DB pension tax treatment if I don't take lump sum

ProDave

I have a UKAEA DB pension. It will give me a tax free lump sum, and then a (taxable) pension income.

There is the option to commute the tax free lump sum to an increased pension. If I do that, how will it be treated for tax? Will a portion of that increased income be tax free or will the whole lot be taxable?

molerat

Only the lump sum received is tax free, all regular payments are taxable. You either swap taxable pension for increased tax free lump sum or tax free lump sum for increased taxable pension.

ProDave

That seems a little unfair. It rather skews it in favour of taking the lump sum and sticking it in an ISA instead.

I would have thought they would treat it as drawing the TFLS in stages so a bit of each months payment was tax free.

Audaxer

ProDave wrote: »

That seems a little unfair. It rather skews it in favour of taking the lump sum and sticking it in an ISA instead.

I would have thought they would treat it as drawing the TFLS in stages so a bit of each months payment was tax free.

One thing important in deciding whether to take the lump sum is the commutation factor. For some DB pensions it is as low as about 12:1 which means that for every £12 of lump sum you give up, you only get an extra £1 of pension a year. Some DB pensions can have commutation factors of 20:1 or higher which is much better. If it was that it would be worth considering taking the lump sum as it would take 20 years or so of pension payments to match the lump sum value. If the equivalent lump sum value was in a tax free ISA that would be even more beneficial as it would last even longer.

xylophone

I would have thought they would treat it as drawing the TFLS in stages so a bit of each months payment was tax free.

This is UFPLS in a DC Scheme


You are taking benefits from a DB Scheme.

If you take increased pension, then the income is taxable in the normal way - that is to say, you have a tax free Personal Allowance with non savings/savings/dividend income taxed as appropriate to your circumstances.

SMcGill

“It rather skews it in favour of taking the lump sum and sticking it in an ISA instead.

That’s my reaction too. I have a DB pension with USS which offers a commutation factor at 67 of around 17:1 so every £1 gross pension income I sacrifice is worth £17 as a tax free lump sum. Actually, as the £1 is taxable it’s more like giving up 80p a year to gain £17 one-off.

It’s appealing at first glance but course DB income is index linked and that makes a difference. I think I’ve seen advice on this forum to take TFLS out of DC pension before considering taking it from a DB pension although I don’t recall the details.

Audaxer

SMcGill wrote: »

That’s my reaction too. I have a DB pension with USS which offers a commutation factor at 67 of around 17:1 so every £1 gross pension income I sacrifice is worth £17 as a tax free lump sum. Actually, as the £1 is taxable it’s more like giving up 80p a year to gain £17 one-off.

Yes, taking the tax into account it's more like a commutation factor of 20:1, and as you'll will not be getting the pension until you are 67, that would see you until you are at least 87 even if you decided to keep it in cash savings and draw from that, although most would probably invest it for income if no plans to spend the lump sum.

Another thing to bear in mind is that although DB pensions are index linked, some are capped. Mine is index linked with RPI but capped at a maximum increase of 2.5%.

jimi_man

Audaxer wrote: »

One thing important in deciding whether to take the lump sum is the commutation factor. For some DB pensions it is as low as about 12:1 which means that for every £12 of lump sum you give up, you only get an extra £1 of pension a year. Some DB pensions can have commutation factors of 20:1 or higher which is much better. If it was that it would be worth considering taking the lump sum as it would take 20 years or so of pension payments to match the lump sum value. If the equivalent lump sum value was in a tax free ISA that would be even more beneficial as it would last even longer.

Equally important is the age as compared to the commutation rate. Mine was 22:1 but that was at age 51 - potentially 30-40 years of lost pension. At age 65 I might have thought it was ok, but at 51 I considered it a bad deal and didn’t take it.

PJM_62

In 2 years I plan to take early retirement at 55 with a reduced DB pension.
I will have choice of 6.5k pension + 19.5k TFLS, or 7.5k pension + no TFLS.
I figured an extra 1k a year from 55 was best option ??

AnotherJoe

Probably. Will you also be working or have extra taxable income ? If so it's an extra £800 / year since youll pay 20% tax.

Apodemus

PJM_62 wrote: »

In 2 years I plan to take early retirement at 55 with a reduced DB pension.
I will have choice of 6.5k pension + 19.5k TFLS, or 7.5k pension + no TFLS.
I figured an extra 1k a year from 55 was best option ??

I guess, though, it depends on your attitude to risk and the balance of any other sources of retirement income. I intend leaving my DB pension untouched to normal retirement age simply to increase the guaranteed proportion of my retirement income and remove some of the market risk associated with my DC pension and S&S investments. By leaving the DB alone to normal retirement age, my DB + State Pension will equal about 64% of my required income, rather than 51% if I took the DB early. Both DB & State Pension will also rise with inflation, giving further added protection against the risk of any long-term flat performance of the stock market.