Pension - Higher or lower lump sum

QrizB

Here's an example of what happens if your investment return is 5%, inflation is 3.7% and you take sum from your investment each year equal to the LGPS pension you're missing out on.

You run out of money in year 18.

Linton

Jim777 said:

Ok, I’m no expert at this, but I’ve been playing around with some figures.

I’m in the LGPS. I can increase my lump sum by £100,000 and lose £8333 pension per year which mean 12 years of pension. However, the £8,333 is taxable giving £6,667 which now equates to 15 years pension.

If though I invest the £100,000, I can expect to earn around 5% interest. If this is compounded over 20 years, after tax on the interest, my lump sum becomes equivalent to close to 40 years pension.

This would suggest to me that the taking the lump sum makes more sense. Am I missing something in my calculation or have I got this wrong? 

Have you taken inflation into account?  You are unlikely to get interest of 5%+inflation.

Jim777

Sarahspangles said:

Jim777 said:

Ok, I’m no expert at this, but I’ve been playing around with some figures.

I’m in the LGPS. I can increase my lump sum by £100,000 and lose £8333 pension per year which mean 12 years of pension. However, the £8,333 is taxable giving £6,667 which now equates to 15 years pension.

If though I invest the £100,000, I can expect to earn around 5% interest. If this is compounded over 20 years, after tax on the interest, my lump sum becomes equivalent to close to 40 years pension.

This would suggest to me that the taking the lump sum makes more sense. Am I missing something in my calculation or have I got this wrong? 

The LGPS commutation rate is among the lowest at 1:12

You haven’t factored in that your £8,333 payment is also index linked. You mention investing, but then refer to 5% interest and paying tax on the interest. 5% interest rates on larger sums are becoming harder to find, the current situation where it’s possible to match or beat inflation with savings interest rates is likely to be short lived. Investments may beat inflation but returns aren’t guaranteed, unlike your £8,333.

I take your point, but even if the interest rate is as low as 3% then the lump sum still equates to around 25 years pension.

Sarahspangles

Jim777 said:

Sarahspangles said:

Jim777 said:

Ok, I’m no expert at this, but I’ve been playing around with some figures.

I’m in the LGPS. I can increase my lump sum by £100,000 and lose £8333 pension per year which mean 12 years of pension. However, the £8,333 is taxable giving £6,667 which now equates to 15 years pension.

If though I invest the £100,000, I can expect to earn around 5% interest. If this is compounded over 20 years, after tax on the interest, my lump sum becomes equivalent to close to 40 years pension.

This would suggest to me that the taking the lump sum makes more sense. Am I missing something in my calculation or have I got this wrong? 

The LGPS commutation rate is among the lowest at 1:12

You haven’t factored in that your £8,333 payment is also index linked. You mention investing, but then refer to 5% interest and paying tax on the interest. 5% interest rates on larger sums are becoming harder to find, the current situation where it’s possible to match or beat inflation with savings interest rates is likely to be short lived. Investments may beat inflation but returns aren’t guaranteed, unlike your £8,333.

I take your point, but even if the interest rate is as low as 3% then the lump sum still equates to around 25 years pension.

You’re modelling this as if you can predict future interest and inflation rates, and returns on investment. Whereas you need to model a series of scenarios. In some you’ll be better off commuting more pension to lump sum, in others you’ll lose out. Regular posters on this board point out repeatedly that people aren’t paying attention to the effect of inflation and underestimate the ‘risk’ they’ll live a long time. The models have to be more complicated that most of us initially assume - we don’t know what we don’t know.

Faced with a chance of having a lot of cash upfront a lot of people go for that option for reasons that aren’t rational. That’s just human nature.

Nebulous2

How old are you? The younger you are, the worse that 12:1 is. 

I was in almost exactly that situation,  retiring at 59. I didn't take a lump sum at all, as I was used to my salary dropping in my bank account every month, and liked the idea that I would have a base payment which met most of my needs. 

We've had two very good CPI increases since I retired and I've no regrets at all about my decision. 

MK62

Jim777 said:

Sarahspangles said:

Jim777 said:

Ok, I’m no expert at this, but I’ve been playing around with some figures.

I’m in the LGPS. I can increase my lump sum by £100,000 and lose £8333 pension per year which mean 12 years of pension. However, the £8,333 is taxable giving £6,667 which now equates to 15 years pension.

If though I invest the £100,000, I can expect to earn around 5% interest. If this is compounded over 20 years, after tax on the interest, my lump sum becomes equivalent to close to 40 years pension.

This would suggest to me that the taking the lump sum makes more sense. Am I missing something in my calculation or have I got this wrong? 

The LGPS commutation rate is among the lowest at 1:12

You haven’t factored in that your £8,333 payment is also index linked. You mention investing, but then refer to 5% interest and paying tax on the interest. 5% interest rates on larger sums are becoming harder to find, the current situation where it’s possible to match or beat inflation with savings interest rates is likely to be short lived. Investments may beat inflation but returns aren’t guaranteed, unlike your £8,333.

I take your point, but even if the interest rate is as low as 3% then the lump sum still equates to around 25 years pension.

It only equates to 25 years of today's pension - but the pension will increase annually with inflation.....at 3.2% inflation (ie market expectation of inflation over the next 25yrs - which, fair enough, could be wrong), in 25 years the pension will be paying c.£17750pa.
How long your lump sum would last if paying out the equivalent of the pension each month depends on the return you get on that lump sum and inflation.......but to give some idea, if inflation averages that 3.2%pa, then at 3%pa return, the lump sum would last c.12yrs, while at 5%pa, c.15yrs........you'd need around 10%pa to make it last 25yrs.

PS.....to give an idea of the relative value of that index linked £8333 starting pension, have a look at how much it would cost to buy an equivalent lifetime annuity.

PPS......we are talking average life expectancy here of course.......if you were unlucky and shuffled off after 7-8 years, for instance, then you (or rather your beneficiaries) would likely have been better off if you'd taken the lump sum........there's no getting round that.

finbaar

Hmm, some interesting reading and opinions on here considering my own situation (58, eligible for full DB pension in 2 years) that I've been pondering. My DB pension which should give me about £30k (possibly a little bit more as the final three years will be in a CARE scheme instead of FS) with a lump sum of about £80k. The approximate figures if I went for the lowest pension and biggest lump about £21k and £160k. Personally I have almost decided to go for the bigger pension as having a guaranteed higher income that will rise by CPI every year seems most attractive. Also I'm married and although my wife has pensions they will not be as good - although by the time we both reach state pension age we will have lots of income each month, about £5.3k after tax if that were today.
Personally I don't think that income can be beaten unless you have a reason to take the higher lump sum. And by reason I don't mean shoving it in a bank and drawing down, I mean buying something or investing in a business.
The real thing for me to ponder is what to do at 60. I'm 100% not going to stay in my current role on full time hours. I possibly could drop a couple of days. Or I do have some sellable skills and could do some agency work 3 days a week for a couple of years. Or something else.

spaniel101

Albermarle said:

Silvertabby said:

Albermarle said:

It is a pity that with such a poor commutation rate, that there is not an option to not take any lump sum at all and get an even bigger pension.

LGPS inverse commutation was phased out many moons ago.  Too expensive. 

As I've said before, over 90% of LGPS retirees go for the maximum commuted tax free cash, despite the poor rate.  Helps keep the scheme affordable, I suppose! 

ADD:  A tiny number of very old deferred records still have reserved rights to inverse commutation.  Even in my time, the cost of adding software that would hardly be used was deemed to be an unneccessary expense, so the calculation had to be done manually,  Our policy was that initial pension quotes would be based on normal/maximum tax free cash options, but we would add that an entitlement to convert automatic lump sums to extra pension existed, and to ask us for the figures.  Again, over 90% of these went for the maximum tax free cash. 

I have learnt something today. I have never heard of inverse commutation before!
I just assumed the baseline for any DB pension, was maximum pension and no lump sum.
Like you say I suppose forcing you to take some lump sum at a poor commutation rate saves some money, although it sounds like very few people would take a maximum pension option anyway.

The Railway pension scheme (RPS - funded) has inverse commutation via Brass contribution (AVC).   Partial Brass fund value @ NRA forms your lump sum (as opposed to reducing your annual pension), any 'excess' Brass can be inversely commuted @ 12:1 to increase annual pension.

Phossy

I'd look at how much income you think you need per annum and how much you would like per annum.

If you have a full state pension, then simplistically your pension income will be either:

1) £29 K per annum up to 67 then £41.5 K/ annum thereafter, or               (£25,714/ £35,714 after tax)
2) £21 K per annum up to 67 then £33.5 K / annum                                   (£19,314/  £29,314 after tax)

If you factor in the lump sum on the assumption you want to use it  maximise your spending between now and 67 ( 7 years), then these become 

1a) £34.7 K per annum up to 67 then £41.5 K/ annum thereafter, or          (£31,414/ £35,714 after tax)
2a) £41K per annum up to 67 then £33.5 K / annum thereafter                  (£39,314/  £29,314 after tax)

The lump sum is potentially a great way to maximise income in your early retirement, which for me is the right way round. Whether that works for you is really down to you/ what you want.

All these are in todays money as it is too complex to know what will happen in the future,  and in terms of investing a a lump sum I would caution that  just because it is a DB scheme does not mean it is protected from inflation. My (deferred) pension has a 5% CPHI cap and it has fallen behind inflation by about 12% over the last 15 years. If I put money in a simple savings account right now then it would be outpacing the growth of my DB pension. 

Working out what you would need as an income is a good starting point.

QrizB

Phossy said:

 I would caution that  just because it is a DB scheme does not mean it is protected from inflation. My (deferred) pension has a 5% CPHI cap and it has fallen behind inflation by about 12% over the last 15 years.

Th OP (who has yet to reply to this thread) has a local government pension. LGPS tracks uncapped CPI, so doesn't face that risk.