Advice on income tax on DB pension.

tiddles

Hi. I am slightly confused, and looking for advice please.

My husband is due to take early retirement at the start of April. He is a member of a defined benefit/final salary pension scheme, and is considering not taking the tax-free lump sum, in order to receive a decent monthly income, hopefully for many years to come.

Am I correct in thinking that the first 25% of each monthly payment received will be completely tax free, in lieu of the lump sum? So, for example, say he receives £30,000 per year, would £7,500 be tax-free, then the next £12,500 tax-free because of his personal allowance, meaning that he would only pay tax, at 20%, on the remaining £10,000?

Dazed_and_C0nfused

No, you are mixing up DB and DC schemes.

How much is lump sum is he giving up and how much extra pension is he getting in return?

tiddles

Lump sum of approximately £143k and £8437 per year extra.

Dazed_and_C0nfused

If he is going to be paying 20% tax on the extra pension it is really only worth £6,750/year.

But the extra pension may go up with some form of inflation related increase?

What would he do with the £143k?

tiddles

Thank you Dazed - that makes a difference to our calculations.

If he were to take the TFLS it would represent about 21 years of income difference, although probably less since pension payments will be index linked. He would possibly invest it in S&S ISAs, since the lump sum would not be needed straight away as we have other savings to supplement the pension.

xylophone

With a DB Scheme you take any lump sum at the time you begin drawing the pension - the pension itself is taxable at the rate (s) applicable to the individual. He does not pay NI on pension income.

  £143k and £8437 per year extra.

Is a commutation factor of around 17:1 - not bad but  not generous.

You say that he is retiring "early" - at what age exactly? Does he have normal life expectancy?

Does he expect to be a basic rate tax payer in retirement?

How does the pension increase in payment?

Does he have a particular use for the lump sum?

tiddles

Thanks Xylophone.

He is retiring at 61 and has normal life expectancy. Yes, he will be a basic tax payer in retirement. I believe that the pension is index linked and increases with inflation. No, he doesn’t really have a specific use for the lump sum, apart from possibly investing it to provide extra income for me, as his wife, should he die early.

kinger101

You'd only have a £20K ISA allowance each, so it would take a while to get it all into ISA.  

Your husband might be able to put some into a pension, provided he does so within the pension recycling rules.  Hopefully someone with correct me if I'm wrong, but my understanding is provided the cumulative contribution isn't more than 30% of the TFLS, this isn't a problem.  Pension contributions do need to be made from relevant earnings though (which might be high if he retires before the start of the new tax year), but after that, he can put in £2880 net each year and it will be grossed up to £3600 if he has no earnings.

The lump sum could also be used to make contributions to your pension scheme if you're still earning.

xylophone

 I believe that the pension is index linked and increases with inflation.

Does he have pre 88 and/ or post 88 GMP?

He will reach GMP age at 65.

What does his scheme booklet have to say about increases on GMP and excess? Is indexing based on CPI or RPI? Capped or not?

Has he obtained a state pension forecast?

https://www.gov.uk/check-state-pension

Is £143000 the maximum PCLS available? He can take a lesser amount?

drumtochty

Assume they get a 3% return after investment costs and assuming the couple have no other savings or investments outside an ISA, there will be no tax to pay on their returns over the 3.5 years it takes to get the lump sum into an ISA..

It will be say 83 to get more from the non commuted pension and say 87 or so to get a big chunk of extra money from the non commuted pension.

If the husband dies pre age 80, the lady is in a better financial position with the lump sum.

As suggested depending on the ladies earnings at present and in to say 67 or so, their is a case to look at increaseing her private or works pension provision or to look at increaseing both of their state pensions if they can add to their state pension after they receive their state pension forecast..

tiddles

Thank you everyone. We’ll both be retiring on the same day, at the end of the current financial year, when my husband will receive a stepped pension. My only pension is a SIPP, so I am going to leave that intact for the time being, and top it up by £3600 per year.

We have decided to take the PCLS, invest both of our SIPPs, which are currently held cash-only, invest some of the PCLS in ISAs and use the rest as drawdown to finance major house renovations and holidays.