How to work out tax due on CETV payment

Camster

I am taking early retirement from work in May this year, and I'm looking at my options for my Defined Benefit pension.

I have been given a pension quote of £22,300 per year with no lump sum, which will increase by CPI capped at 2.5%. It also has a 50% pension for my wife after my death. The pension quote also gave a CETV of £600,000.

After reading comments on this board, I'm leaning towards taking the annual pension. I'm looking for some advice on the tax that I would need to pay if I took the cash transfer, to allow me to fully consider this option. I'm currently a basic rate taxpayer, and on retirement, I would need to invest the lump sum payment to generate an income.

Any advice on what tax I would need to pay on the cash transfer amount would be appreciated.

xylophone

You would not pay tax on the Transfer as such.

Once you had obtained advice from a Pensions Transfer Specialist, you would arrange for your chosen pension provider to arrange the transfer of your DB pension to the new DC arrangement.

You could choose to take 25% tax free, with any other money taken being taxed as income in the tax year it was drawn.

You would choose the funds etc in which your pension was invested.
https://www.royallondon.com/Global/documents/GoodWithYourMoney/COMPANY-PENSIONS-FIVE-REASONS-TO-TRANSFER-OUT-AND-FIVE-REASONS-NOT-TO.pdf

PensionTech

If you would be investing the lump sum payment then just leave it in the DC pension to which you'd be transferring, and invest it through that. You don't pay tax until you start to withdraw cash from the pension. Given that any withdrawals over 25% of the fund value will be taxed as income in the year of receipt, it would be insane to take it out of the pension wrapper and incur a hefty tax bill if all you're going to do is reinvest it and draw an income from it gradually anyway.

Given that you don't seem to have any immediate need to spend the money, and the CETV is not crazily large compared to the pension (though the index-linking isn't as generous as some - having said that I would be surprised if your whole pension was CPI to 2.5% as that would mean it was all accrued in the last 12 years), and you would just draw a regular income, and you're married... it sounds like you might be better off with the DB pension anyway. But that is very much subject to a number of personal circumstances and preferences.

mgdavid

I'd be inclined to stick with the DB pension too;
BUT do you have other savings or investments to bump up your retirement income until State Pension kicks in?
What age are you now?

Camster

PensionTech, sorry, the pension is capped at 2.5% for years after 2002 and 5% for years prior to this, so I would get increases somewhere in between these figures.

I've got a healthy amount of savings in cash and through a stocks & shares ISA, and I'm mortgage free, so I don't need the cash transfer for any large expenses such as clearing a mortgage. My wife is also 11 years younger than me, so I'm thinking she would probably be receiving the 50% of my pension for quite a long time after I'm not around. I will be 59 at the end of this year.

All of these factors are swaying me towards taking the pension rather than the transfer, but I just needed a bit more information on tax before makling a final decision.

PensionTech

I assume you mean 2005, rather than 2002, as there is a statutory requirement to index-link DB pensions accrued between 1997-2005 by a minimum of CPI capped to 5% in retirement so they really shouldn't be doing any less than that. But I'm nitpicking! Sounds like you're thinking about the right things, anyway.

Do you need to retire early at all? Could you finance the period between leaving your job and reaching your Normal Retirement Age using your other savings? Your pension will usually be reduced for retiring early, and often it can make more sense financially to live on your savings until you get to 60/65/whatever in order to avoid that reduction.

Camster

Yes, sorry it's 2005 for the 5% cap.

I spoke to the pension scheme administrators about deferring taking the pension until I was 60 in about 18 months time, and I was told my pension would only be around £1100 a year more for doing this.

As I would be giving up £33,450 of gross pension income by deferring, I didn't think it was worth doing this.

kidmugsy

Camster wrote: »

I spoke to the pension scheme administrators about deferring taking the pension until I was 60 in about 18 months time, and I was told my pension would only be around £1100 a year more for doing this.

As I would be giving up £33,450 of gross pension income by deferring, I didn't think it was worth doing this.

Say you live to 85: that's 25 years from age 60. Your widow lives a further 11 years, because she's younger; another 2 years, because she's a woman; and we assume another 11 years because it's longevity risk that the DB pension is particularly useful for.

Right so you get £1100 p.a. extra for 25 years and £550 extra for 24 years. Call it £40k extra, index linked. Sounds quite good to me in return for £33,450 fixed forever.

A counterargument is that extra income will seem less valuable once your SRP has begun (and then eventually your wife's pensions too) so it would be tempting just to start the DB pension right away. On the other hand could you bridge the 18 months gap until 60 by using, say, 0% credit cards for the two of you, and bridge the gap until your and her extra pensions begin by taking out a cheap mortgage? Borrowing is cheaper than it's been for 5000 years, or so they say.