DB Pension: Lump sum yes/no? NPD or earlier?

BarbaraG2000

I am 60 (and 7 months) and ceased work three years ago, as did my husband.  He is 64. Have been living off of a monthly withdrawal from an ISA. This is about to change, as we realise the logic of the IFA who recommended this (that we needed to reduce our estate to reduce liability to inheritance tax) was barking up the wrong tree, as we have no children and want to use our capital to make our retirement secure and enjoyable, rather than preserve it for others to enjoy!

My pension savings/entitlement are as follows:

1) Personal pension pot, current value c. £220K
2) Full state pension entitlement from age 66
3) Occupational DB scheme from age 66 and 8 months (don’t ask), c. £5.5K pa at latest estimate.
4) Occupational DB scheme from age 65, £12,895. Or if taken from age 63: £12,213.

I also have a small personal pot of £4K, which I am in the processing of transferring into pot 1 to neaten things up.  I then plan to take 25% from the personal pot, then put it into flexible drawdown, taking an amount which keeps me below the income tax threshhold.  That won’t be enough to live comfortably, so the plan is to supplement that income from the lump sum - which I will invest into ISA’s, premium bonds, term accounts etc, managed to bridge the gap until the DB pensions are in payment.  We would also do some ‘big spends’ out of the lump sum (plus my husband’s, which is bigger than mine).

I have two questions:

Both of the DB pensions come with the option of up to 25% lump sum, plus a 50% spouse’s pensions.  What are the pros and cons of taking the lump sum? I can see it for the DC pension, as it’s a way of getting more of that pot tax free.  Is it as simple as that with the DB pensions?

And secondly: what are the pros and cons of taking the bigger DC pension at 63 rather than 65?  I would be receiving it 2 years earlier, and the cost of that is £680 per year (or less than that if I took the lump sum option).  How do I work out which is the better deal?

horsewithnoname

You would need to know when you are going to die to work out which would provide the most money. 

Same for working out whether to take the lump sum; if you have a need for a chunk of money then you might want to take it now rather than later, but if not, would you do better investing it than you would with having extra pension? Is the pension index linked for example? It’s not really possible to say one way is better than the other without knowing your full financial circumstances. 

BarbaraG2000

Good points!  Pension providers rely on mortality statistics to decide how to adjust pension at different ages, but I’ve only got one life, and no way of knowing how long it will be.  The pension is index-linked, yes.

michaels

You don't want to be living just of ISAs as you are wasting your annual income tax allowance.  You want to be taking at least your personal allowance from your pension every year.

BarbaraG2000

michaels said:

You don't want to be living just of ISAs as you are wasting your annual income tax allowance.  You want to be taking at least your personal allowance from your pension every year.

That’s why I’m about to put my personal pension pot into drawdown.

Albermarle

Why take all the 25% tax free from the pension?
For example you can take some tax free and some taxable income each year, with most modern pensions.
Also saves on the hassle of opening new accounts to put the lump sum in.

mark55man

So I've done a fair bit of spreadsheet modelling with my DB schemes.  Lump Sum or Not - Taking it early or not (Scheme age 65).  My findings for my scheme (yours may differ) suggest I take max lump sum, but leave it as late as possible to trigger. 

So for the decision on whether to take it early or not - whatever age I took it - taking the lump sum would be better for you than no lump sum (higher income) until you were 80 +/1 a year or so.  As I don't expect to get close to 80 I can live with that.

Comparing benefits of lump sum at 62, 63, 64, 65 I found that 62 was way worse than taking it later in terms of total return after a small number of years had passed.  That trend continues, although the period before worseness grew, so much so that taking it one year early was only marginally worse than taking it at Scheme age.

All the above modelling assuming basic rate tax on income.
Additionally - if you saved (not splurged or gifted) the lump sum cash and generated interest from it then this makes taking the lump sum early much less disadvantageous bit still worse in the long term (again 80+). 

My decision from this will be I am retiring at 62 and will drain savings and SIPP capital and dividends for income to take me up to DB at 64 then State pension at 67. I would consider taking DB at 63 as its close run thing and I would prefer my SIPP to be less cautiously invested than I feel constrained to be whilst relying on income.

My final thought was if I do live past 80 and end up on the debit side of the decision then I will be just so delighted it won't matter.  

MX5huggy

If your figures are correct with the DB at 63 vs 65 it would take you 35 years to make up for waiting 2 years. Inflation would reduce this somewhat, but not by much and if you just banked (invested) the £24k then waiting maybe never catches up. 

The choice of lump sum vs bigger pension comes down to the ratio offered public sector pensions generally offer 12:1 ie £12000 of lump sum for loss of £1000 of annual pension this is poor value especially as you seem to have enough lumps of cash available already if it’s not like 25:1 then more thought is needed.

mark55man

My figures in the XLS are clear and not what you suggest.  My commutation factors are low 19.x at 62 and mid 20.x at 65.  Also the lump sums are different at each year its the approx 10K increase p.a. in LS and 6-8% increase in income explains the speed at which taking it later is superior

I have disregarded inflation as the increase in pension in payment and increase in pension as deferred will be very similar

ETA: All the figures are taken from the pension providers online service the day after my birthday each year

najan49

mark55man said:

My figures in the XLS are clear and not what you suggest.  My commutation factors are low 19.x at 62 and mid 20.x at 65.  Also the lump sums are different at each year its the approx 10K increase p.a. in LS and 6-8% increase in income explains the speed at which taking it later is superior

I have disregarded inflation as the increase in pension in payment and increase in pension as deferred will be very similar

ETA: All the figures are taken from the pension providers online service the day after my birthday each year

Interesting- illustrations for my deferred DB pension show the commutation factor decreases the older I start to draw it.

mark55man

Its pretty maginal.  There does seem to be a definite switch as you actually hit the scheme age - the values 62 63 64 pretty similar - but didn't want to make too much detail on OP's thread - just indicating that modelling is necessary as its not intuitive and not the same between schemes