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

jamesd

It takes 5% plus inflation to match the benefit, ignoring spousal and any other benefits. Long term return from the main UK stock market has averaged around 5% plus inflation long term but you need to allow at least 0.5% for costs. So on the face of it the income level can't be matched without depleting capital. But depleting capital gradually is fine, after all, that's what the pension does, dropping to nothing when it stops paying out.

The tax difference between money inside S&S ISA compared to the pension is significant, suggesting that investing and drawing an income may beat it.

As well as the stock market there are a range of other investment options available that can pay say 11% (P2P) or 6% (regular saver) taxable, 11-12% tax free (VCT). With property or other security for the P2P and property for most of the relevant VCT.

Given the concern about spending, VCT looks like a good choice since the money has to be kept invested for five years or the 30% initial tax relief has to be repaid. Tax relief is limited to the income tax actually paid in the tax year, so this provides a cap on the sensible annual investment level.

P2P lending with secured loans also has effective lock-ins for part of the money because loans are normally repaid gradually over time.

Then go with conventional investments inside an &S ISA to generate income and long term growth beyond that, as the core of the investments.

For both, the capital does become available so a degree of self-restraint is required. Knowing that the money is generating more income than the pension (probably) so is producing higher spending money levels might help.

Provided P2P and VCT are suitable, at least one of them, and mostly equity investments for the rest, then taking the lump sum does appear to have a reasonable prospect of generating higher income and also having a larger lump sum value remaining at death or for contingencies.

jamesd

kidmugsy wrote: »

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

It's perhaps also worth pointing out what Norstad didn't do:

1. Follow the Guyton or Guyton and Klinger safeguards that are shown in similar studies to increase the safe withdrawing rate to almost 6%, not 4%, of the initial pot value:

B. "there is no increase in withdrawals following a year in which the portfolio’s total investment return is negative, and there is no make-up for a missed increase in any subsequent year"
A. "the maximum inflationary increase in any given year is 6 percent, and there is no make-up for a capped inflation adjustment in any subsequent year"

2. Use an equity release mortgage with variable drawing and repayment to avoid drawing on funds during a drop, producing a further increase in success rate or safe drawing rate. Reversing the Conventional Wisdom: Using Home Equity to Supplement Retirement Income explained "the 30-year cash flow survival probability for an initial withdrawal rate of 6 percent is only 55 percent when the conventional strategy is used, but is close to 90 percent when the coordinated strategy is used" and later showed that the drawing rate could be increased to 6.5% with almost 90% success rate when combined with the Guyton and Guyton and Klinger rules.

3. Use higher paying investments than bonds and cash, or sometimes shares, like those I mentioned.

4. Consider the UK ability to use capital to fund deferring the state pension to get 5.8% inflation-linked, if the rate from next year is still available in twenty years.

Lots of caution is needed for studies that don't assume sensible drawdown using the guidelines that substantially increase safe drawing rates or success rates. And more also because the studies are largely US-based.

The task here is just to at least match but better beat the 4% after tax inflation-linked from the Police pension. That seems doable if following the rules and also using some interesting investments not considered in that or most other papers.

The major catch here isn't really the investment return or the rules, it seems to be the psychology of the person retiring and whether she will have the self-restraint needed to follow the rules rather than see a big lump sum and spend it. VCT can help reduce overall income tax, P2P can boost income as can the VCTs and both provide some degree of tie in, but would it be enough? We just don't know.

kidmugsy

Here is my edited version of some wisdom I found here.
https://www.kitces.com/blog/valuing-social-security-benefits-as-an-asset-on-the-household-balance-sheet/

"The value of a Police Pension is … unlike that of traditional assets; the value is actually higher when inflation rises, and is greater when interest rates are low. As a result, viewing a Police Pension as an asset actually reveals that it is a highly desirable asset for a retiree, uniquely capable of hedging many risks in retirement that traditional portfolios cannot… and making it all the more appealing to preserve the Police Pension “asset” for its diversification by getting as much as possible!"

In other words, the Police Pension might be an excellent complement to whatever other retirement provision the pair of you have. That would apply in spades if your own pension is DC rather than DB.

green_man

Thanks all for the info/advice.

My wife will certainly not want to investigate the various options/techniques required to (reasonably) safely maximize her return. If we were to go down this route it would likely be myself that was making the investment decisions (and god help me should the returns be less than typical BS returns)

I've got to admit I know little about VCTs. I will have to investigate these, I know there are certain tax benefits, but the returns quoted above look remarkable, are these levels of return risking the capital figure? (seem too good to be true if not!)

kidmugsy

jamesd wrote: »

It's perhaps also worth pointing out what Norstad didn't do.

But with those "safeguards" added you are no longer comparing it with a steady after-tax 4% p.a. real per annum: you would be accepting an erratic income. Fair enough if that's what you want; but if it isn't, then the comparison becomes invalid.

You are also assuming that the spendthrift wife could discipline herself to apply the safeguards: but the whole point of the OP's enquiry is that neither member of the couple think that that sort of discipline is remotely likely. Heavens, the much lower level of discipline required for Norstad's modelled policy is presumably beyond her.

In the end the enquiry boils down to "neither my wife nor I would trust her with £100k; might we be wise to swap that for a net income of £4k p.a., guaranteed and index-linked?"

Ivrytwr3

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.

Perhaps if you had tried harder at school you may have been able to attain the role and the pension that goes with it?

Anyway, i am Armed Forces and a lot of people are of the opinion that you should take the lump sum and commute as much as possible as 'you never know what may happen'.

As long as you aren't crippled with debt, outstanding mortgage etc, then it seems foolish to take a lump sum to reduce a pension - a lump sum will go but a pension is for life (well, unless the Govt mess with it!).

But with your figures i would certainly be seeking professional advice.

kidmugsy

green_man wrote: »

My wife will certainly not want to investigate the various options/techniques required to (reasonably) safely maximize her return. If we were to go down this route it would likely be myself that was making the investment decisions (and god help me should the returns be less than typical BS returns)

Then let me commend to you my earlier suggestion: "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."

princeofpounds

To be frank, it all seems rather complicated just to give yourself a good chance of matching and maybe, maybe, beating* a riskless income.


(and given what the OP says about lifestyle, it seems they need the income, they are considering a very, very long time period, and they are not sophisticated investors)


Furthermore, I very much doubt that the official financial advice was that taking the lump sum was a 'no-brainer'.


* and I would add given where asset prices are compared to historical levels, I doubt you would even be able to do that without taking unacceptable risk.

puk999

atush wrote: »

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.

Very good point which I hope you won't mind me re-quoting in case it got missed.

rpc

As I stated if she takes the lump sum she would not then have enough to live off!

It seems pretty clear to me - you can't afford to take the lump sum.