Pension - Higher or lower lump sum

Phossy

QrizB said:

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.

Understood, and  that's a fortunate position that many aren't in. I took time to detail a response that hopefully is broader than just this original question and in some way response to the general push on here which tends towards being the richest in the graveyard.

Cobbler_tone

The reason the majority of people take at least some of their lump sum is…many people will not got the opportunity to get that much tax free cash in a lump again and no-one has any idea how long they will live. If you are technically ‘worse off’ in your 80’s then it probably isn’t going to matter. 

As with most things it comes down to other pension provisions and overall plan.
It is why the choice is normally there to do either.

hugheskevi

Roberts12 said:

I am a 60 year old women.

I am single with no dependents and no mortgage. Do I take the higher lump sum or the lower one? 

Higher is £140.000 tax free lump sum and £ 21, 000 annual pension 

or

Lower is £48,000 tax free lump sum and £29,000 annual pension. 

The Civil Service offers inverse commutation, and publishes factors at this link. Whereas lump sum commutation is at a fixed 12:1 exchange, inverse commutation is calculated to be actuarially neutral. All public service pensions use the same discount rate and so looking at the value of inversely commuting £92,00 (£140,000 less £48,000) shows the actuarial value that lump sum should purchase.

For a 60 year old woman, own pension only, it would give £4,315 of annual pension (a commutation ratio of 21.3). Whereas to get a lump sum of £92,000 requires £7,667 of pension to be given up.

The discount rate is set by HM Treasury, based on long-term economic growth expectations. If instead market-based factors were to be applied, we could look to the PPF commutation factors that are set to be actuarially neutral based on market values.

The PPF factors would give a commutation factor of 19.9 and so similar to the actuarially neutral inverse commutation rate in the Civil Service scheme.

So the offer of a 12:1 commutation factor is giving about 55-60% of the actuarially fair value. This is offset by the lump sum being tax free, but accepting those terms is agreeing to a significant loss of value.

poseidon1

Typically, doesn't look as if the OP is going to return with any reaction to the wealth of responses to her original query.  Therefore the  situation  I will highlight below might assist others faced with the OP's quandary.

An acquaintance of mine was a member of a particularly generous DB scheme with a major ftse 100 company. He had augmented it over  15 years by way of AVCs, so by the time he was 56 the value of his benefits was so high, continuing with his employment would sail very close to the lifetime allowance and penal taxes thereon, so he took early retirement.

Intial quoted package was £32.5k indexed pension with £240k TFC which he fully intended to take eventhough he had no immediate use for the cash , and interest rates on savings were around 1% at that time.

 His primary rationale however was the low pension should ensure he would not breach 40% tax bracket for some years to come.  It was incumbent on me to talk him out of this rather perverse mode of thinking. 

Long story short, I convinced him to forgoe £100k of TFC  in exchange for an additional  £17k pension income taking his total to £49.5k ( a particularly attractive commutation rate). That was 2015.
10 years later with RPI increases his DB pension will breach £75k this year plus full  state pension now coming on stream.  He is a little astounded that at this stage of retirement he has guranteed  pensions that now exceed what he used to earn when he worked, and reflects on why he was intially so set on minimising the starting level of his DB pension.

The obvious point being made here is the higher one can commence one's DB pension the greater the compounding effect of inflationary increases thereon. I would have thought getting to a position where pension income (at least notionally ) equals or exceeds original employed earnings, should be a goal worth achieving?

cfw1994

Silvertabby said:

I'll say it before anyone else does - the LGPS commutation rate of 1:12 (give up £1 of fully index linked pension for the rest of your life in return for a one-off tax free £12) is a pretty p.poor rate.....

Unless you have an immediate and desperate need for the extra cash, or you have a life limiting illness, then the smaller lump sum/bigger pension should give you the overall better return.  But it's very much your choice - choose wisely and don't be influenced by 90%+ of your collegues urging you to take the bigger lump sum 'because it's what they will do'. 

P.S.  You will be re-joining the LGPS in respect of your reduced hours post, won't you?  Note that any R85 protections you may have had (in respect of any pre 2008 service) won't apply to your new record, but it's still well worth having. 

I think this is the right answer…

Unless you have a very compelling need for the extra cash or life-limiting illness, go with the lower….
Good luck!

PropertyGuru_Wannabe

MeteredOut said:

There's no right answer to this, but you may want to consider the "how long do i expect to live" approach, and see which would give you more over that lifetime.

eg, Assuming 20 years:

£140,000 + (£21,000 * 20) = £560,000
£48,000 + (£29,000 * 20) = £628,000

Another way to look at it is the you'd be getting an extra £92K TFLS in exchange for £8K less pension each year, so if you expect to survive more than 11.5 years, the lower tax free lump sum would be better from a pure "which provides more money" perspective.

Neither of these taking into account inflation, or how any TFLS might grow if you invest it, or whether the pension is index linked in any way.

But, with an ongoing income of £30K, you'd need to consider the 40% tax implications if you take the lower TFLS and higher pension (and also take state pension into account for when you get there).

Do you need to draw it now, and do you need the higher TFLS for a particular reason, as that should also go into your decision.

I am voting for this answer.  As @MeteredOut has said, there is no right or wrong answer.  It purely depends on your objectives, your financial savviness, and your personality.  

Cobbler_tone

poseidon1 said:

Typically, doesn't look as if the OP is going to return with any reaction to the wealth of responses to her original query.  Therefore the  situation  I will highlight below might assist others faced with the OP's quandary.

An acquaintance of mine was a member of a particularly generous DB scheme with a major ftse 100 company. He had augmented it over  15 years by way of AVCs, so by the time he was 56 the value of his benefits was so high, continuing with his employment would sail very close to the lifetime allowance and penal taxes thereon, so he took early retirement.

Intial quoted package was £32.5k indexed pension with £240k TFC which he fully intended to take eventhough he had no immediate use for the cash , and interest rates on savings were around 1% at that time.

 His primary rationale however was the low pension should ensure he would not breach 40% tax bracket for some years to come.  It was incumbent on me to talk him out of this rather perverse mode of thinking. 

Long story short, I convinced him to forgoe £100k of TFC  in exchange for an additional  £17k pension income taking his total to £49.5k ( a particularly attractive commutation rate). That was 2015.
10 years later with RPI increases his DB pension will breach £75k this year plus full  state pension now coming on stream.  He is a little astounded that at this stage of retirement he has guranteed  pensions that now exceed what he used to earn when he worked, and reflects on why he was intially so set on minimising the starting level of his DB pension.

The obvious point being made here is the higher one can commence one's DB pension the greater the compounding effect of inflationary increases thereon. I would have thought getting to a position where pension income (at least notionally ) equals or exceeds original employed earnings, should be a goal worth achieving?

An attractive commutation rate is extremely appealing, especially if you don't have any plans for the lump sum. 
However, I don't see the point in having aspirations to produce the income you had whilst working. You won't be paying into a pension, no NI and lower IT...you would hope!

Unless of course your plan is to have tip top health into your 70's and 80's and suddenly change your lifestyle, which IMO would be a bit of a shame to leave it that long.
The reality is that most people would die with a large bank balance. Pockets and shrouds. 
In this example (and I know someone the same) it can be hard for someone to avoid wealth! My single retired friend has to spend £50k net a year to stay under the 40% threshold (which would mortify him!) and spends £40 a week in Aldi's. At least his house is always warm these days and he treats himself to a new car every year.

finbaar

Good grief! What is wrong with people? If you are in the fortunate position, at any time of life, to be in the 40% (or 45%) income tax bracket then you are doing very well. Doing things to avoid this situation in mental.

Cobbler_tone

finbaar said:

Good grief! What is wrong with people? If you are in the fortunate position, at any time of life, to be in the 40% (or 45%) income tax bracket then you are doing very well. Doing things to avoid this situation in mental.

During retirement and having too much money, possibly.
Deciding not work because you will pay more tax, possibly.
Whilst working and maximising your income for your future, whilst minimising tax exposure, definitely not.

Moonwolf

MeteredOut said:

There's no right answer to this, but you may want to consider the "how long do i expect to live" approach, and see which would give you more over that lifetime.

eg, Assuming 20 years:

£140,000 + (£21,000 * 20) = £560,000
£48,000 + (£29,000 * 20) = £628,000

Another way to look at it is the you'd be getting an extra £92K TFLS in exchange for £8K less pension each year, so if you expect to survive more than 11.5 years, the lower tax free lump sum would be better from a pure "which provides more money" perspective.

Neither of these taking into account inflation, or how any TFLS might grow if you invest it, or whether the pension is index linked in any way.

But, with an ongoing income of £30K, you'd need to consider the 40% tax implications if you take the lower TFLS and higher pension (and also take state pension into account for when you get there).

Do you need to draw it now, and do you need the higher TFLS for a particular reason, as that should also go into your decision.

In my opinion this is the best answer but I would add...

It really does depend on what you would do with the money. 

I know of people who took the maximum lump sum "because I might die tomorrow" and put it in a savings account.  They then did die early so technically it might seem they were better off, but they still had most of the cash in a basic savings so they didn't actually get the benefit (although their dependants did).

On the other hand I met someone on a cruise who had taken the maximum lump sum, they had worked out that the reduced pension plus state pension was more than enough to live on.  They were then spending the lump sum on lots of expensive holidays including cruises while they still had the energy, front loading that higher expenditure. This doesn't seem daft to me.