Inverse Commutation

Mr_Prudent

Hi, I’ve been considering taking my pension 2 years early and in order to reduce the effect of actuarial reduction (around 11%) I have been toying with the idea of inverse commutation on the entire lump sum to bring the pension back to roughly what it would have been had I left it to NRA.
Having the pension paid out early would also effectively give back a large chunk of the lump sum I have sacrificed because of the 2 years worth of payments. The reasoning behind this is that it gives me access to the cash earlier without being too big a hit on what the final pension would have been.
Any thoughts from the experts would be much appreciated. Thanks in advance.

kidmugsy

(i) What is the inverse commutation rate? (That is, how much lump sum do you give up to get an extra £ p.a. of pension?)

(ii) Does inverse commutation increase your widow's pension? (In the case of one of my schemes, neither commutation nor inverse commutation altered my widow's pension.)

(iii) How old are you? When do you qualify for your State Retirement Pension?

(iv) How's your health? Is your family long-lived?

Mr_Prudent

Hi Kidmugsy
A1 to Q1
I think it’s going to be in the region of £4-85 for every £100 of lump sum (not great I know) but it would be linked to CPI.
A2 to Q2
I’m a singleton so not concerned with widow’s pension. When I’m gone so’s the pension!
A3 to Q3
I’m 58 and qualify for state pension at 66 Year 2023.
A4 to Q4
Although parents are well into their 80’s and reasonably OK, my brother died from brain cancer last December just shy of his 63rd birthday.
The Pension in question is the BTPS (section final salary.

kidmugsy

Mr_Prudent wrote: »

I’m a singleton so not concerned with widow’s pension. ....Although parents are well into their 80’s and reasonably OK, my brother died from brain cancer last December just shy of his 63rd birthday.

Singleton, early death of brother ... to me those would both argue for taking the lump sum rather than inverse-commuting it. You could spend part of the capital each year to bridge the gap until your State Retirement Pension begins.

Mr_Prudent wrote: »

I think it’s going to be in the region of £4-85 for every £100 of lump sum (not great I know) but it would be linked to CPI.

"Not great" as you say, though not dreadful either. Suppose you took the lump sum; would you be kicking yourself thereafter for making an irreversible decision that might be wrong? No need; there's a way you could reverse it if you wanted to. Just defer drawing your State Pension when the time comes. That pays an extra 5.8% p.a. for every year of deferral.

Lastly, consider some ways of bridging the gap to 60 so that you needn't pay an actuarial reduction at all. For example, borrowing is very cheap at the moment, and could be cleared in two years' time with your lump sum. It's especially cheap if you put lots of your expenditure on a 0% credit card, taken out while you still have a salary.

Mr_Prudent

Hi Kidmugsy.
Thanks for your replies, and you have certainly given me food for thought.
As regards credit card financing for a couple of years to bridge the gap, I would not feel comfy with this as I no longer work, having taken EVR back in 2010 for reasons of sanity! This is why I am trying to figure a way of releasing cash from my pension whilst minimising the reduction factor.
This seemed like a reasonable solution whilst minimising the hit on the index linked pension. It’s just so damned hard trying to weigh up the pros and cons for each option!!

kidmugsy

Mr_Prudent wrote: »

As regards credit card financing for a couple of years to bridge the gap, I would not feel comfy with this as I no longer work

The purpose of taking a loan is to make compatible the desire to spend some money now when you are short of funds, with the fact that funds are certain to arrive in known amount at a known time in the future. As long as you borrow substantially less than your forthcoming lump sum, it seems a good idea to me. In hand-waving terms: wouldn't you rather be billed for 5% p.a. (say) interest for two years than give up around 5.5% p.a. (CPI-linked) for the rest of your life?

You won't be allowed to secure the borrowing on your pension - that's forbidden. I suppose you could secure it on your property if you own one, but I'd guess that the faffing around wouldn't be worth it for just a couple of years.

The only case I can see for taking the pension early - and even then you ought to take the lump sum, not reverse commute it - is the fear that there is a substantial objective risk that you might die early, like your brother. If that really concerns you, you could always have an MRI scan just to see that your brain is in no danger at present, or more generally have a serious talk with your GP. Maybe he could assure you that your brother's death does not imply a substantially raised risk of early death for you.

In short: if you really think you might die early, start the pension pronto, take the lump sum, and borrow if needs be in a few years time. Your State Pension will eventually ride to the rescue if you survive.

On the other hand, if you expect to live into your 80s like your parents, don't start your pension until you are 60, and weigh up the advantages of reverse-commuting nearer the time, comparing it with eventual State Pension deferral. If you have borrowed to bridge the gap, at least take enough pension lump sum to clear the debt.

Mr_Prudent

Thank you again Kidmugsy for your detailed reply.
Perhaps I was looking at things a little too simplistically, but I thought that by using the lump sum to increase the pension and then taking it early I would be effectively getting back part of the lump sum via the early payments whilst having the advantage of an enhanced annual pension, but obviously my thinking must be flawed. Thanks again.

jamesd

Frankly, you're being foolish. Your resisting borrowing is going to cost you 11% of your pension income for life. You can easily borrow far more cheaply than that if you have a home, using equity release. You may also have other savings and investments that you could use that will cost you far less than 11% for life if you use them.

Just borrow and commit to repaying the borrowing out of say 50% of the higher income you have by not taking the pension early and/or out of the lump sum pot. You'll be better off.

What are your assets? Really no savings and no property and no capacity for borrowing so you actually have no choice but to take the pension early? Tell us more and we can undoubtedly come up with a far, far cheaper solution to your problem.

Mr_Prudent

Hi Jamesd. I’m afraid I am somewhat “old school” and the idea of borrowing when there could be another solution is something that is alien to me. If that makes me foolish then so be it!
I do have other assets that I could call upon, but using these would only mean less return on these as opposed to less return on the pension. I appreciate that the pension is an 11% hit for life but by taking it early I would have to be into my eighties before I began to lose out.
As for equity release I would have thought that this would be a “last resort” solution and many have warned against this due to the high cost of the compounding interest.
Think it may be an idea to seek out an IFA as to the best way forward, but many thanks for your input.

kidmugsy

Mr_Prudent wrote: »

I appreciate that the pension is an 11% hit for life but by taking it early I would have to be into my eighties before I began to lose out.

Your parents have reached their eighties!!

Mr_Prudent

Fair point, but to be honest their needs financially are a lot less these days as they no longer take holidays, drive and maintain a car and go out socialising as they used to when they were younger and more active due to age related health problems. They do seem happy enough with what they have and if they need to go into care in the near future fully expect to fund it with their home which, I fully support. I’m not one of those people who want my parents to leave everything to me and expect the state to support them.