How to decide whether to start DB early

leosayer

My wife and I plan to retire in a few years time when we are both age 55. This will be funded by a combination of DB pension, state pensions, DC pots and ISAs. The DB pension comes with the option to take the PCLS from the linked DC pot.

By the age of 67 we will have more than enough coming in from our DB and state pensions that we won't need to draw from our ISA and DC so the question is, what's the best way to fund the period before this?

The options from age 55-66 seem to be:

1. Drawdown from DC and ISAs only - then start DB pension at normal retirement age of 60

2. Commence a reduced DB pension early at age 55 and top up income needs with DC/ISA as necessary 

3. Something inbetween eg. start with option 1 and then moving to 2 if DC/ISA investments drop significantly.

I'm edging towards no.2 because what's the point of having a DB pension if you don't use it when you're retired?! Also, it will give me the benefit of the income earlier rather than later in life when we may not need it.

Clearly the actuarial reduction for taking the DB early will be a factor but how will I judge whether it's good value or not?

What other factors are there to help us decide the approach?

Pat38493

leosayer said:

My wife and I plan to retire in a few years time when we are both age 55. This will be funded by a combination of DB pension, state pensions, DC pots and ISAs. The DB pension comes with the option to take the PCLS from the linked DC pot.

By the age of 67 we will have more than enough coming in from our DB and state pensions that we won't need to draw from our ISA and DC so the question is, what's the best way to fund the period before this?

The options from age 55-66 seem to be:

1. Drawdown from DC and ISAs only - then start DB pension at normal retirement age of 60

2. Commence a reduced DB pension early at age 55 and top up income needs with DC/ISA as necessary 

3. Something inbetween eg. start with option 1 and then moving to 2 if DC/ISA investments drop significantly.

I'm edging towards no.2 because what's the point of having a DB pension if you don't use it when you're retired?! Also, it will give me the benefit of the income earlier rather than later in life when we may not need it.

Clearly the actuarial reduction for taking the DB early will be a factor but how will I judge whether it's good value or not?

What other factors are there to help us decide the approach?

Probably you need to post your figures and spending needs to get better comments.

Regarding the DB pension - are you saying that even if you take it early, your income at 67 will still be enough to cover all needs?  If so then I guess you have not much to lose there.  If not, you are looking at your attitude to risk.

In theory, the total benefit you receive on the average lifetime should be the same either way from the DB part so it's a gamble on how long you will live.

This is the type of area where it might be worth getting an IFA to model the options for you (or if you want to DIY it you can do it yourself using spreadsheets or signing up to a retirement planning class that includes a subscription to cash flow planning software).

From the modelling I've done in my situation, taking the DB early seems like the better option in that it gives a higher chance of delivering my spending needs.  DB early results in about 90% of joint desired spend covered by guaranteed income at 67 (more than 100% of the basic must do spend).  DB late results in just over 100% but with a significant risk of having to reduce spending at some point before 67.

You might get people saying it's always best one way or the other but it's going to depend on your individual figures and priorities.  Also - don't discard the option of taking the PCLS - the models I looked at seemed to indicate that taking the PCLS would be viable or even slightly better, even with a commutation rate that would be stated as "not very good" on these boards.

michaels

I have the same issue.  One way to model is to work out how much you would need to take from your DC to 'fill the gap' until DB then Stat Pension become payable.  This sum could be calculated based on the cost of a fixed term index linked annuity or a 'bond ladder' made up of index linked gilts.  Basically you can approximate this by multiplying the size of the gap by the number of years.  Eg if you are 12 years from state pension and it is £10,600 pa then you need to subtract 12 x 10,600 from your DC pot to cover this period.

You can then obviously do the same for the different early vs late DB scenarios.

Having thus modelled a 'guaranteed income level' covering from retirement date for life I then model the remaining DC pot as providing a 'swr' income of about 3-3.5% also 'forever' - or less if there is an intention to leave a legacy.

Doctor_Who

A very good question! I retired early at ~55 and am currently using my DC pot. I have a good DB pension to take from 65. I considered taking the DB pension early, but didn't like the actuarial reduction (once you take the DB pension you can't 'untake' it!). I live in Scotland, so also have to consider higher rate tax (~£43K @ 42%). Taking the DC pot over the next ~10 years keeps me under HR tax now, whereas taking it together with the DB pension definitely wouldn't.

Albermarle

In theory, the total benefit you receive on the average lifetime should be the same either way from the DB part so it's a gamble on how long you will live

Having said that there does seem some variation in the % reduction for each earlier year taken between different DB pensions, not always for very obvious reasons. Also we have seen posts from people where the early payment reduction has suddenly increased, probably when new actuaries have a look at the scheme.

Also at least one public sector scheme ( I can not remember which one) has a non linear % . For example taking the pension one year early = a 3% reduction, but 10 years early was a 40% reduction ( or something along those lines)

OP a typical % reduction for each year taking the pension early is about 4% I think.

Pat38493

One other comment of course is to remember that you don't have to go one extreme or the other - you can also use the DC for a few years, and review it each year and maybe take the DB in between for a lesser reduction.

Pat38493

Albermarle said:

In theory, the total benefit you receive on the average lifetime should be the same either way from the DB part so it's a gamble on how long you will live

Having said that there does seem some variation in the % reduction for each earlier year taken between different DB pensions, not always for very obvious reasons. Also we have seen posts from people where the early payment reduction has suddenly increased, probably when new actuaries have a look at the scheme.

Also at least one public sector scheme ( I can not remember which one) has a non linear % . For example taking the pension one year early = a 3% reduction, but 10 years early was a 40% reduction ( or something along those lines)

OP a typical % reduction for each year taking the pension early is about 4% I think.

True - I suppose there are different assumptions used by different actuaries that could result in different results for the same theoretical objective.  In the end though I suppose it comes down to what works in your individual situation rather than trying to say one rate is good or bad.

I guess the same is true for commutation rates for PCLS - in theory you should not be advantaged or disadvantaged by taking the cash but each provider might have slightly different modelling assumptions, and in the government funded pensions, I guess they don't even have that constraint so they offer you 12.

One other point for the OP to keep in mind - usually DB pensions are better protected against inflation when they are not yet in payment, so you should check the rules of your scheme for increases both in deferment and in payment.  In deferment the inflation increase is generally applied cumulatively which effectively means you can get away with a year or two of high inflation and still get the full increase.

MallyGirl

Are you hoping to leave an inheritance for children/others?
If you take a combination of less DC and a reduced early DB then the DC pot would be less depleted than if you have burned through it as your sole income. Your spouse will likely get a survivors 50% of the DB pension but there won't be anything for adult offspring (or anyone else you might want to leave an inheritance to) from it.

michaels

Another factor (for me CS Alpha) is that once the pension is in payment I can chose to take a lower payment in order to increase the spousal benefit above the standard 37.5%.  This matters for me as our current pension provision is very unequal and I want the situation to be that the only difference in income between two of us and one of us is the lost state pension.

Albermarle

MallyGirl said:

Are you hoping to leave an inheritance for children/others?
If you take a combination of less DC and a reduced early DB then the DC pot would be less depleted than if you have burned through it as your sole income. Your spouse will likely get a survivors 50% of the DB pension but there won't be anything for adult offspring (or anyone else you might want to leave an inheritance to) from it.

To add to this, if you withdraw from an invested DC pension/investment ISA, at a low rate, there is a good chance the pot will hold up quite well for many years even as markets go up and down. If you were lucky it might even increase in size despite withdrawing from it, and your heirs will get a nice windfall.
Of course if you increase the withdrawal rate, it is more likely to deplete quicker, but again if markets were kind it may still last you out and still be some left.
However there will be a withdrawal % level where the pot will not be able to recover and this process will accelerate as the pot shrinks.

leosayer

Thanks all for your comments - loads to think about.

I'm pretty handy with excel and modelled all 3 scenarios but found them really hard to compare because of unknowns around inflation and investment performance.

Looking at the the terms below on my pension increases, it would seem to make sense for me to defer if inflation persists above 5% (due to compounding increases) but as Doctor_Who said, once I've commenced the pension, I can't untake it if inflation drops then rises again.

With regard to inheritance, I had only really thought of it in terms of my son, but I also have to think of my wife in case I go first. For this reason it makes, sense to start DB first because she will get 2/3 of my DB and the residual of the DC. Personally, I also like the idea of having a larger pot to call on should the need arise, although I am intending to limit annual income so I only pay basic rate tax.

Just to clarify regarding the DB PCLS - I can take it from the linked DC scheme tax free without reducing the DB pension. Sounds like a no-brainer to me even if it does bring those funds into my estate.

DB terms: