Planning ahead: How to fund income gap from retiring at 62 to drawing DB and state pension at 68

SarahB16

I’m looking for opinions please regarding how best to bridge the gap from when I hope to retire (aged c.62) to when I can draw my DB and state pension (currently at 68 but who knows as to whether this will rise).  By way of background I am 50 years old.   

I will share my current thoughts but would be very grateful to hear what people think and how much I should grow the Standard Life DC pot to.  However, anything going in that DC pot is money that would otherwise have gone in to my LGPS AVC pot.  I will of course continue to appraise my financial circumstances and I closely monitor my expenditure to help with forecasting in the future.

Ideally I would like to retire at 62 (but this could be 64) but I thought it would be best to set out my pension provision in this post by way of background and I don’t wish to waste my personal income tax allowance.

I refer to a Standard Life DC pension below and this is a small pension pot of c.£12k (in the pot) that I built up whilst working for an employer in years 2008 to 2009 and am thinking I may wish to add to this pension pot to build up a total pot of c.£100k to help bridge my income gap from age 62 to 68.

I would prefer not to draw my LGPS DB pension until I reach state pension age so I am looking at my options and income from age c.62 to 68.  I have a small (currently c.£12k DC pension) with Standard Life and I’m thinking it would be sensible to grow this DC fund to at least c.£100k (and draw down to nil at age 68/state pension age). 

Assuming I retire at age 62 my thinking is:

Age 62 – 65: an income shortfall and the purpose of this post/question. 

Standard Life DC pension via income drawdown of at least £16,760 (using today’s personal income tax allowance amount).  First 25% is tax free and then my personal income tax allowance will be used on the remaining 75% drawn.  I will also need to live off some of my savings too in these years.  

Age 65 to state pension age:  Start drawing at 65 my DB pension from a previous employer and this will provide c.£6k per annum (increasing with RPI up to 5% cap) and also draw approximately c.£14k from the Standard Life DC pension (and aim for this to be nil at age 68).  I’m aware I will need to pay the basic rate of income tax on some of this pension income. I will also need to use some savings to live off too. 

Age 68/State pension age: State pension, DB pension (the one referred to drawing at 65 above continuing) and start drawing new LGPS DB pension from my current employer.  Replenish savings which I have been using since the age of 62 with the AVC pot.  I’m working on the assumption the Standard Life DC pension has now been fully drawn down or only has a relatively small amount left.  

My calculations in terms of how much would need to be in the pension pot (in today's money) with Standard Life are:

Age 62 – 65: 3 years at c.£17k drawn = £51k 

Age 65 – 68: 3 years at c.£14k drawn = £42k (in these years I will also have c.£6k per annum pension income from another employer)

It is probably prudent for this Standard Life pension pot to grow to at least £100k to ensure I am making full use of my tax free personal income tax allowance in the years from 62 to 68. 

My question:

Does this seem the most sensible approach for me to take, i.e. to increase my DC pot with Standard Life so that I make full use of my personal tax allowance each year I am retired. 

Any contributions I make to my Standard Life DC pension would be from my net pay.  How would I ensure that the amount going into my pension had the tax relief added?  What would I need to do?  

I’m very grateful to hear what people think please.  I do hear SIPPs mentioned on this wonderful forum but it is not something I have ever looked into (so therefore don’t really understand) with me being in the very fortunate position of having an LGPS DB pension scheme and an AVC pot that I can contribute to via salary sacrifice.  My view is that the Standard Life DC pension pot may be just what I need for those 6 years.  

I should add I’m not saying that I will be able to afford to retire at 62 as I will need to appraise my financial circumstances nearer to the time but I would like to plan ahead as to how to fund being able to retire before I reach the state pension age but without drawing on my LGPS pension.

Thank you in advance for any replies.  

Marcon

SarahB16 said:

1. Any contributions I make to my Standard Life DC pension would be from my net pay.  How would I ensure that the amount going into my pension had the tax relief added?  What would I need to do?  

2. I’m very grateful to hear what people think please.  I do hear SIPPs mentioned on this wonderful forum but it is not something I have ever looked into (so therefore don’t really understand) with me being in the very fortunate position of having an LGPS DB pension scheme and an AVC pot that I can contribute to via salary sacrifice.  My view is that the Standard Life DC pension pot may be just what I need for those 6 years.  

1. Nothing, if you are a basic rate taxpayer. Standard Life will add the basic rate tax top-up directly to your pot with them. If you are a higher rate taxpayer, you would need to claim the 'extra' tax relief via your self-assessment tax return if you do one, or directly from HMRC
2. Do a bit of reading on pension basics and you'll feel much more confident, not least with the jargon! See https://www.moneyhelper.org.uk/en/pensions-and-retirement/pensions-basics

Albermarle

Does this seem the most sensible approach for me to take, i.e. to increase my DC pot with Standard Life so that I make full use of my personal tax allowance each year I am retired. 
Sounds like a good plan. 

I do hear SIPPs mentioned on this wonderful forum but it is not something I have ever looked into (so therefore don’t really understand)
A SIPP is a DC pension, so in most important aspects very similar to your Standard Life pension.
All DC pensions work with the same basic rules about tax relief, earliest withdrawal age, tax free cash etc
Differences tend to between charging structures, and the choice of investments available.

It is more important that within a DC pension, your money is in the right sort of investment fund for your age/risk tolerance. That is the same whether it is a SIPP, or some other type of DC pension.

phynix_uk

Without more info it's difficult to say.

You AVC pot is linked to your LGPS meaning you could potentially draw all of this out (or significantly more than the 25% the SL DC pot offers) when you draw the DB.

Why wouldn't you draw the LGPS element early? I appreciate early retirement factors apply but these are unlikely to be significant (c.4/5% per year). This is guaranteed, index-linked income. You will then have a smaller demand to utilise other assets.

I appreciate that in the long run, you can draw more from DB pension by deferring them but you have to live long enough to do this! If by the time you receive the state pension you have enough income from the state and reduced DBs you're still financially secure and still have other assets to draw from at your convenience. 

SarahB16

phynix_uk said:

You AVC pot is linked to your LGPS meaning you could potentially draw all of this out (or significantly more than the 25% the SL DC pot offers) when you draw the DB.
 

Yes, my intention is to draw all of my tax free AVC pot when I begin drawing down my LGPS at 68 (my current state pension age).  I actually think this is a requirement of the LGPS AVC.  I would expect and hope my AVC pot to be significantly more than 25% of the Standard Life DC pot.   

However, based on your comment (which I really appreciate as this is a discussion) I would not be using my personal income tax allowance unless I started drawing down my LGPS 6 years early. 

phynix_uk said:

Why wouldn't you draw the LGPS element early? I appreciate early retirement factors apply but these are unlikely to be significant (c.4/5% per year). This is guaranteed, index-linked income. You will then have a smaller demand to utilise other assets.

I appreciate that in the long run, you can draw more from DB pension by deferring them but you have to live long enough to do this! If by the time you receive the state pension you have enough income from the state and reduced DBs you're still financially secure and still have other assets to draw from at your convenience. 

The LGPS is, as you quite rightly say, guaranteed index-linked income so I would prefer when I begin drawing this for it to be as high as possible which I will achieve by only beginning to draw on it when I reach the state pension age. 

I'd like to think I have a sensible head on my shoulders and I do wish to have a comfortable amount of pension income to lead a comfortable retirement (I do not have extravagant taste but do not wish to be watching where every penny goes) hence not wishing to draw my LGPS at 62 to fund my years from 62 to 68.  

Thank you for your reply as it does help me to think this all through in case I have missed something. 

Universidad

SarahB16 said:

I'd like to think I have a sensible head on my shoulders and I do wish to have a comfortable amount of pension income to lead a comfortable retirement (I do not have extravagant taste but do not wish to be watching where every penny goes) hence not wishing to draw my LGPS at 62 to fund my years from 62 to 68.  

Thank you for your reply as it does help me to think this all through in case I have missed something. 

It is worth looking at the actual maths involved in taking the DB pension early, to see if it works out better than you think, because of your specific circumstances. To whit, you're not deciding between retiring early and not retiring early, you're just trying to arrange your finances for an early retirement.

This matters, because the actuarial reduction for early retirement is to account for the extra time the pension will be paid out, it's not intended to be punitive. Do some math with your pot, and see how it works out for you for various lengths of retirement.You might find that you have to live quite a long time to end up any worse off for taking the DB pension early.

Albermarle

hence not wishing to draw my LGPS at 62 to fund my years from 62 to 68.  

You could take the LGPS early ( as pointed out you do not really lose out by doing this) and drawdown from the SL DC pot over a longer period of years. Probably end up with a similar result.

MX5huggy

My strategy currently is to maximise the Salary Sacrifice AVC the 12% NI saving compared with using a SIPP where only tax relief is received, Building up a larger AVC pot (exceeding 25% of LGPS value) that the excess is then converted to LGPS pension in payment seems to me to be better than building a DC pot. I will then take my LGPS as early as possible (when it’s big enough to live on hopefully at 60 (18 years to go)). The reductions in LGPS for going early are fair. I keep bumping up the AVC so I only get just above National Minimum Wage, for me this avoids Student Loan repayment as well so that’s another 9% going into the AVC. 

SarahB16

MX5huggy said:

My strategy currently is to maximise the Salary Sacrifice AVC the 12% NI saving compared with using a SIPP where only tax relief is received, Building up a larger AVC pot (exceeding 25% of LGPS value) that the excess is then converted to LGPS pension in payment seems to me to be better than building a DC pot. I will then take my LGPS as early as possible (when it’s big enough to live on hopefully at 60 (18 years to go)). The reductions in LGPS for going early are fair. I keep bumping up the AVC so I only get just above National Minimum Wage, for me this avoids Student Loan repayment as well so that’s another 9% going into the AVC. 

My current strategy is similar to yours in that I make sizeable AVC contributions each month (however I have only just begun making these) and I too would love to be in that position that my AVC pot exceeds 25% of the LGPS value and the excess is then converted to LGPS pension in payment. That is definitely what I am aiming for but I don't know if I will achieve it.

It is really interesting and helpful hearing you say that your strategy seems better than building up a DC pot and I actually think the strategy you are adopting is the one I too should continue to adopt going forward so no additional contributions to the Standard Life DC pension that I last contributed to in 2009 and retire when I have enough to live on.

Thank you MX5huggy that really was very helpful for me to read.

Nebulous2

SarahB16 said:

phynix_uk said:

You AVC pot is linked to your LGPS meaning you could potentially draw all of this out (or significantly more than the 25% the SL DC pot offers) when you draw the DB.
 

Yes, my intention is to draw all of my tax free AVC pot when I begin drawing down my LGPS at 68 (my current state pension age).  I actually think this is a requirement of the LGPS AVC.  I would expect and hope my AVC pot to be significantly more than 25% of the Standard Life DC pot.   

However, based on your comment (which I really appreciate as this is a discussion) I would not be using my personal income tax allowance unless I started drawing down my LGPS 6 years early. 

phynix_uk said:

Why wouldn't you draw the LGPS element early? I appreciate early retirement factors apply but these are unlikely to be significant (c.4/5% per year). This is guaranteed, index-linked income. You will then have a smaller demand to utilise other assets.

I appreciate that in the long run, you can draw more from DB pension by deferring them but you have to live long enough to do this! If by the time you receive the state pension you have enough income from the state and reduced DBs you're still financially secure and still have other assets to draw from at your convenience. 

The LGPS is, as you quite rightly say, guaranteed index-linked income so I would prefer when I begin drawing this for it to be as high as possible which I will achieve by only beginning to draw on it when I reach the state pension age. 

I'd like to think I have a sensible head on my shoulders and I do wish to have a comfortable amount of pension income to lead a comfortable retirement (I do not have extravagant taste but do not wish to be watching where every penny goes) hence not wishing to draw my LGPS at 62 to fund my years from 62 to 68.  

Thank you for your reply as it does help me to think this all through in case I have missed something. 

I considered giving a similar reply to the one above, but held back, as you seemed determined to draw your DB pension later. Drawing early should be financially neutral. You get less, but you get it for longer.

I left last year at 59, with an LGPS pension. It will meet most of our basic needs, and once we reach state pension age we will be quite well off. We have enough resources to fund the gap to get us to that point. 

In April I'll get an increase to my LGPS pension, in line with CPI, of 10.1%. My ex-colleagues will be lucky to get 4%. I've the security of a monthly payment, into my bank account, as I had for 40 years of paid employment, without being dependent on drawdown or how the stock market performs.

Yes, if I had left it until 65 or 67, the payments would have been much bigger, but how able to enjoy them will I be then? 

phynix_uk

You really need to crunch the numbers. 

The first assumption is that generally the AVC is a better option than the SL DC pot. The main benefits of avoiding NI on the way in (salary sacrifice), the ability to potentially draw up to 100% of this pot out as TFC when utilising the main DB and the underlying cost (the AVC is likely to be cheaper than the SL DC). It is also important to note that the SL DC pot is likely to offer drawdown which the AVC can't and offer greater fund options. The AVC wins hands down overall.... until the underlying value of the pot exceeds 25% of the DB pot value (20 x the annual pension + any automatic lump sum payment).

The next decision is whether to draw the LGPS early. This decision clearly doesn't need to be made for a while so looking at current inflation rates is kind of irrelevant, yes they're higher now but they will drop and the scheme indexation levels will typically be sufficient to protect pensions in payment over the longer term.

The question is whether it's sensible to draw it early. You can do basic calculation here. for example...

£20,000pa pension at normal retirement age 65, or take it 5 years early and take a 25% (5 years x -5%) hit and receive £15,000pa at 60. This is an over estimated reduction.

At age 65 (ignoring inflation) you'd be £5,000pa better off BUT this extra £5,000 would be taxable so you'd really only be £4,000 up. Still winning.... however, you've have given up 5 year's of £15,000 income (£14,514 net pa) totalling £72,570! Even with a pension paying £4,000 per year more it'd take you 18 years to make the money back meaning you'd be over 83 before you actually win the race.

Now, these numbers aren't accurate and inflation will reduce the crossover BUT the only way you ever win by deferring drawing the LGPS is by living long enough. Let's say you do, you live well past your 80's... are you going to care? You'd also have preserved more funds in the DC pot which could grow.

It is generally rare that deferring drawing DBs early isn't a good option if you're retiring. 

Crunch the numbers.