USS Pension Options

Simes122

Hi All, after some advice or a sanity check re my USS options.

My circumstances are:

Retiring at 59 end July 23, live in Scotland so subject to HR tax from £43663 of 42%.   I have Forces DB pension (£40400 pa) in payment, which combined with any of the below USS options (for the DB portion), will make me a HR taxpayer in retirement due to the low HR Tax threshold up here in Scotland.  I thus have a good core pension.

USS figures provided by Statement are:

Annual Pension £5055.60 with TFLS of £15166.8

Investment Builder pot of £203856

The default USS Hybrid quotes were:

1. Max Pension:  £5531.4 PA with 0 TFLS and £203856 left uncrystallised in my pot.

2. Max TFLS:   £5531.4 PA, with £36876 TFLS £166978 left uncrystallised in my pot.

Following discussion on here, I did some modelling in the conversion modeller and the following options would be available:

3.  Min Pension:  £4431 PA with £29552 TFLS and £203856 left uncrystallised in my pot.
4.  Std Pension: £5056 PA with £33703 TFLS and £185325 left uncrystallised in my pot.

In all options, the annual pension added to my Forces pension will mean my marginal rate for any of my uncrystallised funds is 25% TF and 42% tax on the remainder.

So my thinking is Option 3 and 4 are the most attractive for my Tax circumstances.  I'm slightly torn between 3 and 4 and maybe Option 4 is a good compromise perhaps.

Both option 3 and 4 will give me around the £80k tax free (mortgage outstanding is £67k in 2025 so I'll use to clear that).  

Am I missing anything - I think 1, 2, the default options are less attractive than 3 or 4.

Need to make a decision soon given the time to retirement - I have considered other options such as deferring taking the USS pension, but from my modelling, it seems be almost swings and roundabouts unless I plan on living to around 95 (which would be nice, but I won't need so much income then).

Cheers

Simon

Simes122

Hoping @ussdave might see this thread as he's been very helpful before

Simes122

My logic for Option 3 being attractive is that all my annual pension is exposed to 42% income tax, whereas my DC pot will have 25% tax free.  So it looks better for me to sacrifice annual pension as the commutation rate is ok, with the added advantage of only 31.5% tax instead of 42% tax.  Even with index linking, I think I’m better off.  Option 4 is a bit best of both worlds I think.

ussdave

Sorry, busy long weekend so I didn't really have an opportunity to reply.

I'm not an expert on tax matters (I get the basics of course) so I'm going more from a gut feel on this than anything else.

It seems to me that you have sufficient regular income for your needs and that the impact of the higher rate tax makes the highest TFLS option fairly appealing.  The real test I suppose is whether or not you have a use for the additional tax free cash.  If you do (even if it's just buying yourself something nice/going somewhere) nice then....why not?

For myself I'd be tempted to do the sums to a sufficient level of detail that I definitely wasn't doing something really silly by taking one option over another, simply so I wouldn't in future years wonder "what if".  That done (and assuming the options are quite close to each other), I'd then choose based primarily on whether or not I had a use for the extra tax free sum.

Simes122

Hi Dave,

Thanks for your feedback and no worries – it has given me time to look under the hood and do some detailed modelling and analysis of the options.  I thought I’d share my thoughts, as others may be benefit, even though you may know all of this, but it’s good to help my understanding of how it works!  Standby for worked examples! 

One thing I would say, is the USS default options are not great – hard to see that they’d be the right choice for anyone.

My pension quote baseline was as follows:

RB (DB) Pension of £5055.60,  RBLS of 3 x RB = £15166.8 and I have £203856 in my IB (DC) pot.

The USS default options were Max Pension and Max Tax Free Lump sum.  My analysis of these was as follows:

A:  USS Max Pension:  RB £5531.40 pa, RBLS = 0 and £203856 left in my IB(DC) pot.

Analysis:  This is using reverse commutation on my RBLS, to buy extra pension to the maximum allowed by the scheme.   Essentially it ‘costs’ me my ‘tax free’ RBLS of £15166.8 to buy an extra £475.80 a year taxable, leaving my IB(DC) pot untouched.  Reverse commutation factor is impacted by age (me 59) and works out at around 31.88 (smaller is better in the reverse direction).   Tax is really important to consider here.  For me, that £475.80 is impacted by 42% tax, but is subject to indexation increases.  After tax is factored in, I need to live to 86 (if CPI is 5%), 96 (if CPI is 2%) or 83 (if CPI is 10%/7.5%) before I start to be better off using this option.  And that’s assuming I’ve spent that RBLS rather than invested and grown it.

B:  USS Max Tax Free Lump Sum: RB £5531.40 pa, RBLS = £36876, and I have £166980 remaining in my IB(DC) Pot.

Aside, per HMRC rules: for this scheme, the maximum hybrid TFLS achievable is 6.6666 x one’s RB(DB).   

Analysis.  £5531.40 x 6.666 = £36876 (which more than coincidentally is the figure above).    Per the above explanation in A), my RBLS is being reverse commuted to increase annual pension per Option A to £5531.40.  That disposes the RBLS via commutation.  My critique there is the same.   The difference now, is the scheme flexibility is being used to allow the 6.6666x under HMRC limits to give a TFLS from my DC pot and £36876 is now given Tax free status, while leaving the balance of £166980, uncrystallised in my IB/DC pot.   That can be later taken at 25% tax free, with the balance at one’s marginal rate or moved elsewhere as it’s uncrystallised.   So this option is not great from the reverse commutation perspective, but does allow you to extract more in total from your IB/DC pot tax free.  The ‘maximum’ total that can be taken from both sides of my pension using this hybrid option, is £36876, plus 0.25 x residual DC pot (£166980 x 0.25) = £41745, which gives a total tax free extraction of £78621 across both sides of the pension.   My suspicion is that many USS default users, will see this as the best option for them because it says Max Tax Free and if that’s what they want and need, and will choose this.   However, I established in A) that the reverse commutation was not ideal due to the factor used.   But in other regards, it’s quite useful for gaining a good sum of Tax free money – but is it the best?  Not for me.  You’ve noted this previously too in advice to others.  That reverse commutation is not good value in my view.  Also total coming back to me from USS via this route in cash terms is 166980 + £36876 = £203856 total back to me.

------------

I then added in Option C and D, by using the conversion modeller.   My analysis of these is as follows:

 C:  Minimum Pension.  RB £4432, RBLS = 29540, and I have £203856 completely unused in my DC pot.   This is the same 6.66666x being applied to RB to give RBLS.  

 Analysis:  Essentially this time, I’ve commuted RB to RBLS.   At a cost of £623.60 PA from my RB pension, I’ve increased my RBLS from £15167 to £29540.  Or in other words, £14372 tax free has been generated from the sacrifice of £623.60 PA gross, or £361.69 net in my case (42% tax).  A conversion factor on the gross amount of 23 ish, and, on the net amount as will apply to me – effectively a forward commutation rate of 39.74 – which is a great deal (bigger = better in the forward direction).    I won’t live long enough for this to be a factor, irrespective of CPI growth indexation rates.   Interestingly despite USS Option B billing itself as Max TFLS – well it is and it isn’t.   Because I’ll get £29540 out tax free under the scheme rules, and my DC pot remains untouched and uncrystallised using this route, there is a further 0.25 x £203856 = £50964 available tax free.   A combined TFLS of £80504.   So better from the size of TFLS perspective overall.   Also, in total, USS will be giving me back, £203856 + £29540 = £233.4k in total, because nothing has come from my DC pot.   For me this gives me £233.4k to play with, while just sacrificing £361.69 net from my annual income.

D - No Commutation.   RB: 5055.60 pa, RBLS: £33704, and leaves £185325 uncrystallised in the DC pot.

This one is more simple I think.   6.6666 factor is used to determine max TF of £33704 allowable under scheme rules.  £15166.80 comes from the RBLS, and the balance from the DC pot, to make up the £33704.

It leaves me with a total of £33704 + £185325 total (£219028 in total cash terms) from the scheme and 5055.60 pa.  

 Summary

Overall then for me as a HR taxpayer, option C is indeed the better option irrespective of whether I need the TFLS or not, as indexation can’t better it, because of the tax advantages effectively increasing the commutation factor skywards.  I get more overall to invest as I see fit, and the largest TFLS.   I think, but haven’t done the sums, that a lower rate taxpayer would perhaps similarly benefit.  The key thing is the commutation factor has a greater effect because it’s applied against gross income, not net income if that makes sense.   And reverse commutation magnifies that in the opposite direction – and in both the defaults, they are making you buy annual pension at ugly conversion rates via reverse commutation.

 Everyone is different in terms of marginal tax rates, so worth working through for your own tax circumstances.  However, the default options quoted by USS might be ok if say you absolutely needed Annual Income directly and weren’t perhaps a taxpayer.

 Sorry that’s been an essay, but maybe it’ll be useful to someone!   Please feel free to point out errors or issues!  Caveats include: I am not an expert in this, I may have made mistakes or faulty assumptions, and this has mostly been an exercise in which might be the best USS option for me and my particular tax circumstances!  YMMV.

 Cheers, Simon

Simes122

As for having a use for the TFLS - in my case, it's tax avoidance and because the scheme factors make it unattractive for me not to commute given my tax circumstances.  It turns a bit of conventional logic on its head - it's certainly poor value to buy extra annual pension using their factors, and by reducing annual Taxable income in favour of Tax free lumps at what is a decent factor in the forward direction, I don't see much downside if I live to a decent age.  I do have a need for the Tax free now anyway - the differences in TFLS overall in my case, aren't huge so that's not really a decision point - but not taking TFLS would almost certainly cost me money overall I think.

ussdave

Really useful analysis   Thanks for sharing it.

In regards to my statements about "having a use for the TFLS", they were based on the assumption that there was little overal difference in benefit of any of the outcomes you were likely to choose.  Now you've done the workings out, it really doesn't apply (or certainly isn't as important a factor).

Simes122

Thanks Dave - it has been a useful exercise in satisfying myself why I’d make a given choice - it’s certainly complicated to get one’s head around.

The bit I found interesting was the 6.6666x. And what I’ve called the tax free RBLS, and the TFLS from the DC pot.  I think that’s useful for anyone wondering how much they can take tax free out of uss as a hybrid scheme in very simple terms.  Eg if your annual pension is 10,000 then the max you can extract from your DC pot will be 66,666 - this is your RBLS and is tax free.   If your pot contained 166,666, then the 66,666 would be taken from that for your RBLS, leaving 100k in your DC, uncrystallised.  You can do with that what you like when you like, but when you take it or transfer it, £25k of that will be a TFLS too. 

They sure don’t make it simple or easy do they? 🤣. Appreciate your help on this journey!

bluenose1

They certainly don’t explain it well in their statements, I have had to read your above options several times…. Good to see your calculations as I think it is important we understand as they don’t make it easy.
I will be a basic rate tax payer in retirement so for me I think it would be Option D for the standard pension with the max TFLS, though will do the calculations for option C again first before I decide as could be a close call. 
I totally get why option C is best for you as a higher rate tax payer.
Would be interested to know if USS come back with same figures as the conversion modeller for Option C and D. Just wondering if rules are different for commutating if taking combined with DB/DC hybrid scheme as not sure if there is a limit on the tax free amount allowed by HMRC.
Thats really good to know re the 6.6666, saves us doing the complicated calculations.
Pity USS aren’t as helpful in explaining the options.

Simes122

bluenose1 said:

They certainly don’t explain it well in their statements, I have had to read your above options several times…. Good to see your calculations as I think it is important we understand as they don’t make it easy.
I will be a basic rate tax payer in retirement so for me I think it would be Option D for the standard pension with the max TFLS, though will do the calculations for option C again first before I decide as could be a close call. 
I totally get why option C is best for you as a higher rate tax payer.
Would be interested to know if USS come back with same figures as the conversion modeller for Option C and D. 
Thats really good to know re the 6.6666, saves us doing the complicated calculations.
Pity USS aren’t as helpful in explaining the options.

Think option D is worth modelling and testing.  10k taken instantly tax free will always be worth more than 10k taken over time at 20% tax, all else being equal.  

Depending on your age using option C to generate that 10k, will cost 10k/23 (age dependent conversion factor approx).  So £434 pa gross.  Had you taken that £434 gross pa and were a basic rate taxpayer, you are actually getting  £347 pa net.

in simple terms that means £10000/347 = 28.81 years before you’d be worse off.

Now of course the £347 is indexed.  So will rise by cpi ish (subject to caps).  While the £10k could be invested, achieving say better than cpi ish hopefully.  But your starting point is 10k invested rather than incremental cumulative investments of £347.  My sense is that the 10k tax free is the better proposition if you are a taxpayer as it would win from the start if invested.  If it’ll get spent either way, then it’s 28.81 years before you are worse off using that factor.  That would take me to 88.  I think if I get beyond that point, I doubt I’ll regret having fun at 59 for the sake of a few quid over the next couple of years I’d have left.   The forward conversion rate of 23 ish is generous for a taxpayer it would seem.

I’ll let you know re the conversion modeller but I think my calcs work when using the factors provided for forward and reverse commutation in the IFA guide on the uss home page - within a few quid, mainly because I’ve not bothered adjusting for the slight inaccuracy caused by differing conversion rates for post 1 Apr 22 contributions. 

Tommy2024

Simes122 said:

One thing I would say, is the USS default options are not great – hard to see that they’d be the right choice for anyone.

I'm planning to retire in July 2024 and have been trawling these USS threads and found them very informative to help my thinking, not least because of the contributions of @ussdave @MPLMPL and others.

The comment above jumped out at me because I think I might be one of those cases where one of the default options seem to the most obvious choice!

After much planning my minimum gross pension requirement is £35,000pa.

My USS retirement quotation says:

Annual DB pension £34,574, TFLS £103,722

Investment Builder DC pot £124,313

My default USS quotes are:

Max pension:  £37,835pa with £0 TFLS and £124,313 left uncrystallised in DC pot (70.51% LTA)

Max TFLS: £34,491pa with £229,942 TFLS and £0 left uncrystallised in DC pot (85.71% LTA)

The max TFLS option is close enough to my annual income needs (£35,000) and enables me to claim my entire DB and DC lump sums tax free on retirement.

The only other option would be to leave the DC pot of £124,313 invested by USS but my reading is that I would lose its initial tax free status (ie. I'd be subject to only 25% tax free on future drawdowns). I suppose the only scenario in which that makes sense is if the Investment Builder DC investment returns considerably outstrip whatever I might do with the £124,313 myself (eg. savings and/or shares). 

My (very rough) calculations suggest that to match an average 4% savings return from £124,313 over 10 years, then Investment Builder returns would need to average 7% over the same period, which seems quite optimistic.

Happy to be challenged over my thinking here to help me make the right final decision!

Many thanks