Early Reduction Factors vs using DC pot - maths question

michaels

Say I have a pension of 30k at 67 and a DC pot of 800k and was looking to retire at 55.  Pension is CPI linked both deferred and in payment so all calcs are in constant money terms.

I could take the DB early with a 43.2% reduction = £17,040 and value the 880k at an SWR of 3.25% = £26,000 - total £43,040

Alternatively I could drawdown an extra £17,730 from my DC in year 1 leaving £782,270 and not take my DB pension until a year later when the reduction factor is 40.9% so the DB pension is £17,730.  Now the remaining DC pot at 3.25% will give £25,424 so a total of £43,154.  An extra £114 a year.

If I wait to state pension age to take any DB but instead bridge the gap with the DC (I assume I can do this at 'par' value by utilising an index linked bond ladder) then the annual total increases to £44,300 or £1,260 more a year than if I take the DB early.

In other words, it makes more sense for me to leave the DB pension as long as possible and spend off the DC money unless I think the DC will grow enough in real terms to overcome the impact of the early reduction factors.

The same logic may also apply to taking the pension late.

Drawback of spending the DC pot first would seem to be inheritance reduction.

Have I got the sums correct?  Anything else I should consider?  Thanks

michaels

So a play with the model and the result is very sensitive to the assumed SWR, increase this to say 3.6% and it become better to start taking the DB at age 62/3 and the overall effect is much smaller - perhaps the kids get their inheritance after all....

Note this is intended to be an SWR for a UK investor with a globally invested portfolio with a sensible mix of stocks, bonds and money market lasting at least 40 years based on retirement at 55 with zero historic failures and about 15 basis points total fees.

FIREDreamer

michaels said:

So a play with the model and the result is very sensitive to the assumed SWR, increase this to say 3.6% and it become better to start taking the DB at age 62/3 and the overall effect is much smaller - perhaps the kids get their inheritance after all....

Presumably sensitive to the growth of the DC pot when compared to inflation too? What are you assuming for that?

michaels

FIREDreamer said:

michaels said:

So a play with the model and the result is very sensitive to the assumed SWR, increase this to say 3.6% and it become better to start taking the DB at age 62/3 and the overall effect is much smaller - perhaps the kids get their inheritance after all....

Presumably sensitive to the growth of the DC pot when compared to inflation too? What are you assuming for that?

Am assuming that any 'DB pension replacement funds' will have zero real growth (invested in index linked gilts ladder to remove all inflation and market risk so equivalent to taking the DB early). 

For the balance of the DC pot I am using an SWR model rather than any sort of assumed real return model, hence it is this SWR rate assumption that can skew the relative advantages of converting DC to 'pseudo DB'

NedS

Personally I think other factors will be more important than trying to eke out an extra couple hundred pounds per year on paper, when such calculations are fraught with assumption and error.

Factors already touched upon such as the importance (or not) of leaving an inheritance, or provision for a partner should one member of a couple die early would be more significant factors influencing my decision.

Like you, I have both DB and DC assets. I would not take my DB pension early to the point it reduced my guaranteed income below the point of covering my essential living costs in retirement. I do not want to be managing a DC portfolio and drawdown strategy at 80+ years old, so essential income needs to be covered, inflation-linked until death. Once that is covered, actuarial reduction is an option for the remaining.

I also hope to leave a substantial inheritance from the DC pot, as the family home may end up having to be sold to cover care costs. So ideally we would like to have a substantial amount of DC assets remaining by the time all of our DB/SP pensions have come into payment. Spending the lot bridging the gap would not be ideal.

Then I have to consider my partner if I should die first, and vice versa, to try to ensure a roughly even split in survivor benefits. DB survivor benefits are 50% or worse, whereas 100% of DC pots can be transferred.

These are my priorities, and how I take my pensions will be tailored to meet these priorities. At no point have I attempted to calculate which option would give the greatest overall return as this is not a priority for us, relative to achieving the above.

AlwaysLearnin

I'm looking at a similar scenario.  Most of my thoughts have been covered above, however one other consideration I had was that reducing the DB pension does have the effect of reducing taxable income in years you might not want/need to take out of the DC.  That balance is a very personal thing again though

ali_bear

You don't mention what you are planning to do with your tax free lump sum assuming you take it as. You could live off that for quite a while unless you blow it on cruises and motorhomes. 

Think about minimizing the overall amount of tax you end up paying. You could use part of your DC pot for income to last until your other pensions kick in. 

And I think its better to keep things flexible rather than make a fixed plan that maximises income. Circumstances can change, as can the laws and regulations. 

Moonwolf

This was my question on the same thing.  https://forums.moneysavingexpert.com/discussion/6489313/choices-choices.  There is an option of a fixed term annuity as a bridge as well.

In the end I have almost certainly decided to go with using the DC pot as a bridge BUT I don't have a a need to leave anything, if I do the niblings will be happy but it isn't a driver for me. My partner is 14 years older than me so I don't need to plan to have anything left if don't die until my 90s. In my case the full DBs and state pension still give a comfortable lifestyle - that is an important consideration, I could live quite happily on just my DB pensions.

I have modelled on a spreadsheet and used guiide as well.  Most scenarios have me a bit better off taking the DB early, but in the worst cases of very poor market performance I'm better off with the bigger DB.

Overall, personally I'm just more comfortable with guaranteed income but that is me.

LHW99

The same logic may also apply to taking the pension late.

Check that - AFAIK not all DB pensions do increase income if delayed beyond NRA, you just lose what you haven't had.

michaels

NedS said:

Personally I think other factors will be more important than trying to eke out an extra couple hundred pounds per year on paper, when such calculations are fraught with assumption and error.

Factors already touched upon such as the importance (or not) of leaving an inheritance, or provision for a partner should one member of a couple die early would be more significant factors influencing my decision.

Like you, I have both DB and DC assets. I would not take my DB pension early to the point it reduced my guaranteed income below the point of covering my essential living costs in retirement. I do not want to be managing a DC portfolio and drawdown strategy at 80+ years old, so essential income needs to be covered, inflation-linked until death. Once that is covered, actuarial reduction is an option for the remaining.

I also hope to leave a substantial inheritance from the DC pot, as the family home may end up having to be sold to cover care costs. So ideally we would like to have a substantial amount of DC assets remaining by the time all of our DB/SP pensions have come into payment. Spending the lot bridging the gap would not be ideal.

Then I have to consider my partner if I should die first, and vice versa, to try to ensure a roughly even split in survivor benefits. DB survivor benefits are 50% or worse, whereas 100% of DC pots can be transferred.

These are my priorities, and how I take my pensions will be tailored to meet these priorities. At no point have I attempted to calculate which option would give the greatest overall return as this is not a priority for us, relative to achieving the above.

Some good points.

Taking the DB early means a bigger proportion of my overall income is subject to market performance, in the example above, the fixed cpi linked part is 17k (out of 43k) if I take the DB as soon as possible or 30k (out of 44.3k) if I leave it till SPA.

The inheritance bit?  Taking DB early means 17k x 12 = £204k DB taken by age 67 so the same increase in any DC inheritance pot.

Partner gets 35% of the unreduced pension if I pre-decease so it makes less difference, if the pension is not in payment there is also some form of life cover and when it is put into payment there is the option to take a small reduction to allocate a higher proportion to partner.  The plan is that on the first death the surviving partner is worse off only by 1x state pension plus the loss of one personal allowance.

michaels

ali_bear said:

You don't mention what you are planning to do with your tax free lump sum assuming you take it as. You could live off that for quite a while unless you blow it on cruises and motorhomes. 

Think about minimizing the overall amount of tax you end up paying. You could use part of your DC pot for income to last until your other pensions kick in. 

And I think its better to keep things flexible rather than make a fixed plan that maximises income. Circumstances can change, as can the laws and regulations. 

TFLS commutation factor is 1:12 so despite the tax advantage it is not worth taking