Should I take a lump sum from my Civil Service Pension?

pauln

Hi,  I'll be retiring in a few years and am wondering whether I should take a lump sum in return for a lower annual pension.

I don't need the lump sum as I'm fortunate enough to have paid off my mortgage and have no outstanding debts or plans for big purchases in retirement.  Therefore I hadn't planned to take a lump sum but a colleague advised me that you should always take the lump sum as it's tax free whereas the annual pension will be taxed.  As a result I'm now considering taking a lump sum and using a bit each year to supplement my annual pension back to the amount it would have been if I hadn't taken the lump sum.

I'd welcome comments on whether this is a good idea.  Is it as simple as doing a calculation along the lines of the following with some made up numbers?
Pension without lump sum = £20k = £18k after tax
Pension with lump sum = £15k = £14k after tax, Lump sum = £80k
Therefore I would use £4k per year from the lump sum to increase my pension after tax to what it would have been if I hadn't taken the lump sum.
So therefore if I think I'll live for more than 80/4 = 20 years in retirement then I should have not taken the lump sum.

Obviously the £80k could be invested and maybe generate an income of £800 per year at 1% interest which would reduct over time.

I don't really want to take the lump sum as I prefer the idea of having a known amount each year and not having to worry about the lump sum running out, but I don't want to make a decision which leaves me significantly worse off.

I'd be grateful for advice on this conundrum.

Marcon

pauln said:

Hi,  I'll be retiring in a few years and am wondering whether I should take a lump sum in return for a lower annual pension.

I don't need the lump sum as I'm fortunate enough to have paid off my mortgage and have no outstanding debts or plans for big purchases in retirement.  Therefore I hadn't planned to take a lump sum but a colleague advised me that you should always take the lump sum as it's tax free whereas the annual pension will be taxed.  As a result I'm now considering taking a lump sum and using a bit each year to supplement my annual pension back to the amount it would have been if I hadn't taken the lump sum.

Colleagues are extremely good at giving this sort of blanket advice, regardless of whether what they are saying actually holds true for everyone else (or indeed even for themself!).

pauln said:

I don't really want to take the lump sum as I prefer the idea of having a known amount each year and not having to worry about the lump sum running out, but I don't want to make a decision which leaves me significantly worse off.

Then I think that's your answer. Nobody can predict the future and if your preference is for a known amount (particularly from a rock solid, index linked pension scheme) you can safely ignore well meaning input from other people.

jimi_man

Hi.

It's very much an individual decision and despite what others may say, there is no right or wrong answer. Financially it seems that £80k lump sum will cost you £5k per year (£4k after tax) - which is a commutation rate of 16:1 (20:1 after tax) which isn't particularly great though not the worst. It depends how old you'll be too.

As an example mine was 21:1 when I retired but with the context that I was 51, so it was pretty dreadful. I didn't take it.

If you're in good health with reasonable life expectancy then financially you're likely to be better off by not taking it.

However that's only half of it. If you want a lump sum to do xxxx with or would like the flexibility of having a backup amount of cash if you don't have that, then you might feel inclined to take it. 

As you say you don't have a need for it and don't really want to take it, then don't!

Colleagues aren't always the best financial advisers!

dunstonh

but a colleague advised me that you should always take the lump sum as it's tax free whereas the annual pension will be taxed.

With some types of pension that is the correct thing to do.  With other types of pension it is the wrong thing to do.

Workplaces are often the worst place to get opinions.   They can be a hotbed of misinformation.  Sometimes accidental as people project what they think onto others and it may be right for them but not you (or they could be in a different version of the pension).  Sometimes it can be malicious.   Union reps have been known to be quite hostile to pensions in the public sector leading to horrendous financial decisions being made by some.

As a result I'm now considering taking a lump sum and using a bit each year to supplement my annual pension back to the amount it would have been if I hadn't taken the lump sum.

But your pension is not the type where a general guide is going to be correct (and even general rules of thumb are not right 100% of the time).

I don't really want to take the lump sum as I prefer the idea of having a known amount each year and not having to worry about the lump sum running out, but I don't want to make a decision which leaves me significantly worse off.

Work out the breakeven point noting that the income will increase every year.     Do not do it on the basis of the income staying the same each year.

Also, consider health - life expectancy can impact on the decision.
Spouse provision - does your spouse have their own pensions or is reliant on yours. 
Other lump sums - you don't just need an income in retirement but also the capital.  Do you have enough of that already? you will have capital spending needs during your retirement.

Linton

pauln said:

Hi,  I'll be retiring in a few years and am wondering whether I should take a lump sum in return for a lower annual pension.

I don't need the lump sum as I'm fortunate enough to have paid off my mortgage and have no outstanding debts or plans for big purchases in retirement.  Therefore I hadn't planned to take a lump sum but a colleague advised me that you should always take the lump sum as it's tax free whereas the annual pension will be taxed.  As a result I'm now considering taking a lump sum and using a bit each year to supplement my annual pension back to the amount it would have been if I hadn't taken the lump sum.

I'd welcome comments on whether this is a good idea.  Is it as simple as doing a calculation along the lines of the following with some made up numbers?
Pension without lump sum = £20k = £18k after tax
Pension with lump sum = £15k = £14k after tax, Lump sum = £80k
Therefore I would use £4k per year from the lump sum to increase my pension after tax to what it would have been if I hadn't taken the lump sum.
So therefore if I think I'll live for more than 80/4 = 20 years in retirement then I should have not taken the lump sum.

Obviously the £80k could be invested and maybe generate an income of £800 per year at 1% interest which would reduct over time.

I don't really want to take the lump sum as I prefer the idea of having a known amount each year and not having to worry about the lump sum running out, but I don't want to make a decision which leaves me significantly worse off.

I'd be grateful for advice on this conundrum.

Is your pension inflation linked?  Assuming it is:

Your calculations ignore your pension inflation adjustment whereas your £80K interest has none, quite the reverse.  So the break even figure is less than 20 years.  Assuming 2.0% inflation the break even would be at 17 years which is below your life expectancy assuming you are of average health.. AT 2.5% inflation the break even reduces to 15 years.  Of course you may lifve significantly longer than average.

Look at things another way - you would be giving up £4K/year after tax for a lump sum of £80K.  Assuming you get your pension at 65 and that you are of average health If you bought a guaranteed inflation linked income until you die with that £80K you would get about £2200 /year.  Using the often quoted 3.5% safe withdrawal rate if you took drawdown from the £80K invested mainly in shares you could expect an inflation limked income until you die of £2800.

If you dont need the cash lump sum the £4K after tax from the pension looks much more valuable unless you have good reason to believe your life expectancy is significantly lower than average.

MX5huggy

There’s no point taking a lump sum if you’re going to just try to convert that annual income which will fall short of the annual income on offer.

You could invest the £80k and the expectation is that returns should be in the rang of 4 to 7 % per year on average but with risks of significant drops as well.

If you are retiring before state pension age then the lump sum could be used to smooth your income till then. Ie £10k per year from 60 to 68 to top up the £15k pension. Then you have SP kicking to replace it. Instead of living off £20k pension for 8 years then the SP bumping up to £30k. 

hugheskevi

pauln said:

Pension without lump sum = £20k = £18k after tax
Pension with lump sum = £15k = £14k after tax, Lump sum = £80k

I suggest checking this - the commutation rate is 12:1, not 16:1.

Brie

Worst case scenario.....you take the lump sum when you retire and then get hit by a bus/have a stroke/catastrophe and need care for the rest of your life.  Assuming you don't have that £80k in an account joint with a spouse that will be the first point of call to pay for any care you need until it's whittled down to whatever the savings limit is at the time. (£23k? now)  Now it's possible that you won't be able to really take advantage of the pension(s) being paid to you but it will always be the smaller amount.

You wouldn't necessarily lose your home assuming you continue to live there (or your spouse is) but obviously that may be the next thing to be consumed by your care costs.  

Secret2ndAccount

You have done the sums. Clearly you will get more money out over an average lifetime by declining the lump sum. Your friend is prepared to cut off his own nose to spite the taxman's face.
Here are other things to consider:
1. Inheritance
If you were to die, whatever remained of the lump sum would form part of your estate. If everything passed to your spouse, there would likely be no inheritance tax. Otherwise, IHT would be possible. If you left the money in the pension, would your spouse receive a larger widow's pension, or would the extra money simply be lost? Think about what makes the best provision for those you leave behind, and to what extent that is important to you.

2. Spending 
If you can afford to take the lump sum, and still have good provision for the rest of your days, why not take it and spend it? Will you need the higher pension when you are older? Will you be able to enjoy it? If you realise you can afford to treat yourself to something, you might still decline the lump sum, and take the money from a different source. You seem quite capable of doing the maths for yourself.

HTH

Dazed_and_C0nfused

I hadn't planned to take a lump sum but a colleague advised me that you should always take the lump sum as it's tax free whereas the annual pension will be taxed. 

Does your colleague understand the impact of the inflation proofing element of your pension and how much that might be worth over the next 30+ years.

Most people would rather have more money after tax than pay no tax and be worse off.

ukdw

A lump sum from a DB pension is similar in a some ways to a CETV for part of the pension.   

For CETVs the government insist you take financial advice for anything above £30k, but for lump sums very often well above £30k and almost always at terms much worse than CETVs there is no requirement for advice.

Doesn't make a lot of sense to me.  

Also it doesn't seem very fair that DB pensioners who don't take lump sums often effectively pay 25% more tax than DC pensioners (who almost always take 25% tax free).  I'm surprised that the DB schemes haven't found a clever way around this - such as having some sort of linked tax free annuity scheme.

In terms of whether to take a lump sum, if the net commutation factor was above 25 then I would consider it.

If I had health problems which are likely to significantly reduce life expectancy I would consider it.

If the lump sum can come entirely out of AVCs (without reducing the DB), then I would probably take it - unless the rate of buying additional DB from AVCs was very good.

If I had no savings I might take a part of the lump sum (if it is an option) to allow some extra enjoyment at the start of retirement.

Otherwise at a net commutation factor of 20x like the OP I would decline it, and take the extra income.