the AVC as the lump sum and no more. This way you will get the tax relief on the way in but no tax on the way out.

It's unlikely to be a good deal to take money from the main pension, particularly when it's RPI linked. This depends to some extent on the commutation rate, the lump sum paid per Pound of annual income given up. Bad rates are 12:1 or worse. Good rates are 25:1 or better. Middling common sort of rates are in the 16-20:1 range. RPI linked income is worth more than any of these rates if you're in normal health.

If you can't use the AVCs the next best option is to take the income and use it to make more pension contributions to a personal or defined contribution work pension. You'll pay tax on the income but get tax relief of the same amount when paying in. When you take it you'll get 25% tax free, making at least the tax avoided on that as a gain.

The last paragraph also applies to some extent to any personal or defined contribution work pensions you have. You can take the lump sum and invest that in ISA investments and recycle the income into more pension contributions to get the tax relief and 25% tax free on the way out.

There is one particularly useful thing to know about the changes proposed for April 2015. People who have even £1,000 of less in income drawdown will be able to take the income allowed by the GAD cap for that pension and all other defined contribution and personal pensions without triggering a reduction in the annual contribution allowance from £40,000 to £10,000 a year. That gives a significant incentive for people to start drawdown on at least some money before the start of the next tax year. This is so useful for those who will want to pay in more than £10,000 that it is likely to be wroth even starting a new personal pension just to put it into drawdown. Only those aged 55 or over can do this.

Deferring is probably a bad idea. It's more likely to be good for women who live longer to get the higher amount for longer, those in the professions and south of the country. It's less likely to be good for men, those in Scotland or those in manual or outside work. All of those are based on general trends in life expectancy instead of knowledge of a specific person's health.

kidmugsy

"The pension is frozen from previous employment – if I defer each year 6% is added." To give you some context: the old-style State Retirement Pension allows deferral and pays 10.4% extra for every year. This is universally recognised as a wonderful offer for the pensioner and a dreadfully expensive one for the taxpayer: it's been particularly wonderful for those women who could take it at 60.

For the new-style State Pension the reward will be cut to 5.8% and will be paid, increasingly, to people who will be over 65, and then 66, and then.... So 6% at 60 is still pretty good. After all, you'll get your reward for six years more than somebody who could take it only at 66.

One more bit of context: if you could buy new issues of the much sought after Index-Linked Savings Certificates from ns&i, they'd pay you 0.05% p.a. above RPI inflation i.e. a tax-free 2.55% p.a., index-linked, for the next five years. Your 6%, taxed at 20%, therefore pays 4.8%, being currently 2.3% p.a. above inflation, for the rest of your life, even if you live to be 105. The price is that you give up for ever one or two years worth of £8.5k per annum.

In summary, it's an attractive low-risk investment, probably a good complement to whatever you invest your £120k in. You might even decide on a trade off: defer for two or three years, and "get back" the money you've given up by taking the full AVC as tax-free lump sum.

Two questions: first, if you were to ask for your £26k AVC to buy you more pension rather than take it as lump sum, how much would it buy you? Secondly, what would you plan to do with a bigger lump sum if you were to take it?

atush

If you can take your TFLS from the AVC, do it. If the AVC isn't 25% of the sum you could take, leave it as just the AVC amount.

Take no TFLS from the main pension- keep the maximum income.

If you are still working, and dont need the income after it can no longer be deferred for benefit, then do pay income into a DC pension. Will provide another TFLS. And money that can be used as and when you like, at a bare minimum if you dont need it, take some out each year and put into S&S isas for the longer term.

balbs

Thanks to all the posters who have given me much food for thought... I have one final query... I had read about the recycling pension money rules on the HMRC site and ended up more confused than ever - is there a more easy to understand paragraph lurking on the boards that explains this. Again many thanks.

jamesd

There are currently no rules regarding recycling of pension income. From 6 April 2015 there will be a drop from £40,000 a year to £10,000 a year in annual pension contribution limit to personal pensions if more than the 25% tax free lump sum is taken by a person who does not already have a personal pension product in capped drawdown. So putting one into drawdown in effect raises the limit that can be taken before getting cut to £10,000 and that increase applies to all pension pots whenever you pay the money in or take it out.

There are restrictions on recycling pension tax free lump sums into pension contributions. For this year one key rule is £12,500 minimum lump sum to be affected, from 6 April 2015 that will drop to £10,000. Even if more than those it's still possible that you would not be affected because the increase in pension contributions has to be both more than 30% of the lump sum take and not explainable by normal retirement planning.

There's some more discussion of the rules in Pension contributions and avoiding recycling.