Lump Sum from Police Final Salary Scheme - "Mad not to take it"

green_man

My wife will be retiring from the police next year and has had some quotes on pension levels and lump sum options. I had advised my wife that in our case we would probably be better taking zero lump sum. However we were out with some of her recently retired colleagues at the weekend, they had all taken the max lump sum and stated that the financial advice given (arranged by the police) stated that you would be mad not to take the max lump sum. So please advise if I have this so wrong in my analysis:

The facts:
Wife will be 50 on retirement in good health with no hereditary health issues.
Lump sum conversion rate is approx 20:1 so £100,000 lump sum means £5000 less pension per year.
Pension is index linked
Wife will be a Basic rate tax payer.
Wife has approx £70K savings
Mortgage will be already paid off.

Other info:
We have calculated we will need the higher rate of pension to support my wifes extravagant lifestyle So if we did take the lump sum it would have to provide income to fill the gap.

My wife is not good at being able to leave sums of money like this and I feel (so does she) that she would not be able to resist dipping into this pot if it were there.


So are her colleagues correct. Is it a no brainer to take the max lump sum available?

Marktheshark

Perfect example of why the country can not afford theses copper bottomed (pun) pensions.
Retire at 50 with £100,000 to spend and enough money to live off.

No way on earth has that amount of money been paid in.

kidmugsy

20:1 sounds pretty good, but you have to remember that at 50 she could be giving up the £5k p.a. for another 50 years. Index-linked, little risk, for 50 years. Try getting a quotation for an index-linked annuity at 50: websites will provide. Then marvel at how much less than 5% p.a. they would pay. She wouldn't get half that.

£100k sounds vast, but bung it into equities and after one market crash it could be £60k. Then she might panic, sell the shares, and decide she's a lousy investor, and "better just to spend it". Then it's all piddled away.

Or it is invested, it flourishes, then when she's 80 and her intellectual level has declined, someone will relieve her of the lot.

"Is it a no brainer to take the max lump sum available?" Only in the sense that people with no brain will seize the lump sum without giving it any serious thought. The case for taking the lump sum is strong, I suggest, only if (i) she has objective reason to expect a short lifespan, or (ii) the pair of you have some compelling purpose for the money. To take it just to invest seems imprudent: why not just leave it invested in the pension scheme? Where else could you find an investment with its desirable characteristics?

If half the secret of investing is "know thyself", then your account of her temperament cries out "take the extra pension".

atush

I think I could invet 100K to bring 5K per annum over decades, but not sure your wife can with her sticky fingers.

The friends are right in that this is a good communtation rate comared with others ie 20-1, but that 5K is indexed and would soon be 6K and so on. And it pays out s long as she lives.

As you/she have 70K i would think that a sufficient LS, depending on your pension, LS and other assets.

Linton

In my view it's not a complete no-brainer to take the cash. At first sight, to replace the pension lost you would need to invest in shares via funds to be able to provide an inflation matching return of 5% initially for perhaps 40 years assuming currently predicted average life expectancy, perhaps nearer 50 to be safe. This could not be guaranteed and may even be a bit ambitious if the income is always taken at a steady rate rather than reducing the take during the bad times.

But then we need to consider tax which reduces the £5K requirement to £4K. Over 3-4 years you could get all the £100K into S&S ISAs between you so income would be tax free. 4% could, with care, be OK, though of course not guaranteed.

So you have the choice of the security of the £5K annually versus the flexibility of the £100K pot. To gain a reasonably secure steady income from the latter you need to take an detailed interest in your investments. One advantage is that should your wife die before you, you would keep all the money whereas presumably the police pension would drop significantly

green_man

Marktheshark wrote: »

Perfect example of why the country can not afford theses copper bottomed (pun) pensions.
Retire at 50 with £100,000 to spend and enough money to live off.

No way on earth has that amount of money been paid in.

Thanks for the useful contribution. As I stated if she takes the lump sum she would not then have enough to live off!, To be honest though I agree. The wife does put a large contribution in (over 14%) but the benefits for that are excellent. However you should be happy that this has all now changed and current recruits have a much less generous scheme.

"Is it a no brainer to take the max lump sum available?" Only in the sense that people with no brain will seize the lump sum without giving it any serious thought. The case for taking the lump sum is strong, I suggest, only if (i) she has objective reason to expect a short lifespan, or (ii) the pair of you have some compelling purpose for the money. To take it just to invest seems imprudent: why not just leave it invested in the pension scheme? Where else could you find an investment with its desirable characteristics?

Yes this is my current thinking as well.

OldBeanz

Ford Mustang; 5l; soft top.

You need at least £40k for that

Freecall

green_man wrote: »

.........the financial advice given (arranged by the police) stated that you would be mad not to take the max lump sum.

It sounds a bit counter-intuitive to me. I would expect to be able to achieve a 5% withdrawal rate over the long term (although my own target is more like 4% because I am cautious in that respect) but for a new investor looking to manage a portfolio for decades ahead I am not so sure.

How well do you know these folks? If they are good friends they may let you have a look at the financial advisor's report which would show the justification.

It may be a sensible course of action and I recognise that 'you would be mad not to' is a paraphrase but you really need to see the justification for that statement.

atush

If you did take it, and put it into S&S isas, then invest in a range of income funds and investment trusts- many of which have records of growing dividends annually over decades and pay 4%.

So you'll get a stable income, but the funds will rise and fall with the markets- all the while the dividend continues to be paid and rise. The remaining fund to be inherited.

kidmugsy

OP, visit this blog
http://theretirementcafe.blogspot.co.uk
and this one
http://retirementresearcher.com/blog/
and also this chap.
http://www.norstad.org/finance/aasurvival.pdf

Umpty-um simulations strongly suggest that someone hoping to draw an annual 5% from an investment "pot" will empty it long before 50 years are up. Hell, they typically simulate for only 30 years, and find that drawing an annual 4% may be a bit too high. So if your wife's need is income, take the loot as income not as capital. She can always try disciplining herself to put an annual amount into a personal pension to accumulate a new capital sum. If she finds she can do that then her capital sum will be restored, and, if not, she will have confirmed the wisdom of taking the extra pension.

kidmugsy

For those put off by his maths, let me point you to Norstad's conclusion.

"The figures and tables on the following pages show the 30 year portfolio survival rates for real withdrawal rates of 3%, 4%, 5%,...
At a 3% withdrawal rate the 30 year survival rates are very good. The maximum survival rate of 98% is achieved by a number of portfolios. All of the optimal portfolios contain at least 20% cash, at least 20% stocks, and at most 40% bonds. …

At a 4% withdrawal rate the 30 year survival rates are considerably less attractive than they are at 3%, but still not bad. The maximum survival rate drops from 98% to 88%. The optimal portfolios contain at most 10% cash, between 20% and 40% bonds, and at least 60% stocks. …"

So at 4% "real" (i.e. linked to inflation), after 30 years about 12% of the portfolios he examined would have been emptied. And that assumes that your wife has the capacity to keep running a portfolio of "optimal" structure right through the bad times, with the ability to avoid high charges and taxes. Heavens, your wife would only be 80, which is no age at all for a woman nowadays.

I understand that private investors typically overestimate how much they can reasonably expect to make from their activities, which is why I suspect that looking at someone's simulations, where the assumptions are all laid out explicitly, makes sense.