Early Pension Quotation Queries

Balderdosh

Hello. This my first MSE forum post.


I hope someone can help me with a couple of queries I have, as follows:


I recently obtained an early retirement quotation (at age 55) from a deferred Final Salary DB scheme, which includes AVC funds currently valued at £20624.


Option 1:
No Tax Free Lump Sum
Pension from scheme £11258pa
Pension from AVCs £724pa
Option 2:
Tax Free Lump Sum from scheme £40680
Tax Free Lump Sum from AVCs £20624
Pension from scheme £9203

It would appear I can take 100% of my AVC fund as a TFLS. Can someone please explain this, as I thought the maximum was 25%?


The reduced pension after taking a TFLS appears to represent a commutation factor of 18.3. Is this a fair figure?


The quotation also included the option to use my AVCs to purchase an annuity on the open market, but Drawdown was not mentioned.
The scheme presumably does not offer drawdown, but am I correct in thinking that I can do drawdown if I chose the open market?


Many thanks.

jamesd

It is possible for schemes to have a protected ability to offer more than the current 25% if they previously offered more. I don't think that you are getting more than 25% of the total value of the defined benefit and AVCs combined. That combined value is what is used for working out what it is 25% of.

It's likely to be possible to transfer the AVCs to a personal pension that will allow you all options but it is also likely to be a bad idea to take that choice when you can instead take it as a tax free lump sum, pay it into a new pension and get tax relief on the way into that new pension. Subject to the limits on recycling of pension lump sums.

It is usually a bad idea to reduce the scheme pension so what you really should ask about is how much scheme pension you can get if you take none of the scheme part as a lump sum.

The AVCs appear to be used to buy an income of 3.51% of the value of the AVCs in choice one. Possibly increasing with inflation, possibly not. Knowing whether it is inflation-linked is important to working out whether it is good or bad value. If it is inflation-linked then it is probably better than any comparable open market option annuity you could get unless you have reduced life expectancy due to ill health. However, it will not increase your income as much in the years before you reach state pension age if you take it as income and you may have that need to cause you to want to take the AVC as a lump sum.

In Option 2 the pension from the scheme appears to be using a commutation rate of 19.8 to 1. That is moderately good if it was at 60 or 65 but it's that way because you're asking about only 55 so the scheme has five or ten fewer years to pay out. It's comparable to getting about 5% income from investments, increasing with inflation. That target is probably too high so you should not consider taking the scheme part of the lump sum unless you badly need an income boost from now until state pension age or you have reduced life expectancy or some other good and pressing reason to need a lump sum.

Barring ill health or similar considerations it looks best to take the maximum income from the scheme part. What to do with the AVC part depends mainly on whether it is inflation-linked, to which inflation measure (CPI, RPI or other) and whether it has a cap on that (5% cap is common), and on such things as your potential need for capital or higher income until state pension age.

Do you have any other financial assets at all that could allow you to not take the pension at 55, living on other resources for a while instead? Financial assets means anything from a home through valuables to savings and investments.

Do you know how your pension (both parts) is reduced for being taken early? Usually it's best to try to use other resources to wait until normal retirement age for the scheme, or until as close as practical.

AlanP_2

JamesD has a lot more experience than I have of answering queries on here but it occurred to me when I read the original post that they are offering to let you take the majority of the 25% you can take as a TFLS out of the AVC pot as opposed to sacrificing annual pension income for it.

This is an option (or at least was for AVC plans around before April 2014) in the LGPS scheme,

Taking your numbers:

TFLS = £66,704

@ 25% that would indicate that your overall pot (DB + AVC) is worth £266,816.

Again with the LGPS as an example, taking the TFLS out of the AVC pot leaves you with a higher annual salary from a scheme where the payout is likely to be index linked in some way - thus working out as the preferable option in many cases.

Balderdosh

Thank you both very much for your comments.
I presume a TFLS limit of 25% of the AVC fund only applies if it's treated separately on the open market.
Can you please further explain why it is usually a bad idea to reduce the scheme pension?
I was under the impression it was usual for the full TFLS to be taken, regardless of need, or is that an outdated viewpoint?
I will certainly ask the scheme if a there is a further option to take a TFLS from AVCs only.
The scheme and the AVC pension would be index-linked to RPI and capped to 5%.
The scheme has not quoted the early retirement factor applied, but based on my own recent estimates of future value using scheme revaluation statements, I reckon its about 7%pa, which seems high to me.
When I left the scheme in 2001 they quoted 4%pa.
The normal retirement age for this scheme is 60.

Luckily I have sufficient savings & investments to fund my usual living expenses until two deferred DB company pensions pay up at age 60.
Plus I also have a further DC pension payable at age 65.
So, I don't need to take a pension early.
Essentially, I'm trying to ascertain whether I may as well take the dosh sooner rather than later, if the breakeven point is much later in life.
Using estimates of inflation (2.5%), reinvestment returns (real 4%), income tax and allowances, I reckon my breakeven point is beyond age 75.
I have no spouse or dependents; no mortgage or other debts and my health is good (I think!).
I've read other threads where opinion appears to be somewhat divided on taking DB benefits early, albeit any decision is highly dependent on personal circumstances,
attitude to risk, investment experience, etc.
In my case, I am willing and able to take the funds & income early and managing/investing accordingly.
However, since I no longer work, are there any tax advantages to be gained?

My main motivations for considering taking the pension(s) early are:
a) access to the lump sums early to reinvest;
b) reducing my long-term income tax by utilising 5 years-worth of personal allowance
and reducing the effective rate of tax on the pensions in payment.

Once again, thank you for your comments so far, and any further comments you or anyone may have.


Balderdosh

kidmugsy

Balderdosh wrote: »

Can you please further explain why it is usually a bad idea to reduce the scheme pension?
I was under the impression it was usual for the full TFLS to be taken, regardless of need

It probably is usual but often it will be a triumph of wrongheadedness because the scheme can be viewed as a good-value index-linked investment. The best reasons for taking the lump sum include (i) you think the scheme's finances are shaky so you'd like to withdraw as much as possible, but aren't so confident of that shakiness that you'd risk transferring out. (ii) You think a large part of the pension's value doesn't apply to you e.g. no widow, and you're in poor health, or whatever. (iii) You've got a better investment to make with the money.

Balderdosh wrote: »

Luckily I have sufficient savings & investments to fund my usual living expenses until two deferred DB company pensions pay up at age 60.

Plus I also have a further DC pension payable at age 65.
So, I don't need to take a pension early.

So why not use the DC pension first?

Balderdosh wrote: »

I reckon my breakeven point is beyond age 75.

That's no age at all nowadays.

Balderdosh wrote: »

My main motivations for considering taking the pension(s) early are:
a) access to the lump sums early to reinvest;
b) reducing my long-term income tax by utilising 5 years-worth of personal allowance
and reducing the effective rate of tax on the pensions in payment.

(a) What makes you think you can make better returns than the scheme offers you for the same level of risk?
(b) Good move, but why not start with the DC pension?

jamesd

Balderdosh wrote: »

Can you please further explain why it is usually a bad idea to reduce the scheme pension?
I was under the impression it was usual for the full TFLS to be taken, regardless of need, or is that an outdated viewpoint?

It is usual. For defined contribution pensions it is usually the correct approach. For defined benefit pensions it is usually the wrong approach.

Taking the lump sum from the scheme portion requires investment returns of 5% plus inflation to match it, ignoring spousal pension and death benefit value. That's achievable but since it's roughly the total return of the FTSE UK index it's not really a great move to try it when you can guarantee that instead just by leaving it where it is.

Taking the AVC part as income gets 3.5% plus inflation. That's an easier target to beat with investments.

Most people take the maximum lump sum just because they can't resist taking it for some reason. Foolish things like paying off a mortgage (expected return below just taking the income and using it to pay the mortgage...).

jamesd

Balderdosh wrote: »

Luckily I have sufficient savings & investments to fund my usual living expenses until two deferred DB company pensions pay up at age 60.

It's worth checking commutation rates for those two in case one or both offers a better commutation rate.

Balderdosh wrote: »

Plus I also have a further DC pension payable at age 65.

What does your total income look like once the state payment is being paid? Are you close to 40% or over it? Or just basic rate?

The tax treatment of the income long term can help the returns outside the pension since I assume you'd put the money in a S&S ISA. But even so for the scheme part it doesn't look much like a good trade to give up the certainty. Unless you have a history of doing significantly better than the FTSE All Share Index in your own investing?

Balderdosh wrote: »

Using estimates of inflation (2.5%), reinvestment returns (real 4%), income tax and allowances, I reckon my breakeven point is beyond age 75.

Life expectancy would be around 85 or so give your current age, at normal good health. Of course that's just average and many will live a good deal longer.

Balderdosh wrote: »

I've read other threads where opinion appears to be somewhat divided on taking DB benefits early, albeit any decision is highly dependent on personal circumstances,
attitude to risk, investment experience, etc.

You're ahead of the game by considering investing instead of spending. But do you really have good reason to have high confidence that you can beat 3.5% plus inflation? How about 5% plus inflation?

Balderdosh wrote: »

In my case, I am willing and able to take the funds & income early and managing/investing accordingly.

There are things to do that could beat leaving the money. the opportunities are probably time-limited but taxable 10% plus is available from some peer to peer investing at the moment. If you're keen on things like that, taking the AVC as the lump sum and not the scheme part of the lump sum could be a good trade.

Balderdosh

Thank you both for the additional analysis.


I hadn't considered taking the DC pension first because its NRA is 65, I'm still making contributions to it, unlike the other schemes, and the fund at £33k is much smaller than the DB values.


I expect to be a standard rate taxpayer even if I take pensions at their NRDs.


My investments include S&S ISAs, funds and equities trading. In the medium to long term I outperform the FTSE but I acknowledge the point that I am taking all the risk.


I certainly hope to live well beyond age 75 but by then I expect to have slowed down a lot and could make better use of additional money earlier in life.


I need to absorb and consider all the excellent feedback received. Before I first posted, my inclination was to take at least one of my DB pensions early. Now I'm not so sure.


It may well be that I should leave them for now unless my financial circumstances change for the worse. In which case, then look to the DC scheme first.


Thank you all.


PS. Sorry I didn't use the quote feature when responding to specific points. I need to practice posting.


Balderdosh.

kidmugsy

Balderdosh wrote: »

I hadn't considered taking the DC pension first because its NRA is 65, I'm still making contributions to it, unlike the other schemes, and the fund at £33k is much smaller than the DB values.

Assuming that you don't have an employer contributing to the DC pension, and assuming that there is no guarantee that it would be folly to give up (such as a guaranteed annuity rate at age 65), it must be tempting to start with it. You can get 25% tax-free at 55, and then (if you want) start drawing income from the reminder under "capped drawdown". Then on 6/5/15 the "cap" vanishes and you can withdraw as fast as you like.

My guess is that you might save on charges if you took only the 25% before 6/4/15, or even took nothing before then, but that won't be clear until the providers publish their charges for the new world of flexible pensions.

If your provider doesn't allow capped drawdown or flexible drawdown, transfer to one that does.

Meantime I suggest you work out which of your DB pensions is cheapest to start early (if that's what you want to do) i.e. which applies the smallest actuarial reduction. You could also calculate which is the best value for trading off pension vs lump sum. In your shoes, waiting for State Retirement Pension, I'd certainly consider taking my AVC as a tax-free lump. I'd also look at making pension contributions for a while so that I could use flexible drawdown again as a tax-efficient stunt when the present DC pot had been emptied.

jamesd

The DC pot has a huge advantage for being taken early compared to the others: no reduction. You just get exactly what it's worth. Then your plan to invest it means it'll presumably do about as well as leaving it where it is, or better or worse depending on your investment ability and the chance that comes with investing.

It isn't always possible to transfer out of an ongoing DC scheme, you'd need to check. Workarounds like leaving, transferring, and then rejoining are possible, though.

I agree with kidmugsy about the DB ones - one of them will have less bad early terms than the others and that's the one to start with, if you really want to do it.

Balderdosh

Thanks once again to all who have posted comments & advice.


Much food for thought.


PS. I hope this dialogue also proves useful to others in similar situations.


Balderdosh