DB Pension – full pension or take a lump sum?

Audaxer

My main DB Pension is due and I can’t decide whether or not to take a tax free lump sum. I'd always planned on taking the maximum pension with no lump sum to get the highest secure income possible, as that along with my State Pension in 6 years time will cover just about all of our annual spending. We are also fortunate to have a large pot of investments in S&S ISAs, and cash savings that I am planning to use for any big ticket spending in retirement.

As we will be buying a new car and moving house soon, I'm now not sure whether it would be better to pay for this from some of the cash savings that I was planning to invest if not spent - or whether it would be better to take a lump sum of up to £40k to cover the planned spending. That would allow me to invest the money from the maturing Cash ISAs. I would be losing about £1,800 DB pension income per annum, but total income including investment income should still be more than enough to cover annual spending.

The commutation factor for the lump sum is 17.2 which I think is quite good. So in some ways it seems a good choice to take a lump sum and lower pension as it will increase my pot and give me more pension money under my control in case we need it, but my cautious head still says I should still take the higher guaranteed pension income as it’s a more secure form of regular income, rather than relying on investment income.

I originally wanted the investments just there for extra income and big ticket purchases when needed, but now think it may be better financially to take the lump sum for the spending so I can invest the money just maturing from Cash ISAs.

Just wondering if you think I am being far too cautious if I don't take a tax free lump sum to cover the initial spending?

Silvertabby

Are you sure about that commutation factor - because 2:17 is abysmal. Do you mean 1:17? that's better, but not fabulous.

Joey_Soap

No, I think you are being very mature, sensible and pragmatic. I have taken a very similar view. I can even work to build up cash if I wish. But one thing I can never, ever do is replace my defined benefit pension income. Indexed for life. Spend your other money. A defined benefit pension that covers your essential living costs is way too valuable to spend on a car or other heavily depreciating asset.

Dox

Silvertabby wrote: »

Are you sure about that commutation factor - because 2:17 is abysmal. Do you mean 1:17? that's better, but not fabulous.

OP gives the commutation factor as 17.2 - I'm assuming that means the scheme provides £17.20 for each £1 of pension exchanged. As you say, not fabulous and might be worth OP asking when the next factor review is due, assuming there is some choice about retirement date.

OP - remember you can take anything from £0 tax free cash to whatever maximum tax free cash the scheme rules permit (which can be lower, but not higher, than the maximum HMRC permits). You don't have to go to extremes - possibly somewhere in the middle of what you are able to take?

kidmugsy

Does it have any effect on the widow's pension?

Audaxer

Silvertabby wrote: »

Are you sure about that commutation factor - because 2:17 is abysmal. Do you mean 1:17? that's better, but not fabulous.

It's stated as 17.2 - which means for every £17.20 of lump sum you take you are giving up £1 of pension. The maximum the annual increases to the pension is RPI up to a max of 2.5%. So if I took £40k I would be giving up about £1,850 pension a year after tax. Even increasing at 2.5% pa it would take over 17 years to get to £40k.

Silvertabby

Audaxer wrote: »

It's stated as 17.2 - which means for every £17.20 of lump sum you take you are giving up £1 of pension. The maximum the annual increases to the pension is RPI up to a max of 2.5%. So if I took £40k I would be giving up about £1,850 pension a year after tax. Even increasing at 2.5% pa it would take over 17 years to get to £40k.

I would have quoted that as 1:17.2, but makes sense now. That's certainly better than the public sector's 1:12 , but then the public sector annual increases, while CPI, are uncapped.

I really depends on what you would spend the money on. If you still have a mortage, for example, could you pay that off with your commuted lump sum?

Audaxer

kidmugsy wrote: »

Does it have any effect on the widow's pension?

No it doesn't, but my wife is happy for me to take the full pension. We have saved hard over the years and have a much larger pot of investments and savings than the maximum lump sum I could take, and we have always thought of the pot as our lump sum which would give us a comfortable retirement anyway.

I have held off taking this deferred DB pension early and waited until my Normal Retirement Age to get the maximum possible. It is only now I am starting to think it might be better to take a tax free lump sum, although I am finding it hard to contemplate taking a reduced pension. I keep changing my mind but think I would sleep easier knowing that the full DB pension was coming in rather than relying on investments. I think I am being a bit risk averse, but interested to know what others would do in a similar situation.

Alexland

I would keep the guaranteed income and sleep easier.

Terry_Towelling

I don't think anyone can really answer your question completely because it's all about how you perceive your security and your own personal circumstances . There may be an answer that has sound financial reasoning behind it but even that will only be a steer and not definitive for your life. It is more than a simple 'which nets me more' question.

Presumably the pension scheme will have used complex probability calculations to weight the lump sum to be enough of a temptation to take it whilst at the same time calculating that their total pay-out to you will then be less, assuming you have average life-expectancy.

It's a gamble because you don't know how long you will live but the £40K could be used to subsidise the loss of annual pension payments for more than 20 years (you'd be over 80 by then). With no lump sum but a higher pension payment you might have to lose up to £10K to income tax (over the years) to amass that much. Taking the extra £2325pa also increases your tax bill by £500 per year.

I don't know whether the tax position is the most valid way to look at it but it may have some bearing. My own view (for what it's worth - and it is entirely personal for my own life circumstances) is that the lump sum is too good to miss if you would still be able to get by comfortably and 20+ years of being able to subsidise the loss of income with the lump sum (if you wanted to) is long enough.

Just steer clear of buses when crossing the road because that will make everything academic.

kidmugsy

I took max lump sum from my principal DB pension for four reasons.

(i) I had debts to clear. (I assume you don't.)

(ii) I took the sunnily optimistic view that I'd find investment opportunities that would do better than just taking a bigger pension.
(CAPE, especially for the US, means that I don't recommend that view to you.)

(iii) It helped me avoid income tax. (Can you be confident that basic rate tax will stay as low as 20%?)

(iv) I thought the finances of that DB scheme, and the competence of its management, were both in doubt. (How's yours?)