TFLS in Civil Service Alpha scheme

player1_2

Hi all, this came up in another of my threads but am posting it here as a topic in it's own right rather than have it buried where many may not see it. Admins, I hope this is ok.

I am in the CSP Alpha scheme and plan to take my pension in around four years at state pension age. Alpha rules are that a lump sum can be taken by commuting annual pension in favour of a lump sum at a rate of £1 of annual pension in favour of £12 of lump sum.

I understand  that a commutation ratio of 12:! is not a good ratio, and I am minded to take the full annual pension with no lump sum. However I have my doubts.

If I understand it correctly (and my maths be wrong) it would take me > 20 years to realise the TFLS value  (42% taxpayer in retirement), by which time I'd be nearly 87. Pus I'd be rescuing some funds for my beneficiaries from a pension that will die with me (I have no dependants).  Therefore it may make more sense to take the lump sum ( I am not anticipating that sort of life longevity but who knows!).

What do others think / do ?  

Universidad

12:1 is a poor commutation rate. But that does not invalidate the choice. 

Tax efficiency is probably the primary reason why you might choose to change your pension arrangements from the presumed "optimal" position. 

If the entirety of your Alpha pension is going to sit in the 42% tax bracket, that will make a difference to the calculations. Whether it makes enough of a difference is up to you.

It is a personal decision. Nobody knows how long they will live, so you can't balance the books until it's too late to matter. 

One thing defined benefit pensions offer is certainty in retirement.

If you are already confident that the reduced amount will be enough to live on, but less certain that you will live a long time in retirement, then you gain a different kind of certainty from taking the commuted lump sum.

No right answer but the one you are happy with.

QrizB

player1_2 said:

If I understand it correctly (and my maths be wrong) it would take me > 20 years to realise the TFLS value  (42% taxpayer in retirement), by which time I'd be nearly 87.

OTOH the Alpha pension is index-linked, so if you're just comparing cash values you're assuming zero inflation for the next two decades.

In a different thread I calculated it would be cheaper to take a mortgage for the TFLS value and then make mortgage payments wirth the pension you haven't commuted. For example, a £60k mortgage rather than commuting £5k of pension. Not sure if that is quite as true for a 42% taxpayer, but you should run the numbers.

hugheskevi

player1_2 said:

If I understand it correctly (and my maths be wrong) it would take me > 20 years to realise the TFLS value  (42% taxpayer in retirement), by which time I'd be nearly 87. Pus I'd be rescuing some funds for my beneficiaries from a pension that will die with me (I have no dependants).  Therefore it may make more sense to take the lump sum ( I am not anticipating that sort of life longevity but who knows!).

What do others think / do ?  

Ignoring inflation and investment returns, it would take (12 / 0.58) = 20.7 years to receive an amount of taxed annual pension equal to a lump sum. Life expectancy, assuming no pre-existing conditions, should be in the high 80s. So there doesn't look to be much in it either way from a neutral financial perspective - so personal circumstances are likely to determine the outcome.

The 12:1 commutation rate applies whether you take the pension at age 55 or age 74, clearly the older you are when you commence the pension the more attractive a lump sum option is - 12:1 for a 55 year old is rancid, but for a 74 year-old is quite attractive.

The pension is indexed-linked so guaranteed against inflation, whereas the lump sum could be invested and over a reasonable term you would expect to receive a higher than inflation return (net of costs) which would change the figures.

Although the pension dies with you (other than spouse and young children provisions), there is nothing stopping you setting aside money from pension payments to add to a legacy. The pension has a 5 year guarantee, and the odds of you surving at least 10-15 years are pretty high so the risk is fairly minimal (and you may survive longer than expected, so the risk is symmetrical).

Personally, I'd be trying to avoid paying 42% in retirement by equalising pensions across myself and spouse and commencing pensions as soon as possible. If you continue working after commencing the pension, saving into a Defined Contribution pension with the intent to leave it as a legacy could be sensible (although you would need to reduce hours by 20% to access alpha pension and continue working). 

player1_2

Thanks Hugheskevi,
yes - it does seem to come down to the question none of us can easily answer (nor would necessarily want to), what is our life expectancy. I have been diagnosed with a couple of chronic illnesses in recent years (prostate cancer although caught early and currently in remission, and osteoporosis which in itself isn't life-threatening) so who knows what  the future will bring.

You are quite correct that I can set aside money from pension payments to add to a legacy. I am quite risk averse and like the 'security' of pension for life. So again it comes down to how long I will be able to draw the pension. 

I don't see anyway of avoiding the 42% tax in retirement. No spouse. I have a DB pension starts paying out in a few months (£28k plus a rather nice lump sum that I will use to buy a property), I have a DC pension lying untouched with £190k in it), my CSP is likely to be at least £15k at SPA (just under four years from now), and a full SP to look forward to. So, whilst appreciating it's a nice problem to have I think I am stuck with the 42% hit. I won't work beyond SPA. 

NedS

player1_2 said:

Thanks Hugheskevi,
yes - it does seem to come down to the question none of us can easily answer (nor would necessarily want to), what is our life expectancy. I have been diagnosed with a couple of chronic illnesses in recent years (prostate cancer although caught early and currently in remission, and osteoporosis which in itself isn't life-threatening) so who knows what  the future will bring.

You are quite correct that I can set aside money from pension payments to add to a legacy. I am quite risk averse and like the 'security' of pension for life. So again it comes down to how long I will be able to draw the pension. 

I don't see anyway of avoiding the 42% tax in retirement. No spouse. I have a DB pension starts paying out in a few months (£28k plus a rather nice lump sum that I will use to buy a property), I have a DC pension lying untouched with £190k in it), my CSP is likely to be at least £15k at SPA (just under four years from now), and a full SP to look forward to. So, whilst appreciating it's a nice problem to have I think I am stuck with the 42% hit. I won't work beyond SPA. 

How old are you now?

How much income do you want / need in retirement.

From your numbers, you are not massively into higher rate tax, so there may be things you can do to minimise the HRT you pay and still achieve an acceptable level of income.

Retiring and taking alpha early with actuarial reduction is one way, as is taking some as a tax free lump sum which may not make you worse off overall assuming you live to an average lifespan.

Do you intend to draw down on the DC pension (thus increasing your taxable income) or keep it for a rainy day / possible care home costs?

And as you say, paying a small amount of HRT is not the end of the world, and the current governments policy of fiscal drag may increase this over time anyway with frozen thresholds working against us.

bucklb

Am I missing something?  You may end up being a 42% tax payer with the pension, but that won't necessaily apply to all of your pension payment (and you won't be paying 42% on any of it as NI will cease to apply, at least to the pension)

You'll have a tax free allowance at £12.57k and then pay 20% on the next £37.7k.  It's only what's over £50k (ish) that you'll pay 40% on.  On the basis of a "back of a fag packet" calculation, if you were to have £60k gross you'd pay about 20% tax overall.  That may change how long you think it would take before taking the TFLS becomes the right/wrong decision.

It may be that you'll be taking in enough to be paying tax at 40% at SPA even before the pension. If so, enjoy the champagne lifestyle

In my case (not going to be paying any tax at 40%) it doesn't feel sensible to take the TFLS from my alpha pension, even taking in to a/c the tax saving

bucklb

Sorry. Hadn't seen the remarks about illness until after posting my comment

Dazed_and_C0nfused

bucklb said:

Am I missing something?  You may end up being a 42% tax payer with the pension, but that won't necessaily apply to all of your pension payment (and you won't be paying 42% on any of it as NI will cease to apply, at least to the pension)

You'll have a tax free allowance at £12.57k and then pay 20% on the next £37.7k.  It's only what's over £50k (ish) that you'll pay 40% on.  On the basis of a "back of a fag packet" calculation, if you were to have £60k gross you'd pay about 20% tax overall.  That may change how long you think it would take before taking the TFLS becomes the right/wrong decision.

It may be that you'll be taking in enough to be paying tax at 40% at SPA even before the pension. If so, enjoy the champagne lifestyle

In my case (not going to be paying any tax at 40%) it doesn't feel sensible to take the TFLS from my alpha pension, even taking in to a/c the tax saving

I think the op is Scottish resident for tax purposes.

So 42% income tax applies to anything above £43,662 😳

player1_2

Thanks all for the views so far. I am approaching 63 and am indeed a Scottish tax payer. I will have £28k per year from December plus a nice lump sum from a private sector DB pension.  I also have a private sector DC pot of 190k that I don’t really need unless circumstances change.
I will continue working until SPA God willing, at which  point I’ll get full SP plus the Alpha pension which will be worth at least 15k per year by then. So I reckon with the SP and if I don’t take Alpha lump sum I’ll have at least 56k per year which I could certainly live comfortably on. I could get by on less though and rescue something from alpha that could be passed to beneficiaries. 

I don’t really need to touch the DC pot, although there is a fiscal drag argument that says I should draw the TFLS from that sooner than later if I plan to draw it at all .

Another complication is I can’t draw down the full TFLS from all pensions without breaching the threshold ( around 260k. 

My gut feel is not to take the Alpha lump sum but feel a wee bit guilty if I die and the pension dies with me when I could have brought funds into my estate. 

Hope this makes sense. It’s good to get views of others of the pros and cons and things to consider.

xylophone

If you are thinking that your DC pension is likely to be left as a legacy, had you considered increasing contributions to it after your deferred DB pension comes into payment in December and you continue to receive a full time salary?