Selling the Golden Goose? (DB scheme pension swap for lump sum)

dunstonh

I see Martin often refers to taking the 25% tax-free amount from pension funds when you start

Although it's actually best advice for many people not to do that.

but I am concerned that this might really only be of significant advantage to DC schemes where annuity rates are so low that it makes sense to get the absolute maximum tax-free.

An annuity purchase is where you would take the 25% upfront (unless a GAR) because you could use a purchased life annuity with the 25%.   A drawdown scheme may be better taking it on drip.

With many DB schemes the option to take up to 25% tax-free involves giving up some of the annual pension. 

DB schemes do not have a 25% tax free lump sum.  They have a pension commencement lump sum that is based on a different calculation.  So, any discussions about 25% TFC do not apply in the same way to DB schemes.


Often it pays not to take Martin too literally.  Many years ago, he told us that he gets very short slots on media and cannot cover all scenarios and will often go for the majority option even if it may not be technically correct for everyone.      Some things, like heating bills, can easily apply to a high majority.  Whereas financial planning is more nuanced and can have very different outcomes.

For example, if you took your lump sum/income and took two different people, you may find that one is better to take the PCLS and the other not to.

they are seeing on the Money Show where Martin takes the 25% up front and then enters into either a drawdown or annuity purchase with the rest.

That would be bad advice for a lot of people and I doubt he would actually say that.   Even if that is how you recalled it.

Silvertabby

MX5huggy said:

diddyflanker said:

Thrugelmir said:

If you take a lump sum what do you plan doing with it?  Big numbers are extremely attractive. Jam today or jam tomorrow. 

Yes. I'm pretty much set on taking the minimum lump sum but many colleagues I think are misinterpreting what they are seeing on the Money Show where Martin takes the 25% up front and then enters into either a drawdown or annuity purchase with the rest. The confusion between DC and DB schemes.

I’ve not watched the show, but I think and @Silvertabby will confirm that a high percentage of people taking their LGPS take the maximum lump sum way before any ML program. People over estimate the affect of the tax on income and underestimate their life expectancy. If you’ve not got a need for the money take the annual pension. 

I’m doing AVC’s to build up a separate tax free pot. 

Certainly up to the time I retired over 90% of LGPS retirees opted for the maximum commuted lump sum.  

Albermarle

People over estimate the affect of the tax on income and underestimate their life expectancy. 

If some of the posts we see on this forum are anything to go by, many people also do not take into account that the pension will increase with inflation until they die, and do not appreciate how valuable that is.

diddyflanker

Albermarle said:

Yes. It is a public sector scheme. I saw that for the lifetime allowance it is twenty times the pension figure hence my assumption that the Government would be 'buying' the pension on the cheap.

I think you might be mixing up two issues.

The 20X figure is an arbitrary one, and most people think it significantly undervalues DB pensions in terms of the LTA %. It also applies to private sector DB pensions. In reality is should be more like 35X.

It is totally unrelated to how the government funds your/public sector pensions, which is effectively by taxation receipts

Not mixing them up but using them as two measures of the same thing.
12X is what they offer.
20X, albeit an arbitrary one, is how they value it for comparison to the LTA
Indeed if your 35X is closer to the mark it makes it even more obvious that the 12X offered is extremely poor.

In addition, that they offer 12X to everyone no matter their age is significant.
A `12X offer to a 75 year old is going to be a lot more appealing than the same 12X offered to a 55 year old.

Dazed_and_C0nfused

In addition, that they offer 12X to everyone no matter their age is significant.
A `12X offer to a 75 year old is going to be a lot more appealing than the same 12X offered to a 55 year old.

Although not many DB pensions will be taken at 75.

Mr.Generous

I took the max lump sum - my pension produces a return of about 5% on the sum invested, I used the lump sum to buy 2 properties that return 8% rental yield - and have already gone up substantially in value.

diddyflanker

Mr.Generous said:

I took the max lump sum - my pension produces a return of about 5% on the sum invested, I used the lump sum to buy 2 properties that return 8% rental yield - and have already gone up substantially in value.

Clearly if someone has a plan on how to use the lump sum it makes a significant difference to one who just sticks it in a bank!

I wonder though, that if instead of maxing out the lump sum what your returns would have been if you had taken out a fixed rate mortgage and used the pension you wouldn't have given up to service that mortgage whether that would have been better or not?

From my calculations the current best 15 year fix I found was 4.6%, a total of £16,560 for every £12,000 of capital needed.
Servicing that with the £800 of pension not given up would take 21 years at the very worst (0% inflation for 21 years).
With inflation at just 2% the £800 initial pension would have grown enough to service that loan in 18 years

To get the pension to cover the loan in 15 years inflation would need to run at somewhere between 5% and 6%.

Taking the 2% figure though I can see that I'd need to sacrifice more* than the £800 I would have given up in the early years in order to hit the 15 year timeframe of the loan but it would have the advantage of continuing to be paid after the loan had been cleared. Something that doesn't happen if you've given up the pension at the start.

*the more is based on the annual repayment being £1110. So, in the first year, £310 more. As each year went by and the £800 got the inflationary increase that excess would become less...if inflation this year is indeed going to be 10% then next year that excess would drop to £230 etc. A figure that I would have thought would have been covered by the rental income.

Flugelhorn

Albermarle said:

Yes. It is a public sector scheme. I saw that for the lifetime allowance it is twenty times the pension figure hence my assumption that the Government would be 'buying' the pension on the cheap.

I think you might be mixing up two issues.

The 20X figure is an arbitrary one, and most people think it significantly undervalues DB pensions in terms of the LTA %. It also applies to private sector DB pensions. In reality is should be more like 35X.

It is totally unrelated to how the government funds your/public sector pensions, which is effectively by taxation receipts

some years (decades) back the NHS pension scheme used to put a notional figure on the annual pension statement - of the amount you would need to buy an annuity to pay the pension at the stated level - it was quite an eye opener and yes makes the 20x a bit of an LTA bargain

nigelbb

diddyflanker said:

Mr.Generous said:

I took the max lump sum - my pension produces a return of about 5% on the sum invested, I used the lump sum to buy 2 properties that return 8% rental yield - and have already gone up substantially in value.

Clearly if someone has a plan on how to use the lump sum it makes a significant difference to one who just sticks it in a bank!

I wonder though, that if instead of maxing out the lump sum what your returns would have been if you had taken out a fixed rate mortgage and used the pension you wouldn't have given up to service that mortgage whether that would have been better or not?

From my calculations the current best 15 year fix I found was 4.6%, a total of £16,560 for every £12,000 of capital needed.
Servicing that with the £800 of pension not given up would take 21 years at the very worst (0% inflation for 21 years).
With inflation at just 2% the £800 initial pension would have grown enough to service that loan in 18 years

To get the pension to cover the loan in 15 years inflation would need to run at somewhere between 5% and 6%.

Taking the 2% figure though I can see that I'd need to sacrifice more* than the £800 I would have given up in the early years in order to hit the 15 year timeframe of the loan but it would have the advantage of continuing to be paid after the loan had been cleared. Something that doesn't happen if you've given up the pension at the start.

*the more is based on the annual repayment being £1110. So, in the first year, £310 more. As each year went by and the £800 got the inflationary increase that excess would become less...if inflation this year is indeed going to be 10% then next year that excess would drop to £230 etc. A figure that I would have thought would have been covered by the rental income.

A pensioner is likely to only be able to get a mortgage that finishes at age 75. If they retire at state pension age that may just be a nine year mortgage.

diddyflanker

nigelbb said:

...

A pensioner is likely to only be able to get a mortgage that finishes at age 75. If they retire at state pension age that may just be a nine year mortgage.

Yes, good point.

Though I'm looking at those going at the, current, minimum age of 55. Most of this group probably already have significant equity in their property to secure a loan rather than sell out their future pension.

Also relevant possibly for those who are below 55 and planning for their retirement who had their eyes on the lump sum as the way they were going to pay off the mortgage.