Early retirement - take pension or use savings first?

MrStanners

Hi,

I have read comments on a few threads that state that the general view is that on early retirement it is better to use savings (even borrow I think jamesd has said?) to avoid drawing a pension with an actuarial reduction applied. I don’t understand this, perhaps I took things out of context. If an actuarial reduction is applied then doesn’t the pension scheme pay out the same amount over time for an average person?

In my case I am planning early retirement aged 55. In my DB scheme I lose 3% a year so at 55 I get 70% of my pension at NRD (65). So using simple numbers and zero inflation if my pension is 10K then assuming I live to 85 then I either receive 10k for 20 years (total 200k) or receive 7k for 30 years (total 210k). So why is it better to delay drawing on the pension?

In fact I can see benefits in drawing the pension early:
- More money to invest & hopefully earn more than inflation
- More money for dependants if I die early
- Greater pension security if the pension fund goes belly up, since retirees get priority on whatever money is left in the fund

Obviously I’m missing something important here but I can’t see what it is. So fellow MSE’ers, if it’s the received wisdom that it is better not to draw your pension before normal retirement date please can someone explain, in simple language, why?

In my case I do have some savings so I could delay drawing my pension for a few years but I don’t understand why this would be beneficial.

Is it something to do with tax? Most things are! I'm a basic rate taxpayer now and will be when I retire.
Thank you.

jamesd

Yes, I've written even borrow.

The trouble with what is called an actuarial reduction is that it isn't normally really an actuarial reduction. Instead it tends to be a fixed percentage, which is part of why it's normally exact round umbers like 3% or 5%. It's also always unrelated to the life expectancy of the person retiring, being decided on an average for the whole scheme instead.

One thing that you don't see is that before writing a post which makes that observation I've evaluated whether I think it's a good or bad idea to take it early for the particular scheme concerned and adjust what I write based on the facts.

jamesd

You're in a relatively good position compared to many schemes because I see 5% deductions more often than 3%. That helps your situation a lot. 5% plus inflation is only a fraction less than the long term UK stock market performance before charges, so most people investing wouldn't make 5%. But at 3% you could hope to do better than that with equities and bonds in a typical retire mixture.

Insurance value is part of the value that's there but relatively hard to appreciate: the guarantee of the higher income if you are one of those who lives a long life. For those in the UK who are 65 today around 25% of them will make it to age 94. You've had better health care and will benefit from more health advances so you can probably add a few years to that.

Given the 3% per year reduction in your scheme and the available investments I don't think it's a particularly bad idea to start drawing now, since much of the benefit from waiting is the long life insurance aspect. And the money you already had can quite readily be invested now to earn 10% tax free and 30% purchase price refunded in say the Albion VCT or 10-12% currently taxable in P2P lending on secured loans. Assuming you're willing to invest it seems entirely possible that you could end up better off by taking it now than by waiting.

There is something else to check: the transfer value. For some schemes those are currently so generous at the moment that transferring can be a far better deal than staying in. This depends on the scheme so other than observing that it's possible there's no way to know if it applies to yours without asking what the transfer value is.

jem16

MrStanners wrote: »

So why is it better to delay drawing on the pension?

It's not always better and far too simplistic.

It's all down to numbers and your own personal circumstances. You need to work out a break even point and see what difference it will make to you. For many they would rather have the money, even if slightly less, whilst young enough to enjoy it.

Using savings/investments - don't have the actuarial reduction but you do have the loss of whatever return you would have been making on your savings/investments.

Borrowing - doesn't sit well with a lot of people who would rather be debt free especially in retirement.

So the choice is really down to the individual.

MrStanners

Thanks for the replies.

I had planned to start drawing my pension at 55 even though it will be reduced. I'm now reassured that I won't be making a silly mistake. I'm also reasonably confident that my savings/investments should make more than inflation so it makes sense not to use them up.

Thrugelmir

MrStanners wrote: »

In my case I am planning early retirement aged 55. In my DB scheme I lose 3% a year so at 55 I get 70% of my pension at NRD (65). So using simple numbers and zero inflation if my pension is 10K then assuming I live to 85 then I either receive 10k for 20 years (total 200k) or receive 7k for 30 years (total 210k). So why is it better to delay drawing on the pension?

What you are actually missing out on is the further years of accrued benefits. If inflation is zero then it's highly lightly that investment returns won't be that great either.

Triumph13

Your 3% factor vs the more usual 5% to 6% makes a huge difference and so it may very well make sense in your case. The other thing to consider though is how it all fits into your overall retirement strategy. Are you someone who is happy to take the risk of running out of money in later life or are you looking more for a guaranteed 'floor' to your spending? If so then how does the reduced DB pension compare to that floor?

atush

I agree with posts 6 and 7.

3% is a lot more attractive to retire 10 years early than the normal 5% which would have meant a 50% reduction. So perhaps if the OP was facing such a large reduction they would not be so keen to retire early.

But your pension will be reduced by more than 70%. AS you wont be adding more years (which you would be isf say you worked for another year or two).

Another thing to look at, if you have a spouse and dependents, how the survivors pension will be affected.

So, if you c an live on 70% of your pension, fine. But could your spouse live on half of that if you get run over no 52 bus a week after you retire?

Lastly how well have your investments done int he last 10 years thru good times and bad?

MrStanners

No I don't want to run out of money.
I have a couple of other small pensions that I can draw at 60 and 65 and I'm not planning to take either of those early. Also I should have enough NI contributions to get the full state pension at 67.
So I will be using up some(most) of my savings to last me until 67 but then I think I (we - I am married & my wife has her own pension) should be ok with my (our) various pensions plus the state pension(s).

In response to a comment by jamesd I hadn't considered transferring any of my pensions into a DC or SIPP because I am married with dependants and so I assumed the DB benefits would be too good in comparison. However I'm curious now so I will request a transfer value from one of my deferred DB schemes, but unless the transfer value is very high I will probably leave it where it is.

MrStanners

Sorry I don't know how to do those text box inserts of earlier comments so I've put earlier comments in quotes and italics.
Reply to atush:

"But your pension will be reduced by more than 70%. AS you wont be adding more years (which you would be isf say you worked for another year or two)."
My pension will be reduced by 30% not 70%. Yes I won't be adding extra years. My annual pension statement tells me what I should get at 65 based on my existing contributions, it also forecasts what I should get if I carry on working to 65. Sorry but I don't get your point. I know that because I will not be paying into a pension it will be less than it could be, but isn't that always the case with early retirement? I prefer my free time instead of contributing a few more years into my pension.

"Another thing to look at, if you have a spouse and dependents, how the survivors pension will be affected"
The spouse pension is reduced by the same factor, 30%, actually I think I had better double check that.

"So, if you can live on 70% of your pension, fine. But could your spouse live on half of that if you get run over no 52 bus a week after you retire?"
I'm not worried about my wife. I know that might sound callous, but she earns more than me & pays into a pension so I'm confident she'll be ok. We have no mortgage or debts. She isn't reliant on my income or pension. Actually, when I give up work she will benefit from a much happier and less stressed husband.

"Lastly how well have your investments done in the last 10 years thru good times and bad?"
Err I don't know the precise figures, the older investments have all done well, the ones in the last few years are more mixed. I'm not planning to touch any of them soon but leave them as long as I can.

Thrugelmir

MrStanners wrote: »

My annual pension statement tells me what I should get at 65 based on my existing contributions, it also forecasts what I should get if I carry on working to 65.

Is your scheme changing to NRA?