Pension: Higher lump sum or lower lump sum?

Pat38493

As mentioned above, 12 is considered to be a very poor commutation rate, so unless you desperately need that extra money it might be better to take the higher pension.  

Icicle_Boy

RogerPensionGuy said:

If I worked out the commutation rare from the OP correctly. 

It's just 11.93 and appears very low.

I just worked out if OP could not accept any tax-free cash if possible and using 11.93 it will make pension PA from 16.4K to 20.5K and obviously loose that 49K tax-free. 

I'm guessing my suggestion isn't possible?

But if it was, the OP could maybe draw the 20.5K PA DB scheme and could allow a big increase of another pension scheme maybe?

It's a LGPS pension so I am assuming I could not look at your option. Been reading that the rate of conversion from pension to lump sum of 12:1 is not that good

hugheskevi

The key things to consider in decisions like this are:

• Commutation rate
• Rate of income tax paid now and in the future
• Life expectancy

Start with life expectancy. The ONS has a calculator at this link. Based on your initial post and your username, I assume you are a 59-year-old male. That gives a life expectancy of 84 years. Note this is usually an underestimate, as the figures are based on the population as a whole, and members of DB schemes have a higher life expectancy than the general population. To adjust for this, you can look at statistics published by the Pensions Regulator about members of DB schemes. These would suggest your life expectancy is 87-88. If you have good reason to believe life expectancy is impaired (eg an existing life-impairing illness), that would affect the calculation and you would not use population parameters but a figure based on your personal circumstances instead.

Assume that you are currently a basic rate taxpayer, and will be until you die, and that the rate of basic rate income tax remains 20%. The commutation rate in this case seems to be 12:1.

If you take tax-free cash, it is clear what you get - £39,000 of tax-free cash payable immediately in exchange for £3,270 of pension income. This will increase in line with investment returns, or in your case would reduce interest payable so the mortgage interest rate would be the rate of return.

If instead you take £3,270 of income, you will receive £3,270 x 80% (60% if a higher rate taxpayer in all future years) = £2,616 per year for life, increasing each year by uncapped inflation and payable for life (ie valuable inflation and longevity guarantees that are not reflected in the calculations). Note that survivor pensions are unaffected by the commutation decision.

If you live to age 84 that is £62,784 of income you would receive after tax (84-60=24, multiplied by £2,616), in real terms. If you live to 88 it is £73,248.

As a quick and easy way to compare the generosity of a commutation factor used by a scheme, it can be compared to Pension Protection Fund (PPF) commutation factors. This is because regulations require the PPF to calculate their factors on actuarial equivalence and they are kept up-to-date. For a 60-year-old, their commutation factor would be in excess of 21:1 

If a factor of 21:1 were to be used, it would give a lump sum of £68,670 which would be far more consistent with the amount you would receive if you chose to take income instead.

Icicle_Boy

hugheskevi said:

The key things to consider in decisions like this are:

• Commutation rate
• Rate of income tax paid now and in the future
• Life expectancy

Start with life expectancy. The ONS has a calculator at this link. Based on your initial post and your username, I assume you are a 59-year-old male. That gives a life expectancy of 84 years. Note this is usually an underestimate, as the figures are based on the population as a whole, and members of DB schemes have a higher life expectancy than the general population. To adjust for this, you can look at statistics published by the Pensions Regulator about members of DB schemes. These would suggest your life expectancy is 87-88. If you have good reason to believe life expectancy is impaired (eg an existing life-impairing illness), that would affect the calculation and you would not use population parameters but a figure based on your personal circumstances instead.

Assume that you are currently a basic rate taxpayer, and will be until you die, and that the rate of basic rate income tax remains 20%. The commutation rate in this case seems to be 12:1.

If you take tax-free cash, it is clear what you get - £39,000 of tax-free cash payable immediately in exchange for £3,270 of pension income. This will increase in line with investment returns, or in your case would reduce interest payable so the mortgage interest rate would be the rate of return.

If instead you take £3,270 of income, you will receive £3,270 x 80% (60% if a higher rate taxpayer in all future years) = £2,616 per year for life, increasing each year by uncapped inflation and payable for life (ie valuable inflation and longevity guarantees that are not reflected in the calculations). Note that survivor pensions are unaffected by the commutation decision.

If you live to age 84 that is £62,784 of income you would receive after tax (84-60=24, multiplied by £2,616), in real terms. If you live to 88 it is £73,248.

As a quick and easy way to compare the generosity of a commutation factor used by a scheme, it can be compared to Pension Protection Fund (PPF) commutation factors. This is because regulations require the PPF to calculate their factors on actuarial equivalence and they are kept up-to-date. For a 60-year-old, their commutation factor would be in excess of 21:1 

If a factor of 21:1 were to be used, it would give a lump sum of £68,670 which would be far more consistent with the amount you would receive if you chose to take income instead.

Thank you. Will have a proper look at that as alot of detail in there. Appreciate all this information which will help me form my decision 

Albermarle

Icicle_Boy said:

xylophone said:

Have you obtained a state pension forecast?

https://www.gov.uk/check-state-pension

Thanks for that mate. Better than nothing, but wonders where all my tax /NI has gone these last 40 years to receive something so minuscule.

The current state pension is £10,600 pa but it will go up every year until your get the pension and then when you are taking it. Currently the annual increase is calculated via the contentious/generous 'Triple Lock'

To buy a guaranteed lifetime pension like this with baked in annual increases, in the open market ( as an annuity) would cost around £300K, so not so miniscule.....

rockers

I think it depends on future plans. Mrs Rockers has just taken her final salary NHS pension with a higher  lump sum.
But our plan is that she will pay me an "allowance" every month from  that, whilst I max out on pension contributions on my pension pot until we have her lump sum plus my tax and NI. Now £60,000 pa - so good timing.
Only stipulation is that she doesn't like the stock market; so it is in a cash fund which TBF, is doing ok.
So essentially 'recycling' her cash  lump sum.
I DID point out that if we got divorced (after 30+ years!) then my pot would be split 50-50. I also said that even though we may think that very unlikely, experience has shown its better to be blunt about these things.
And also I will be aiming for her to outlive me by about twenty years; so always make sure there is enough left to keep her going for that long after I depart this mortal coil.
We're both due to receive the maximum state pension at 67 & 68 respectively so-assuming we make it that far- I just view that as a "payrise" shortly after retiring at 65.

I also have my own final salary scheme and a reasonable pot in a 'zombie' pension with a guaranteed annuity rate of 10% at age 65.
So aiming for a comfortable - if not ostentatious - retirement!

Albermarle

With a NHS pension, plus another final salary scheme, plus a guaranteed annuity , plus two state pensions, then I think any financial advisor would be encouraging you to go highish risk in your current pension, as you will have so much guaranteed income. Especially if you already have some separate cash savings and your pension contributions will be boosted with tax relief.
Maybe some marital education is needed 

xylophone

Thanks for that mate. Better than nothing, 

Have you checked how much you would have needed to save into a personal pension to buy a "triple locked" annuity?

  

The 'triple lock' is a commitment to increase State Pensions by whichever is highest of average earnings growth, CPI inflation, or 2.5%. 

https://www.standardlife.co.uk/articles/article-page/will-the-state-pension-rise

rockers

any financial advisor would be encouraging you to go highish risk in your current pension,

Done. My DC goes into a FTSE All Share low cost  Tracker.

RogerPensionGuy

xylophone said:

Thanks for that mate. Better than nothing, 

Have you checked how much you would have needed to save into a personal pension to buy a "triple locked" annuity?

  

The 'triple lock' is a commitment to increase State Pensions by whichever is highest of average earnings growth, CPI inflation, or 2.5%. 

https://www.standardlife.co.uk/articles/article-page/will-the-state-pension-rise

Yes, a quick review of how much a similar annuity would cost for the difference in a gold-plated pension is an interesting bit of data that maybe helpful in deciding. 

I guess a commutation of 12 is better understood when you view all the data.