Pros and Cons of taking a Lump Sum

hugheskevi

DBdoobydoo said:

hugheskevi said:

Moonwolf said:

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.

A person's future tax rate is also an important consideration - with a 12:1 commutation rate, a non-taxpayer takes 12 years to receive as much through pension as they would have received from lump sum (ignoring inflation increases on pension and explicit/implicit returns on lump sum), a basic rate taxpayer takes 16 years, and a higher rate taxpayer takes 20 years.

For public service pension schemes age is very important too, as the commutation rate is the same for someone taking their pension at age 55 as it is for someone taking their pension age 67.

The 12:1 rate is so poor that even for a higher rate tax-payer taking their pension age age 67 the tax-free lump sum is only around about the same expected value as the taxed pension (noting that DB members have higher than population average life expectancy).

The insurance aspect of the pension also has a value - even if the expected value of lump sum is the same as taxed pension, as the pension continues for life this may well be preferable to protect against longevity risk, although that has to be balanced against a lump sum possibly being of greater use earlier in retirement.

DBdoobydoo said:

Even if you lose £1 of pension for each £12 of lump sum you take it can still be worthwhile if you need the lump sum & have no other source of a large cash sum especially with a small pension that is not a major part of your pension portfolio. Traditionally retirees buy a caravan or motorhome with a tax free lump sum or you might want to pay off the mortgage.

If you had an NHS pension of £10,000 with no TFLS you could opt for a maximum TFLS of £43,000 with a reduced pension £6,400. That would buy a nice motorhome to use for the rest of your life. Paying off the mortgage so you have no debt would also be reassuring. If you can manage without the index linked £3,600 per year then why not?

Other than in niche cases such as reduced life expectancy, I think scenarios such as this are usually a case of failing to plan properly, eg using DC to build up the desired lump sum alongside the DB pension.

Even in this case, the hypothetical person would probably earn something like £30,000 per year. So just by working one more year, they would have £30,000 of earnings plus £10,000 of pension plus around another £3,000 of DC pension (assuming an employer DC pension with combined employer/employee contribution rate of 10%). Some of that will be lost to income tax, NI and pension contributions, but it will still come reasonably close to £43,000 and in return for just one year of work their pension which they accrued over a lifetime of working would be over 50% higher than it would be compared to retiring one year earlier and taking maximum lump sum. That is a pretty compelling argument for one more year, rather than ravaging their pension. 

Sorry but I'm not seeing this apply to the scenario that I quoted (which is based on my personal circumstances). I have several DB pensions. I have no DC pension as I never needed one as I have sufficient DB pensions & in any case never worked for an employer who would have contributed to one.
I will be a higher rate tax payer in retirement. Why shouldn't I commute part of a small DB pension for maximum lump sum to enable me to do home insulation & install solar panels or pay off the mortgage or buy a motorhome? Your suggestion that I work another year is laughable. I'm seventy. Why should I work longer than I want when I don't need to? Why this obsession with how much pension I will be receiving when I'm 80 or 90? It's today when I'm able to enjoy a motorhome not 10-20 years time.

You probably should commute - a higher rate taxpayer taking a PCLS aged 70 would need a very low commutation rate for it not to be a reasonable action. Even at 12:1 it would take until 90 to break even  That would be very different however if we were talking of a non-taxpayer aged 55.

I was not suggesting you personally work one more year - I was illustrating the impact of doing so for a hypothetical individual (which I made clear was hypothetical by stating so in the post you quote) with a pension of £10,000. Far more detail would be required to recommend specific courses of action.

Jonboy1889

hugheskevi said:

DBdoobydoo said:

hugheskevi said:

Moonwolf said:

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.

A person's future tax rate is also an important consideration - with a 12:1 commutation rate, a non-taxpayer takes 12 years to receive as much through pension as they would have received from lump sum (ignoring inflation increases on pension and explicit/implicit returns on lump sum), a basic rate taxpayer takes 16 years, and a higher rate taxpayer takes 20 years.

For public service pension schemes age is very important too, as the commutation rate is the same for someone taking their pension at age 55 as it is for someone taking their pension age 67.

The 12:1 rate is so poor that even for a higher rate tax-payer taking their pension age age 67 the tax-free lump sum is only around about the same expected value as the taxed pension (noting that DB members have higher than population average life expectancy).

The insurance aspect of the pension also has a value - even if the expected value of lump sum is the same as taxed pension, as the pension continues for life this may well be preferable to protect against longevity risk, although that has to be balanced against a lump sum possibly being of greater use earlier in retirement.

DBdoobydoo said:

Even if you lose £1 of pension for each £12 of lump sum you take it can still be worthwhile if you need the lump sum & have no other source of a large cash sum especially with a small pension that is not a major part of your pension portfolio. Traditionally retirees buy a caravan or motorhome with a tax free lump sum or you might want to pay off the mortgage.

If you had an NHS pension of £10,000 with no TFLS you could opt for a maximum TFLS of £43,000 with a reduced pension £6,400. That would buy a nice motorhome to use for the rest of your life. Paying off the mortgage so you have no debt would also be reassuring. If you can manage without the index linked £3,600 per year then why not?

Other than in niche cases such as reduced life expectancy, I think scenarios such as this are usually a case of failing to plan properly, eg using DC to build up the desired lump sum alongside the DB pension.

Even in this case, the hypothetical person would probably earn something like £30,000 per year. So just by working one more year, they would have £30,000 of earnings plus £10,000 of pension plus around another £3,000 of DC pension (assuming an employer DC pension with combined employer/employee contribution rate of 10%). Some of that will be lost to income tax, NI and pension contributions, but it will still come reasonably close to £43,000 and in return for just one year of work their pension which they accrued over a lifetime of working would be over 50% higher than it would be compared to retiring one year earlier and taking maximum lump sum. That is a pretty compelling argument for one more year, rather than ravaging their pension. 

Sorry but I'm not seeing this apply to the scenario that I quoted (which is based on my personal circumstances). I have several DB pensions. I have no DC pension as I never needed one as I have sufficient DB pensions & in any case never worked for an employer who would have contributed to one.
I will be a higher rate tax payer in retirement. Why shouldn't I commute part of a small DB pension for maximum lump sum to enable me to do home insulation & install solar panels or pay off the mortgage or buy a motorhome? Your suggestion that I work another year is laughable. I'm seventy. Why should I work longer than I want when I don't need to? Why this obsession with how much pension I will be receiving when I'm 80 or 90? It's today when I'm able to enjoy a motorhome not 10-20 years time.

You probably should commute - a higher rate taxpayer taking a PCLS aged 70 would need a very low commutation rate for it not to be a reasonable action. Even at 12:1 it would take until 90 to break even  That would be very different however if we were talking of a non-taxpayer aged 55.

I was not suggesting you personally work one more year - I was illustrating the impact of doing so for a hypothetical individual (which I made clear was hypothetical by stating so in the post you quote) with a pension of £10,000. Far more detail would be required to recommend specific courses of action.

Also worth considering your other half if you’re taking pension at a younger age, if you’re older than them, die before them- they may continue to get 50% for 15+ years after 

dunstonh

Why this obsession with how much pension I will be receiving when I'm 80 or 90? It's today when I'm able to enjoy a motorhome not 10-20 years time.

Plenty of active 80 year olds.   80 in 2024 is like age 60 in 1974.

It is all about finding balance between now and then.

DBdoobydoo

Jonboy1889 said:

hugheskevi said:

DBdoobydoo said:

hugheskevi said:

Moonwolf said:

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.

A person's future tax rate is also an important consideration - with a 12:1 commutation rate, a non-taxpayer takes 12 years to receive as much through pension as they would have received from lump sum (ignoring inflation increases on pension and explicit/implicit returns on lump sum), a basic rate taxpayer takes 16 years, and a higher rate taxpayer takes 20 years.

For public service pension schemes age is very important too, as the commutation rate is the same for someone taking their pension at age 55 as it is for someone taking their pension age 67.

The 12:1 rate is so poor that even for a higher rate tax-payer taking their pension age age 67 the tax-free lump sum is only around about the same expected value as the taxed pension (noting that DB members have higher than population average life expectancy).

The insurance aspect of the pension also has a value - even if the expected value of lump sum is the same as taxed pension, as the pension continues for life this may well be preferable to protect against longevity risk, although that has to be balanced against a lump sum possibly being of greater use earlier in retirement.

DBdoobydoo said:

Even if you lose £1 of pension for each £12 of lump sum you take it can still be worthwhile if you need the lump sum & have no other source of a large cash sum especially with a small pension that is not a major part of your pension portfolio. Traditionally retirees buy a caravan or motorhome with a tax free lump sum or you might want to pay off the mortgage.

If you had an NHS pension of £10,000 with no TFLS you could opt for a maximum TFLS of £43,000 with a reduced pension £6,400. That would buy a nice motorhome to use for the rest of your life. Paying off the mortgage so you have no debt would also be reassuring. If you can manage without the index linked £3,600 per year then why not?

Other than in niche cases such as reduced life expectancy, I think scenarios such as this are usually a case of failing to plan properly, eg using DC to build up the desired lump sum alongside the DB pension.

Even in this case, the hypothetical person would probably earn something like £30,000 per year. So just by working one more year, they would have £30,000 of earnings plus £10,000 of pension plus around another £3,000 of DC pension (assuming an employer DC pension with combined employer/employee contribution rate of 10%). Some of that will be lost to income tax, NI and pension contributions, but it will still come reasonably close to £43,000 and in return for just one year of work their pension which they accrued over a lifetime of working would be over 50% higher than it would be compared to retiring one year earlier and taking maximum lump sum. That is a pretty compelling argument for one more year, rather than ravaging their pension. 

Sorry but I'm not seeing this apply to the scenario that I quoted (which is based on my personal circumstances). I have several DB pensions. I have no DC pension as I never needed one as I have sufficient DB pensions & in any case never worked for an employer who would have contributed to one.
I will be a higher rate tax payer in retirement. Why shouldn't I commute part of a small DB pension for maximum lump sum to enable me to do home insulation & install solar panels or pay off the mortgage or buy a motorhome? Your suggestion that I work another year is laughable. I'm seventy. Why should I work longer than I want when I don't need to? Why this obsession with how much pension I will be receiving when I'm 80 or 90? It's today when I'm able to enjoy a motorhome not 10-20 years time.

You probably should commute - a higher rate taxpayer taking a PCLS aged 70 would need a very low commutation rate for it not to be a reasonable action. Even at 12:1 it would take until 90 to break even  That would be very different however if we were talking of a non-taxpayer aged 55.

I was not suggesting you personally work one more year - I was illustrating the impact of doing so for a hypothetical individual (which I made clear was hypothetical by stating so in the post you quote) with a pension of £10,000. Far more detail would be required to recommend specific courses of action.

Also worth considering your other half if you’re taking pension at a younger age, if you’re older than them, die before them- they may continue to get 50% for 15+ years after 

My wife is ten years younger than me so this does apply but interestingly both for NHS pension & one of my other DB pensions the spouse's pension is a percentage of the original pension even if the pension was commuted for maximum lump sum. NHS spouse's pension is 37.5% of original pension without commutation whereas with another of my DB pensions the spouse's pension is 60% of the pre-commuted pension. With the latter I commuted for maximum lump sum & when I die my widow will still receive a pension of greater than 90% of what I receive today.

Are there other DB pensions that also calculate the survivor's pensions as a percentage of the pre-commuted pension? I imagine if the NHS pension scheme does it that other public sector schemes also do. Perhaps it's the norm with most DB schemes?

aldershot

dunstonh said:

Why this obsession with how much pension I will be receiving when I'm 80 or 90? It's today when I'm able to enjoy a motorhome not 10-20 years time.

Plenty of active 80 year olds.   80 in 2024 is like age 60 in 1974.

It is all about finding balance between now and then.

Hmm..I sort of disagree, Longevity has certain increased over the decades, but I would suggest that quality of life through ones 80's and beyond in not really increasing. Of course there are many very active 80 year olds out there but one can have much more fun with life in ones 60s and 70s than 80s and 90s. You're unlikely to be needing new cars at 85 or cruising to Australia (travel insurance?)

Of course it's all about finding a balance, but would contend that you don't necessarily want or need your biggest pension payment in the month before you die (assuming there is a house to pay for dementia care if needed but that's a whole other can of worms).