Simple defined benefit pension explanation and basic strategy

Cobbler_tone

Looking for some simple guidance please. Whilst the talk of portfolios etc is great (and I like to think I'm switched on!) it can be extremely confusing, which I guess why financial advisors exist!

I have a (now closed) DB pension with my current employer and active DC scheme.

I am looking for a simple explanation on what drives the performance and calculations used to show its current value and the subsequent value at different stages. i.e. is it purely due to the date I take it or is there also projected growth in there?

Here are the key details. I am 55 and the transfer value was £420k two months ago.

                     Lump sum         Pension (per annum)
Today           99,637               14,946
Age 56         104,068             15,610
Age 57         111,122              16,668   
Age 65         175,818              26,373 

In terms of strategy (for an early retirement) I am wondering if it is always better to exhaust any others means of capital first....i.e. the DC pot which is £100k today? I guess trying to truly understand the benefit of leaving the DB pension as long as possible. For example, live off the DC for a number of years and then take the DB. 

I'm still working full time and contributing 34% (mine and employer) contributions on a £63k salary to stay below the 40% tax threshold, which I have calculated (with other taxable benefits/salary sacrifice) within £100 a year. These days I just see it building the pot to pull the trigger and increase my contributions every other month of so.

Kids have flown the nest and in an ideal world I want to retire ASAP, which I know is relative but I don't lead an extravagant lifestyle and mortgage free. 

bjorn_toby_wilde

A DB pension isn’t a pot. It’s a promise to pay you an amount at your retirement date.

The sum is reduced when you take it early (because it will be paid to you over a longer period of time. Usually 4-5% reduction per year taken early.

The pension increases, usually in line with inflation but often capped, until the day you take it. Following that it again increases in line with inflation and again usually capped. You need to consult the scheme rules to find out what the increases will be for your particular scheme.

Whether it’s a good idea to take it early is really a question only you can answer.  I’m using other sources until my own main DB pension kicks in at 65.

I hope that helps and isn’t too patronising!

OldScientist

Since the DB pension is now closed there are two reasons why the pension amount will increase

a) Actuarial reduction. This is what is shown in the table above. Very roughly this is a 4% to 5% decrease in your pension for every year you take it early. This is because taking it early means it will be paid out over a longer time and hence the amount paid is less.
b) Inflation increases. These are probably not shown in the table above, but assuming the pension increases with inflation (some pensions will be fully index linked while some have caps with 2.5% and 5% being common). If it is fully index linked, then the amount in the table above will be in real terms (i.e., £26.4k in today's money if you take it at 65). If it is capped and inflation exceeds the cap, then the amount will be reduced in real terms (i.e., the pension will buy less than £26.4k in today's money).

A few things to think about
1) How much income do you need in retirement in the long term. For example, at 67 you will also receive the state pension - would £15k (e.g., DB pension taken now and assuming fully index linked) plus £12k (SP) be enough?
2) How long could you survive on income from your DC pension and other savings without taking the DB pension early? Very roughly, £100k would provide £20k for 5 years, £25k for 4 years, etc.

FWIW, I took my DB pension early (at 56) because I would not have been able to retire without doing so. From a long-term income perspective that might not have been optimal, but in the short term it meant I could retire!

kempiejon

Kids have flown the nest and in an ideal world I want to retire ASAP, which I know is relative but I don't lead an extravagant lifestyle and mortgage free. 

If that is the objective, it would make your world perfect to retire as soon as possible, then make the plan and do it.
Mortgage free, and at age 55+ an eye on a £15k pension and £100k lump sum (which could give an extra £5k per year say) that looks like a good start, infact some might say it is enough. If there are other savings, another person, potential legacy, options to downsize etc in the mix you'll need to do your own workings.

If you look at where you spend your money now, do the assessment of how to reduce your expenditure to within those means and it becomes achievable. But if you do not want to retire asap but only want to retire when you have a pot that far exceeds you minimum requirements it's still worth doing the research and understanding your base level and indulgent levels of hoped for retirement income. I did that and once I saw I had what I like to call FU money, going to work became optional.

Cobbler_tone

bjorn_toby_wilde said:

A DB pension isn’t a pot. It’s a promise to pay you an amount at your retirement date.

The sum is reduced when you take it early (because it will be paid to you over a longer period of time. Usually 4-5% reduction per year taken early.

The pension increases, usually in line with inflation but often capped, until the day you take it. Following that it again increases in line with inflation and again usually capped. You need to consult the scheme rules to find out what the increases will be for your particular scheme.

Whether it’s a good idea to take it early is really a question only you can answer.  I’m using other sources until my own main DB pension kicks in at 65.

I hope that helps and isn’t too patronising!

Not patronising at all 

I understand the DB scheme and that it has a transfer value, as opposed to being a 'pot'.

My wife will also have an option of a lump sum of £75k and £10k per year private pension in a years time. So between us I am sure we will be comfortable in a couple of years. It is that balance of giving up healthy salaries, the huge benefit (for us) of not working, leaving the DB as long as possible, then of course the influx of state pension at 67, which TBH needs to be looked at as a bonus, unless the DB is accessed more flexibly to taper income, which will be an option introduced by my scheme before the end of the year.
£2500-3000 net per month is ample for us to enjoy a good lifestyle.

I am sure we are not alone is wavering over £6k a month coming in but then the danger is that you never get to fully enjoy it. As you get older you get more acutely aware that you really do need to enjoy life now if you are in a position to do so. 

Mark_d

Your DB scheme includes a formula that should let you work out exactly how much you are due at the scheme retirement age (65).  This pension is reduced if you take it early, or increased if you take it later.

Your DC pension arrangement is far less predictable.  Assuming you want to buy an annuity when you retire, then your pension will depend on the fund value at the time and also the annuity rate applicable. Fund value depends on the underlying investments and annuity rate depends [indirectly] on the interest rate at the time you retire.

Triumph13

To meet your stated aims, this is probably one of those cases where you wouldn't delay taking the DB pension.  

If you were to retire in a year's time, assuming your DC had grown by the £20k you'll have contributed and that your wife is the same age as you, your numbers could look something like this:

£10k from wife's pension.  Tax free as below PA

£9.5k pa tax free by spreading wife's lump sum (£75k) and your DC TFLS (£30k) over the 11 years to your SP age.

£15.6k from your pension, excess over PA taxable

£8k pa taxable by spreading the remaining £90k from your DC over 11 years

After allowing for tax that gives you £41k pa spending money vs your target of £30 top £36k.  Once both SPs are on line that becomes £45k (£10k + £15.6 + 2 x £12k -tax).  Looking good.  The upcoming changes to allow a tapered pension in your scheme could make it even easier and let you avoid spending quite so much capital if you don't want to.

The other key question to consider though is will the survivor be okay financially after the first of you dies?

Sarahspangles

Cobbler_tone said:

I understand the DB scheme and that it has a transfer value, as opposed to being a 'pot'.

The CETV (Cash Equivalent Transfer Value) is irrelevant unless you are planning some kind of transfer. The usual scenarios are where some pension benefits are being transferred on divorce or your pension is being transferred, say if you have a right to transfer in to another DB pension as is the case for some public sector schemes.

You could say that it’s useful to have a nominal cash value to enable comparison with DC schemes, but the way CETVs are calculated isn’t designed for that purpose.

What actually matters is the extent to which you have flexibility to commute pension for lump sums, assuming that is an option you’re interested in, and the commutation rate offered. Plus how well the pension is inflation-proofed.

tonydathome19

Triumph13 said:

To meet your stated aims, this is probably one of those cases where you wouldn't delay taking the DB pension.  

If you were to retire in a year's time, assuming your DC had grown by the £20k you'll have contributed and that your wife is the same age as you, your numbers could look something like this:

£10k from wife's pension.  Tax free as below PA

£9.5k pa tax free by spreading wife's lump sum (£75k) and your DC TFLS (£30k) over the 11 years to your SP age.

£15.6k from your pension, excess over PA taxable

£8k pa taxable by spreading the remaining £90k from your DC over 11 years

After allowing for tax that gives you £41k pa spending money vs your target of £30 top £36k.  Once both SPs are on line that becomes £45k (£10k + £15.6 + 2 x £12k -tax).  Looking good.  The upcoming changes to allow a tapered pension in your scheme could make it even easier and let you avoid spending quite so much capital if you don't want to.

The other key question to consider though is will the survivor be okay financially after the first of you dies?

Thanks Triumph,
That is a great message and makes perfect sense. It is a clear direction to plot the spreadsheet.

After 3 major back surgeries (still good for 10k steps a day) there is no way I am waiting for 60+ just to accumulate a chunkier pot that is surplus to requirements. I also understand how many people/couples live to work but that isn't our mindset!

We do discuss the remaining party a lot and want to make sure the other is OK. Whilst I am working it is 4 x death in service. If taking the DB there is a 10k spousal pension. It is one of the considerations when looking at taking the DB out, although the CETV's have clearly plummeted of late. 

Cobbler_tone

tonydathome19 said:

Triumph13 said:

To meet your stated aims, this is probably one of those cases where you wouldn't delay taking the DB pension.  

If you were to retire in a year's time, assuming your DC had grown by the £20k you'll have contributed and that your wife is the same age as you, your numbers could look something like this:

£10k from wife's pension.  Tax free as below PA

£9.5k pa tax free by spreading wife's lump sum (£75k) and your DC TFLS (£30k) over the 11 years to your SP age.

£15.6k from your pension, excess over PA taxable

£8k pa taxable by spreading the remaining £90k from your DC over 11 years

After allowing for tax that gives you £41k pa spending money vs your target of £30 top £36k.  Once both SPs are on line that becomes £45k (£10k + £15.6 + 2 x £12k -tax).  Looking good.  The upcoming changes to allow a tapered pension in your scheme could make it even easier and let you avoid spending quite so much capital if you don't want to.

The other key question to consider though is will the survivor be okay financially after the first of you dies?

Thanks Triumph,
That is a great message and makes perfect sense. It is a clear direction to plot the spreadsheet.

After 3 major back surgeries (still good for 10k steps a day) there is no way I am waiting for 60+ just to accumulate a chunkier pot that is surplus to requirements. I also understand how many people/couples live to work but that isn't our mindset!

We do discuss the remaining party a lot and want to make sure the other is OK. Whilst I am working it is 4 x death in service. If taking the DB there is a 10k spousal pension. It is one of the considerations when looking at taking the DB out, although the CETV's have clearly plummeted of late. 

Requoting my own post as erroneous posting on another log in 

I have modelled taking the DB pension at all ages from 55 to 60 (with max annual increase of 2.5% - linked to RPI) and the corresponding impact of total income at ages 80 and 85.
By 85 you have received £100k more if you took it at 60 as opposed to 55. By state pension age (67) it is marginal to take it at any age from 55 and the total income is roughly the same by then. 

af1963

Saw a friend's DB pension which had rules for annual increases (on one part of the deferred pension) something like:

Before taking the pension: annual increase of a fixed 6% 
After taking the pension: no annual increase

Taking it early in that case would have frozen that part of the pension at its level at that time, as well as incurring the actuarial reduction for taking it at 55 or 60.  So it's worth checking what your particular scheme does for increases, both pre and post retirement. If one is better than the other, it might make it more suitable to take it early, or to wait.