Commutation factor?

Skinnydad

Just a quick question to ask if someone could help me understand the commutation factor of my pensions scheme. I'm due to get paid out next month and I can take I can take a full pension of £6315 PA or I can take £4706 PA + £31,373 TFLS. I asked if I could take a pension of £5000 PA and how much of a lump sum I'd be able to take. The response was a £5K PA pension and a lump sum of £25,600. The commutation factor is £19.50.. I don't fully understand this? Also to have a further £300 PA I'd lose approx. £6K does this seem a reasonable return? or would I be better taking the £6K extra? thanks

Dox

The grandly-named commutation factor of £19.50 means that you will get £19.50 of tax free cash for each £1 of pension you exchange for said cash - i.e. your starting pension is permanently reduced by £1.

£6315 - £4705 = £1609.
£1609 x £19.5 = £31375 (the couple of pounds difference is just down to rounding the figures)

£6315 - £5000 = £1315.
£1315 x £19.50 = £25642

There's no easy answer to is it 'better' to take cash or pension. If you have debts to clear, paying them off might make sense. If you would simply stick the money in the bank and earn a pittance in interest, maybe not such a good idea.

kidmugsy

It might be worth doing a tax calculation. Would the smaller pension avoid income tax altogether when added to your State Retirement Pension?

Dazed_and_confused

Basically they are offering you £19.50 for every £1 of pension you give up.

You get a one off lump sum and in return lose the pension. For ever.

What the best thing to do depends on a lot of factors. If you blow the lump sum on a Ferrari could you live on the £5000 or do you have other income.

If you invest or save a lump sum of £25k could you get a better return than taking the extra pension.

If you have other pension income or a job the pension may well need tax paying on it but if you invest you might get tax free returns (ISA) or have taxable interest which could potentially be taxed at one of the 0% tax rates available for savings interest.

Silvertabby

The commutation factor of 1:19.50 (not £19.50) isn't horrendous.

What it means is that you give up £1 annual pension for £19.50 tax free lump sum. ie,

Annual pension of £6315

or...

£6315 - £5000 = £1315

£1315 x 19.50 = £25642.50

There's no right or wrong answer - it's your choice to take £6315.00 annual pension, or £25642.50 tax free lump sum plus reduced annual pension of £5000, or £31373 tax free lump sum plus further reduced annual pension of £4706.

Do you have debts that would be cleared by taking either of the tax free lump sums?

Silvertabby

Looks like we're all singing from the same song sheet, guys !

Skinnydad

Good replies thanks to all.. no debts and I have another pension which will pay approx. £8K per annum..plus savings and a large money purchase pot.. I was just trying to round the numbers. i.e. 2 pensions bringing in approx. £13K PA, when I turn 66 I'll be able to add the state pension to this. just been laid off so no worries there..wanting to take some time off after working 43 years...I think I was wondering if the £300 PA was worth the £6K that was all...thanks again

Dazed_and_confused

Based on your last post it isn't really going to be £300 for £6k long term.

It may be now but once you start getting the other pension income that £300 will be liable to tax so is really worth £240 (assuming basic rate tax remains 20%).

Silvertabby

Skinnydad wrote: »

Good replies thanks to all.. no debts and I have another pension which will pay approx. £8K per annum..plus savings and a large money purchase pot.. I was just trying to round the numbers. i.e. 2 pensions bringing in approx. £13K PA, when I turn 66 I'll be able to add the state pension to this. just been laid off so no worries there..wanting to take some time off after working 43 years...I think I was wondering if the £300 PA was worth the £6K that was all...thanks again

It's the magic pension question - what will be your date of death?

Sounds like you will be a standard rate tax payer in retirement, so...

You would be giving up £300 - 20% tax (£60) = £240 per year annual pension.

£6K / £240 = 25years.

So, if you die within 25 years of retirement then you'd be better off with the bigger lump sum. But the longer you live beyond 25 years then the better off you'd be with the bigger pension.

Not a taxpayer?

Then £6K / £300 = 20 years break even point.

Peelerfart

Skinnydad wrote: »

.wanting to take some time off after working 43 years

That's not a big ask IMHO

Audaxer

Silvertabby wrote: »

Then £6K / £300 = 20 years break even point.

I think 19.5 is a pretty good commutation factor. However bear in mind that the £300 extra pension or £240 extra after tax, will I assume increase with inflation every year. Best to do a spreadsheet analysis of putting the £6k in an account with for example a 1.5% interest rate, and paying yourself £300 or £240 per month increasing at say 2.5% inflation per year, and see how long it lasts.