Crystallizing pension and few Q’s

Kinclad

Hi,

Been following many threads in this forum and have been able to improve my knowledge in many areas regarding pensions and planning. But i hope someone can assist me on a few point relating to my personal situation.

Im 53 years old.

My annual salary is 60K

 

I have 2 DC pensions :

1 through a previous employer and with Standard life – Current value - £158K

1 through my current employer and with Scottish Widows - Current value - £116K

I currently salary sacrifice 10% of my salary into the Scottish Widows pension and my employer contributes 10.7%

I have an outstanding mortgage of £85K, on a fixed 1.29% deal until May 2026.

So I have a lost of questions, hopefully they are all pretty much 1 liner replies to make things easier.

My Standard life policy has a 14K final bonus, I’m presuming that would be lost if I transferred the value to Scottish Widows and so it probably makes sense to just leave and allow to grow with no additional contributions?

I understand at the age of 55, I can cash in 25% of my pension and it will become crystallised, my questions on this are…

Does the 25% apply across my entire pension portfolio (ie both DC’s?) or can the 25% only be drawn from only 1 of the policies?

If I only took 10% (after I’m 55), does that mean I still have 15% that can be drawn without a tax burden at a later date? Or is it the case you have 1 opportunity and once you take a percentage, and then that’s your 25% opportunity finished?

I'm in a position where I could increase my pension contributions. But based on my current mortgage deal, do you think it would make sense to use that money to make overpayments on my outstanding mortgage up until the end of the fixed rate deal?

At the end of my fixed rate, knowing I’m not likely to get another 1.something deal, my intention would be to then (potentially!) draw the required % from my pension/s and clear my mortgage.

I wouldn’t take the decision to dip into my pension to clear my mortgage lightly as I fully understand its there to provide me a reasonable standard of living once I stop working.

And with the above in mind (based on my desire to retire in around 10 years time and enjoy a reasonable standard of living - I also will have a full state pension). I feel I should really be upping my contribution to my SW pension. Maybe increasing from 10% to 20%, based on the fact the next 10 years is my final opportunity to actually make a difference! (I unfortunately lost 13 years worth of pension saving when I ran my own business and stopped making any contributions). Would be interested on peoples thoughts on this.  

I appreciate that some of the responses to the above are going to be dependent upon market changes (that know one knows), but just interested in people’s views.

Thanks in advance for any guidance.

sheslookinhot

Kinclad said:

Hi,

Been following many threads in this forum and have been able to improve my knowledge in many areas regarding pensions and planning. But i hope someone can assist me on a few point relating to my personal situation.

Im 53 years old.

My annual salary is 60K

 

I have 2 DC pensions :

1 through a previous employer and with Standard life – Current value - £158K

1 through my current employer and with Scottish Widows - Current value - £116K

I currently salary sacrifice 10% of my salary into the Scottish Widows pension and my employer contributes 10.7%

I have an outstanding mortgage of £85K, on a fixed 1.29% deal until May 2026.

So I have a lost of questions, hopefully they are all pretty much 1 liner replies to make things easier.

My Standard life policy has a 14K final bonus, I’m presuming that would be lost if I transferred the value to Scottish Widows and so it probably makes sense to just leave and allow to grow with no additional contributions? Are you sure it’s a DC pension ? Sounds like a different type of policy with reference to a bonus.

I understand at the age of 55, I can cash in 25% of my pension and it will become crystallised, my questions on this are…

Does the 25% apply across my entire pension portfolio (ie both DC’s?) or can the 25% only be drawn from only 1 of the policies? 25% tax free sums can be taken from both DC pensions.

If I only took 10% (after I’m 55), does that mean I still have 15% that can be drawn without a tax burden at a later date? Or is it the case you have 1 opportunity and once you take a percentage, and then that’s your 25% opportunity finished? Yes, you can take 15% at a later date.

I'm in a position where I could increase my pension contributions. But based on my current mortgage deal, do you think it would make sense to use that money to make overpayments on my outstanding mortgage up until the end of the fixed rate deal? No

At the end of my fixed rate, knowing I’m not likely to get another 1.something deal, my intention would be to then (potentially!) draw the required % from my pension/s and clear my mortgage.

I wouldn’t take the decision to dip into my pension to clear my mortgage lightly as I fully understand its there to provide me a reasonable standard of living once I stop working.

And with the above in mind (based on my desire to retire in around 10 years time and enjoy a reasonable standard of living - I also will have a full state pension). I feel I should really be upping my contribution to my SW pension. Maybe increasing from 10% to 20%, based on the fact the next 10 years is my final opportunity to actually make a difference! (I unfortunately lost 13 years worth of pension saving when I ran my own business and stopped making any contributions). Would be interested on peoples thoughts on this.  

I appreciate that some of the responses to the above are going to be dependent upon market changes (that know one knows), but just interested in people’s views.

Thanks in advance for any guidance.

Thoughts in bold.

dunstonh

My Standard life policy has a 14K final bonus, I’m presuming that would be lost if I transferred the value to Scottish Widows and so it probably makes sense to just leave and allow to grow with no additional contributions?

No.   Final bonuses accrue as you go along and the transfer value will include what you have accrued to date.  You can verify this by comparing the current value (which will be the value without final bonus) and the transfer value.   The transfer value will be higher.

Does the 25% apply across my entire pension portfolio (ie both DC’s?) or can the 25% only be drawn from only 1 of the policies?

Whilst pension rules allow one scheme to pay the tax free cash entitlement of other schemes, the commercial reality is that hardly any schemes support that.  So, each scheme will have its own tax free cash entitlement.

If I only took 10% (after I’m 55), does that mean I still have 15% that can be drawn without a tax burden at a later date? Or is it the case you have 1 opportunity and once you take a percentage, and then that’s your 25% opportunity finished?

Yes and no.    If you wanted to draw 10% then you would only crystallise 40% of the pension.  The other 60% would remain uncrystallised and will be subject to investment returns.      You can get 25% of whatever that value is at the time you make further crystallisations.   As that value is likely to be higher, this means overall, you are likely to get more than 25% of that starting value out.

If you use the 25% as part of your income drawdown (a very popular method but little known), then you will never have a crystallised fund (bar pennies for rounding) and will always have the 25% available on the remainder.

I'm in a position where I could increase my pension contributions. But based on my current mortgage deal, do you think it would make sense to use that money to make overpayments on my outstanding mortgage up until the end of the fixed rate deal?

In the majority of periods, the pension contributions beat the mortgage payments (e.g. pension investment returns averaging around 6% a year (plus tax relief uplift) vs mortgage interest).    For higher rate taxpayers, pension contributions become even more beneficial over mortgage overpayments.

That said, often people do a combination (which can also include S&S ISAs) so they edge their bets a bit.

At the end of my fixed rate, knowing I’m not likely to get another 1.something deal, my intention would be to then (potentially!) draw the required % from my pension/s and clear my mortgage.

That normally is not considered a good idea unless it is part of your retirement.  e.g. you have just retired and have £x left on the mortgage which could be cleared by £y from the TFC resulting in your monthly outgoings reducing and therefore not needed to be covered by the pension.   

If you are still working, then its nearly always a bad idea.  Plus, if you use all your TFC on that, you lose the ability to use over the remainder of your lifetime which could increase the tax you pay over your lifetime.

And with the above in mind (based on my desire to retire in around 10 years time and enjoy a reasonable standard of living - I also will have a full state pension). I feel I should really be upping my contribution to my SW pension. Maybe increasing from 10% to 20%, based on the fact the next 10 years is my final opportunity to actually make a difference! (I unfortunately lost 13 years worth of pension saving when I ran my own business and stopped making any contributions). Would be interested on peoples thoughts on this.  

The simple way to look at it is that the more you pay in, the more you will have and its only you (or your family) that benefits from this.  If you don't pay in enough, its only you (or your family) that will suffer.

OldMusicGuy

dunstonh said:

My Standard life policy has a 14K final bonus, I’m presuming that would be lost if I transferred the value to Scottish Widows and so it probably makes sense to just leave and allow to grow with no additional contributions?

No.   Final bonuses accrue as you go along and the transfer value will include what you have accrued to date.  You can verify this by comparing the current value (which will be the value without final bonus) and the transfer value.   The transfer value will be higher.

What dunstonh said. I transferred a Standard Life with profits scheme to my SIPP and it included the full final bonus per the most recent statement of transfer value..

IdrisJazz

OldMusicGuy said:

dunstonh said:

My Standard life policy has a 14K final bonus, I’m presuming that would be lost if I transferred the value to Scottish Widows and so it probably makes sense to just leave and allow to grow with no additional contributions?

No.   Final bonuses accrue as you go along and the transfer value will include what you have accrued to date.  You can verify this by comparing the current value (which will be the value without final bonus) and the transfer value.   The transfer value will be higher.

What dunstonh said. I transferred a Standard Life with profits scheme to my SIPP and it included the full final bonus per the most recent statement of transfer value..

This will not always be right.

Your most recent quoted transfer value will be based on you having transferred on that date, so if you proceed with a transfer soon after, your final bonus will be broadly the same. But that doesn't mean that it hasn't been reduced from what it would be if you waited until retirement age.

I work for a pension provider that provides with profits pensions, and we always reduce the final bonus in the event of an early transfer. The final bonus is not guaranteed - it is calculated at the end, not like an annual bonus.

Unfortunately, your provider will not be able to guarantee what the final bonus will be if you sit tight, because they are not guaranteed and depend on future returns.

Not all providers will work in the same way perhaps, but thought I should bring this to light.

Kinclad

Thank you for all your comments, they have been really helpful. 

I guess my motivation behind making overpayments on the mortgage is the fact that I'm on a low interest rate and so it feels like an ideal time to be making payments knowing its paying more off the balance and not interest. But I appreciate also all the benefits of that money going into a pension pot instead. 

So based on the above I have a question that is intriguing me. If investments normally provide a better return when compared to interest your incurring on a mortage. Then why did endowments disappear? Iirc they were interest only and you relied upon the separate investment to clear the loan and pay you a bonus?

Thanks 

Albermarle

IdrisJazz said:

OldMusicGuy said:

dunstonh said:

My Standard life policy has a 14K final bonus, I’m presuming that would be lost if I transferred the value to Scottish Widows and so it probably makes sense to just leave and allow to grow with no additional contributions?

No.   Final bonuses accrue as you go along and the transfer value will include what you have accrued to date.  You can verify this by comparing the current value (which will be the value without final bonus) and the transfer value.   The transfer value will be higher.

What dunstonh said. I transferred a Standard Life with profits scheme to my SIPP and it included the full final bonus per the most recent statement of transfer value..

This will not always be right.

Your most recent quoted transfer value will be based on you having transferred on that date, so if you proceed with a transfer soon after, your final bonus will be broadly the same. But that doesn't mean that it hasn't been reduced from what it would be if you waited until retirement age.

I work for a pension provider that provides with profits pensions, and we always reduce the final bonus in the event of an early transfer. The final bonus is not guaranteed - it is calculated at the end, not like an annual bonus.

Unfortunately, your provider will not be able to guarantee what the final bonus will be if you sit tight, because they are not guaranteed and depend on future returns.

Not all providers will work in the same way perhaps, but thought I should bring this to light.

I can only say that like OldMusicGuy that I transferred a with profits pension early from SW to a SIPP, and the full value came across, including all the accrued final bonus.

dunstonh

I work for a pension provider that provides with profits pensions, and we always reduce the final bonus in the event of an early transfer. The final bonus is not guaranteed - it is calculated at the end, not like an annual bonus.

It is extremely rare for the final bonus accrued to date to be reduced.  In fact, I don't believe I have ever seen it apart from on extremely old conventional with profits plans.      The most common scenario is that the final bonus accrues as you go along. it can go up and down (potentially on a daily basis).   However, it is not calculated at the end (except on some legacy conventional with profits plans).

It is very common for there to be a transfer penalty on these legacy schemes but the transfer value is typically a totting up of things.  i.e.  Current value + final bonus - transfer penalty and/or MVR
With old fashioned conventional with profits plans, the transfer value could be sum insured+ annual bonus+final bonus adjustment for the early transfer.

I guess my motivation behind making overpayments on the mortgage is the fact that I'm on a low interest rate and so it feels like an ideal time to be making payments knowing its paying more off the balance and not interest. 

Surely its better to make overpayments when the interest rate is higher?    
Overpayments reduce the capital borrowed.  Interest is charged on the balance.   

So based on the above I have a question that is intriguing me. If investments normally provide a better return when compared to interest your incurring on a mortage. Then why did endowments disappear? Iirc they were interest only and you relied upon the separate investment to clear the loan and pay you a bonus?

Multiple reasons why endowments disappeared:
1 - The tax wrapper dropped below PEPs (now ISAs) and GIAs (unwrapped holdings) in the pecking order and effectively only became potentially tax efficient to higher rate taxpayers who had already used up their PEP/ISA allowances and a good chunk on GIAs.
2 - They were inflexible compared to modern alternatives.  That couldn't be adjusted as the tax rules were based in law rather than a choice by providers.    A bit like trying to market a black and white TV in an ultra HD widescreen world.
3 - Investment platforms were replacing life assurance companies as the main home for investments.   Within 2 years of the investment platforms launching, the last mainstream endowment provider withdrew their product.  UT/OEICs became the alternative.
4 - The killing off of MIRAS removed the tax relief on interest making interest only less attractive.
5 - The killing off of LAPR removed the tax relief on life assurance making endowments less attractive than other tax wrappers.
6 - Endowments gained a poor reputation because too many being set with target growth rates that were too high and went on to fail to hit target.  When the economy moved from high inflation and boom/bust to low inflation and stable, the endowments could not be changed to adapt to the new world of lower returns gross of inflation.

When the endowment was set up, the seller could set the target growth required to hit target on maturity.    I used to do endowments at 4.4% target growth rate.  In other words, a return of 4.4% average over the term was needed to hit target.    Yet many endowments were set up needing 11-13% per annum to hit target.    The higher the target growth rate, the lower the monthly premium and less went into the investments.       There used to be media tables on best buys and often they would ask the providers to give their sample quote.   So, the providers, knowing they were going to be in the table compared with others would use high target growth rates to lower the premiums and make them appear cheaper.   The sellers would also do the same.   e.g. agent A, who you see first quotes an endowment policy at 4.4% costing £x per month.   You then see agent B who you have told the figures for the endowment from agent A.  Agent B lowers the premium below that of agent A by increasing the target growth rate to 9%.     You think the second one is better as its cheaper and you buy that one.     Over the years, the actual return turns out to be 6.5% (which is the long term average ballpark for the most common risk level).   Agent A's endowment would have hit target and paid surplus but agent B's endowment didnt hit target and fell short.  

You would have the same outcome even if you used the same fund.  i.e. two endowments from the same provider invested in the same fund but using different target growth rates.    That fund returned 6.5% p.a. average. Any endowment invested in that fund with a target growth rate of 6.5% or less hit target. Any with a target growth rate over 6.5% failed to hit target.

Kinclad

dunstonh said:

I work for a pension provider that provides with profits pensions, and we always reduce the final bonus in the event of an early transfer. The final bonus is not guaranteed - it is calculated at the end, not like an annual bonus.

It is extremely rare for the final bonus accrued to date to be reduced.  In fact, I don't believe I have ever seen it apart from on extremely old conventional with profits plans.      The most common scenario is that the final bonus accrues as you go along. it can go up and down (potentially on a daily basis).   However, it is not calculated at the end (except on some legacy conventional with profits plans).

It is very common for there to be a transfer penalty on these legacy schemes but the transfer value is typically a totting up of things.  i.e.  Current value + final bonus - transfer penalty and/or MVR
With old fashioned conventional with profits plans, the transfer value could be sum insured+ annual bonus+final bonus adjustment for the early transfer.

I guess my motivation behind making overpayments on the mortgage is the fact that I'm on a low interest rate and so it feels like an ideal time to be making payments knowing its paying more off the balance and not interest. 

Surely its better to make overpayments when the interest rate is higher?    
Overpayments reduce the capital borrowed.  Interest is charged on the balance.   

Sure, but I guess I'm looking at it from an affordability perspective, ie my mortgage payment is low due to the low interest rate, so I have spare income, so try and reduce the balance during this period so I pay less interest on the balance when my fixed rate finishes and my new rate is 3-4% more. 

So based on the above I have a question that is intriguing me. If investments normally provide a better return when compared to interest your incurring on a mortage. Then why did endowments disappear? Iirc they were interest only and you relied upon the separate investment to clear the loan and pay you a bonus?

Multiple reasons why endowments disappeared:
1 - The tax wrapper dropped below PEPs (now ISAs) and GIAs (unwrapped holdings) in the pecking order and effectively only became potentially tax efficient to higher rate taxpayers who had already used up their PEP/ISA allowances and a good chunk on GIAs.
2 - They were inflexible compared to modern alternatives.  That couldn't be adjusted as the tax rules were based in law rather than a choice by providers.    A bit like trying to market a black and white TV in an ultra HD widescreen world.
3 - Investment platforms were replacing life assurance companies as the main home for investments.   Within 2 years of the investment platforms launching, the last mainstream endowment provider withdrew their product.  UT/OEICs became the alternative.
4 - The killing off of MIRAS removed the tax relief on interest making interest only less attractive.
5 - The killing off of LAPR removed the tax relief on life assurance making endowments less attractive than other tax wrappers.
6 - Endowments gained a poor reputation because too many being set with target growth rates that were too high and went on to fail to hit target.  When the economy moved from high inflation and boom/bust to low inflation and stable, the endowments could not be changed to adapt to the new world of lower returns gross of inflation.

When the endowment was set up, the seller could set the target growth required to hit target on maturity.    I used to do endowments at 4.4% target growth rate.  In other words, a return of 4.4% average over the term was needed to hit target.    Yet many endowments were set up needing 11-13% per annum to hit target.    The higher the target growth rate, the lower the monthly premium and less went into the investments.       There used to be media tables on best buys and often they would ask the providers to give their sample quote.   So, the providers, knowing they were going to be in the table compared with others would use high target growth rates to lower the premiums and make them appear cheaper.   The sellers would also do the same.   e.g. agent A, who you see first quotes an endowment policy at 4.4% costing £x per month.   You then see agent B who you have told the figures for the endowment from agent A.  Agent B lowers the premium below that of agent A by increasing the target growth rate to 9%.     You think the second one is better as its cheaper and you buy that one.     Over the years, the actual return turns out to be 6.5% (which is the long term average ballpark for the most common risk level).   Agent A's endowment would have hit target and paid surplus but agent B's endowment didnt hit target and fell short.  

You would have the same outcome even if you used the same fund.  i.e. two endowments from the same provider invested in the same fund but using different target growth rates.    That fund returned 6.5% p.a. average. Any endowment invested in that fund with a target growth rate of 6.5% or less hit target. Any with a target growth rate over 6.5% failed to hit target.

Wow, thanks for taking time with the detailed insight. Yes I do recall them gaining a bad reputation. It seemed following this period there seemed to be a period where people had no repayment method at all with interest only mortgages! Quite frightening really