Pros and Cons of taking a Lump Sum

Moonwolf

For DB , to use the NHS scheme as an example

(Ignore the old (1995) scheme includes a 3x pension lump sum which doesn't involve losing any pension.  You get it anyway.)

For the 2015 scheme you lose £1 of pension for each £12 of lump sum you take.  This is the "commutation" rate (you commute pension to lump sum).  In simple terms, that means if you live 12 years after retirement you would have been better off keeping the pension.  Of course your pension will have grown by inflation over those 12 years, so perhaps the lump sum is only the best option if you live less than 10 years; but what would you do with your lump sum, if you managed to invest it and get a good % over inflation or if you paid off expensive debts then you might to be better off taking a lump sum if you live less than 15-20 years.

For reference, if you retire at 67, currently you will expect to live on average another 18 years.  Unless you know something very specific, I would never bet on dying earlier, too many people say "I'm taking the lump sum as I might die tomorrow anyway."

One last point.  If you have a £20k DB scheme and £10k state pension and £30k is your budget then do you want to give up pension for a lump sum and not be able to meet your budget later; or do you think your basic budget is smaller and having cash savings for more expensive holidays in the early years is better.

So is a lump sum the best option?

For a DB scheme you need to know
 - What the commutation rate is? How long will you have to live before you would be better off keeping the pension? 
 - What will you do with the lump sum.  Good might be paying off expensive debt, holiday/new car fund or money for the kids.  Bad could be, "I might die tomorrow", while true is probably less likely than living 15-20 years.
 - Including state pension, what will I have left to live on after taking the lump sum, is it enough?

For DC it is similar but the calculations are more complex and depend if you are drawing down, taking an annuity or a bit of both.

Victorwelldue

dunstonh said:

No.   If you don't take the 25% up front then any withdrawals you make will be taxed on the basis of 75% taxable and 25% tax free.

What happens if you never take the 25% upfront and only regular withdrawals (say once every year)? Does this mean that you will always be effectively taxed at only 15% if basic rate tax payer, or is it only up to a certain point?...do they base it on the amount in your pot on the day you retire or something? I'm just trying to get my head around how the tax bit works if the pot keeps growing due to investment returns.

Sorry OP for jumping in.

LHW99

The 75% drawdown part is always potentially taxable.

But if you are a non-taxpayer, you won't have to pay tax (hence some people take out over £16k pa when they are under SPA and still pay no tax).

On the other hand, if you had SP, and another high level of works pension, then you could have to pay 40% tax on the taxable part of the withdrawal.

It depends on your situation, but the 75% will always be potentially taxable, hence people sometimes get an emergency code which takes too much initially and then claim tax back.

BoxerfanUK

Victorwelldue said:

dunstonh said:

No.   If you don't take the 25% up front then any withdrawals you make will be taxed on the basis of 75% taxable and 25% tax free.

What happens if you never take the 25% upfront and only regular withdrawals (say once every year)? Does this mean that you will always be effectively taxed at only 15% if basic rate tax payer, or is it only up to a certain point?...do they base it on the amount in your pot on the day you retire or something? I'm just trying to get my head around how the tax bit works if the pot keeps growing due to investment returns.

Sorry OP for jumping in.

If the pot keeps growing on the uncrystallised part then so does you tax free amount, happy days

bjorn_toby_wilde

As Sarahspangles says, with DB pensions you need to consider the commutation rate (how much pension you’re giving up for the lump sum). 12:1 is really poor but if the figure is up closer to 30:1 you might consider it a better deal.

Another thing to think about is how the DB pension is revalued annually once you start to take it. One of my DB pensions has a portion increasing in line with inflation (but capped at 5%) whereas the bulk is at the discretion of the company. Despite making huge profits they haven’t awarded any discretionary increases for years.  It made sense to me to take the lump sum and invest it as the commutation rate was good.

Albermarle

Victorwelldue said:

dunstonh said:

No.   If you don't take the 25% up front then any withdrawals you make will be taxed on the basis of 75% taxable and 25% tax free.

What happens if you never take the 25% upfront and only regular withdrawals (say once every year)? Does this mean that you will always be effectively taxed at only 15% if basic rate tax payer, or is it only up to a certain point?...do they base it on the amount in your pot on the day you retire or something? I'm just trying to get my head around how the tax bit works if the pot keeps growing due to investment returns.

Sorry OP for jumping in.

Many take  UFPLS payments, which consist of exactly 25% tax free and 75% taxable ( actual tax will depend on your personal tax position)
It is possible to take regular ones but can be an admin headache with some providers so easier just to do it once a year.

Lets say you have a £200K pot to start with, this is known as an uncrystallised pot.
If you want to take a UFPLS of £20K ( £5K tax free and £15K taxable) you have to crystallise £20K of the pension.
This leaves £180K uncrystallised. This will still be invested and will go up and down . So say after one year it has grown by £5K so you have £185 uncrystallised. Lets say then you take a £30K UFPLS ( £7.5K tax free and £22.5K taxable) you will then have £155 k uncrystallised left that is still invested.

LHW99

Albermarle said:

Victorwelldue said:

dunstonh said:

No.   If you don't take the 25% up front then any withdrawals you make will be taxed on the basis of 75% taxable and 25% tax free.

What happens if you never take the 25% upfront and only regular withdrawals (say once every year)? Does this mean that you will always be effectively taxed at only 15% if basic rate tax payer, or is it only up to a certain point?...do they base it on the amount in your pot on the day you retire or something? I'm just trying to get my head around how the tax bit works if the pot keeps growing due to investment returns.

Sorry OP for jumping in.

Many take  UFPLS payments, which consist of exactly 25% tax free and 75% taxable ( actual tax will depend on your personal tax position)
It is possible to take regular ones but can be an admin headache with some providers so easier just to do it once a year.

Lets say you have a £200K pot to start with, this is known as an uncrystallised pot.
If you want to take a UFPLS of £20K ( £5K tax free and £15K taxable) you have to crystallise £20K of the pension.
This leaves £180K uncrystallised. This will still be invested and will go up and down . So say after one year it has grown by £5K so you have £185 uncrystallised. Lets say then you take a £30K UFPLS ( £7.5K tax free and £22.5K taxable) you will then have £155 k uncrystallised left that is still invested.

Although presumably if you start with quite a large DC pot, there will now be the possibility that at some point all the UFPLS 25% tax-free bits add up to the £268k (or thereabouts) limit, so everything then becomes taxable / UFPLS is no longer an option?

Wyndham

Thank you all for the comments - it's been really helpful to read them and has certainly clarified my thinking! I still have more thinking to do, but feel better informed now.

P.S. @dunstonh Wish I was 18 Let's just say I'm in my very, very, very, very, very, very late teens!!

MetaPhysical

It's normally better off *not* to take the TFS from a DC pot IMO.  But it all depends on your circumstances.  If you need the money to pay off mortgage or for some other pressing purpose then that would be a good use of the TFS.

If you do NOT have a pressing need for the money, consider this.  Let's say you have £100k in your pot.  If you take the TFS you will then get £25k tax free.  Nice and a bird in the hand and all that.......  However, say you don't take the TFS and, instead, you take a 25% tax free from each withdrawal (i.e. UFPLS).  Over several years you can potentially get a *lot* more than £25k because as the pot grows and you keep getting 25% tax free on each withdrawal it can soon make up and overtake the £25k had you took the TFS.

Albermarle

MetaPhysical said:

It's normally better off *not* to take the TFS from a DC pot IMO.  But it all depends on your circumstances.  If you need the money to pay off mortgage or for some other pressing purpose then that would be a good use of the TFS.

If you do NOT have a pressing need for the money, consider this.  Let's say you have £100k in your pot.  If you take the TFS you will then get £25k tax free.  Nice and a bird in the hand and all that.......  However, say you don't take the TFS and, instead, you take a 25% tax free from each withdrawal (i.e. UFPLS).  Over several years you can potentially get a *lot* more than £25k because as the pot grows and you keep getting 25% tax free on each withdrawal it can soon make up and overtake the £25k had you took the TFS.

Only if you spend the tax free cash, or keep it in your current account. If you invested it in a similar way to the pension, it would grow the same as if you left it in the pension.

However overall I  agree that it is better left in the pension if you have no real need for it. The mistake that many make is to withdraw it all 'because it is there' and do nothing with it.