NHS pension - not sure whether to take standard or maximum lump sum

Mr_Crabbs

crv1963 said:

Second part is the Survivors Pension ...

Thankyou. I had a look at some more resources this afternoon. I think this is what they call an 'adult dependant' and you have to nominate your adult dependant, which is probably what  my partner did; allocation looks like something different.

Moonwolf said:

On McCloud ... All I'm saying is check the figures carefully and think about what they mean.

Thankyou. My partner has a member fact sheet which included a lot of information on McCloud, though not very clear. However the assessment and examples in there suggested it's generally more beneficial as well.

From what I'd seen I'd understood that you'd have to make a McCloud decision when sending your pension forms in, bu the member fact sheet suggests they contact you to make your decision during the year AFTER you've taken your pension.

I'm not clear whether, if you're taking the 1995 benefits for partial retirement but choose the 2015 scheme for the McCloud years, you get that part of your entitlement included in the partial retirement or have to wait for it until 67?

I did wonder about point of retirement and whether the best time would be after the point of the 2025 pay rise but that might be worrying too much and it sounds as though it'll only be 2.8%.

Pat38493

Bit of an aside, but when my wife retired, she got paid the max PCLS by mistake, when she had requested the standard one.  Luckily she was able to prove that it was not her that had ticked the box that way - she had been transferred by TUPE to another company but was still in the NHS pension, and the person who had to copy her request over to the NHS ticked the wrong box.  She then had to pay some of the money back and it got sorted eventually.

phynix_uk

Whilst I agree with the 12-1 commutation not being attractive compared to some, possibly most DB schemes, the instant conclusion that this isn't in your best interest is simply false. Stating that it'll only take you 12 years to essentially break even is also incorrect. The calculation needs to take tax into account and if your projecting forward in time, you need to also include potential growth of the £48,000. If you want to stress test numbers, you need to be fair to them.

Ignoring higher rate tax, and tax mitigation (which would absolutely be sensible) the income received under the standard terms would be taxed so the 12-1 ratio would as a minimum need to be 15-1, pushing the crossover age to 75... then you could argue that the additional £48,000 also grows over time, and if the FA you dealing with manages money well then this would push that age put even further. 

Dazed_and_C0nfused

phynix_uk said:

Whilst I agree with the 12-1 commutation not being attractive compared to some, possibly most DB schemes, the instant conclusion that this isn't in your best interest is simply false. Stating that it'll only take you 12 years to essentially break even is also incorrect. The calculation needs to take tax into account and if your projecting forward in time, you need to also include potential growth of the £48,000. If you want to stress test numbers, you need to be fair to them.

Ignoring higher rate tax, and tax mitigation (which would absolutely be sensible) the income received under the standard terms would be taxed so the 12-1 ratio would as a minimum need to be 15-1, pushing the crossover age to 75... then you could argue that the additional £48,000 also grows over time, and if the FA you dealing with manages money well then this would push that age put even further. 

Generally fair points.

But the pension given up is almost certainly only £4k in year one, you can't ignore the annual inflation proofing, whatever that is for this scheme.

Silvertabby

Dazed_and_C0nfused said:

phynix_uk said:

Whilst I agree with the 12-1 commutation not being attractive compared to some, possibly most DB schemes, the instant conclusion that this isn't in your best interest is simply false. Stating that it'll only take you 12 years to essentially break even is also incorrect. The calculation needs to take tax into account and if your projecting forward in time, you need to also include potential growth of the £48,000. If you want to stress test numbers, you need to be fair to them.

Ignoring higher rate tax, and tax mitigation (which would absolutely be sensible) the income received under the standard terms would be taxed so the 12-1 ratio would as a minimum need to be 15-1, pushing the crossover age to 75... then you could argue that the additional £48,000 also grows over time, and if the FA you dealing with manages money well then this would push that age put even further. 

Generally fair points.

But the pension given up is almost certainly only £4k in year one, you can't ignore the annual inflation proofing, whatever that is for this scheme.

As with all public sector pension schemes, the inflation proofing in retirement is uncapped CPI.

Plus, unlike most private sector DB schemes, public sector pensioners who reached SPA after April 2016 receive full CPI increases on both pre and post 1988 GMP elements.

daveyjp

phynix_uk said:

Whilst I agree with the 12-1 commutation not being attractive compared to some, possibly most DB schemes, the instant conclusion that this isn't in your best interest is simply false. Stating that it'll only take you 12 years to essentially break even is also incorrect. The calculation needs to take tax into account and if your projecting forward in time, you need to also include potential growth of the £48,000. If you want to stress test numbers, you need to be fair to them.

Ignoring higher rate tax, and tax mitigation (which would absolutely be sensible) the income received under the standard terms would be taxed so the 12-1 ratio would as a minimum need to be 15-1, pushing the crossover age to 75... then you could argue that the additional £48,000 also grows over time, and if the FA you dealing with manages money well then this would push that age put even further. 

The 48k only grows if you don't spend it.  If there is no intention of spending it receive the maximum monthly payment and save some of it.

phynix_uk

Dazed_and_C0nfused said:

phynix_uk said:

Whilst I agree with the 12-1 commutation not being attractive compared to some, possibly most DB schemes, the instant conclusion that this isn't in your best interest is simply false. Stating that it'll only take you 12 years to essentially break even is also incorrect. The calculation needs to take tax into account and if your projecting forward in time, you need to also include potential growth of the £48,000. If you want to stress test numbers, you need to be fair to them.

Ignoring higher rate tax, and tax mitigation (which would absolutely be sensible) the income received under the standard terms would be taxed so the 12-1 ratio would as a minimum need to be 15-1, pushing the crossover age to 75... then you could argue that the additional £48,000 also grows over time, and if the FA you dealing with manages money well then this would push that age put even further. 

Generally fair points.

But the pension given up is almost certainly only £4k in year one, you can't ignore the annual inflation proofing, whatever that is for this scheme.

Inflation proofing is really the only advantage. Whilst significant over the longer-term, the question members need to ask, is how long to they think they'll live.....as unfair as that may be. The reality is, how many members will reach 75+ years of age and be grateful for the additional income (minus tax) rather than the additional flexibility the lump sum may have offered them in their 60's. The whole point of commutation is to provide a certain element of flexibility to the 'defined benefit', simply put, some people will need the income, some the lump some and others will simply find one option 'more' attractive than the other. 

In most situations, peoples spending tends to decrease as they get older, aside from potential care costs (which is of course a very real risk to us all), will people really need that extra income in the future? The lump sum could in theory, be invested into ISAs within a few years, grown over time (with better than inflation returns) and then also utilised for income if needed, only that income would be tax free.

hugheskevi

It is interesting to consider the breakeven points for a basic rate and additional rate taxpayer in retirement, net of tax.

Assume:

• Pension is taken on 60th birthday
• All pension income is taxed at (a) 20% or (b) 40% on whole of pension in all future years
• A commutation factor of 12:1 is available
• Lump sum is invested in an ISA and returns stated return net of all fees in every year
• Pension income received is invested in an ISA and returns stated return net of all fees in every year
• CPI is 2% in all future years
• No life-limiting health conditions
• Inheritance tax is not a consideration

Life expectancy is likely to be in the high eighties, ie just under 30 years, slightly better than cohort life expectancy as we are considering someone with a decent pension and assumed reasonable health.

If the investment return is equal to CPI, the breakeven point for a basic rate taxpayer is 15 years and for a higher rate taxpayer it is 20 years.

If the investment return is equal to CPI+1%, the breakeven point for a basic rate taxpayer is 17 years and for a higher rate taxpayer it is 23 years. 

If the investment return is equal to CPI+2%, the breakeven point for a basic rate taxpayer is 18 years and for a higher rate taxpayer it is 26 years. 

If the investment return is equal to CPI+3%, the breakeven point for a basic rate taxpayer is 20 years and for a higher rate taxpayer it is 30 years. 

If the investment return is equal to CPI+4%, the breakeven point for a basic rate taxpayer is 22 years and for a higher rate taxpayer it is 35+ years. 

So for someone who is going to be a basic rate taxpayer in retirement, taking the taxed pension is financially better regardless of investment return achieved than taking tax free cash. For a higher rate taxpayer, if they are getting a return of about CPI+3% p/a or more, the lump sum starts to be attractive.

That is the sort of return (net of fees) you might expect from an equities heavy portfolio so you need to be taking a decent amount of investment risk. Sequence of returns risk will be an important consideration, which this example assumes away as an issue but needs to be acknowledged. A lump sum may also be difficult to invest within ISA limits, this is likely to be much less of an issue with pension income.

So from a pure profit maximising perspective, it is difficult to build a case for taking a lump sum except for possibly those paying higher rate in retirement who are happy to invest their lump sum quite aggressively. But retirement is not about profit maximising. Ideally flexibility would be provided for by separate DC pension which is perfect for such a purpose (especially if part of the same scheme as the DB pension, as in the LGPS, and so can be taken largely or entirely tax-free), but if that hasn't been put in place then commutation could be attractive despite the financial loss - particularly for someone expecting to pay higher rate tax in retirement.

Note, this is a very simple and unrealistic set of assumptions and examples designed to reach some broad and general conclusions. You would want to expand this to cover withdrawals from the lump sum and pension income based on personal preferences to see how that affected the breakeven points on different rates of return.

Mr_Crabbs

phynix_uk said:

The calculation needs to take tax into account and if your projecting forward in time, you need to also include potential growth of the £48,000. If you want to stress test numbers, you need to be fair to them.

The lump sum could in theory, be invested into ISAs within a few years, grown over time (with better than inflation returns) and then also utilised for income if needed, only that income would be tax free.

My thinking on this has evolved through these and other discussions in the last few days. Drawing down the lump sum (and so eroding the capital) seems to make a lot of difference. I know this isn't what you're saying, but it's easy to think you've got the capital and income, and it's not that clear cut.

phynix_uk said:

Inflation proofing is really the only advantage. Whilst significant over the longer-term, the question members need to ask, is how long to they think they'll live.....as unfair as that may be.

In most situations, peoples spending tends to decrease as they get older, aside from potential care costs (which is of course a very real risk to us all), will people really need that extra income in the future?

ONS gives an average 61 year old woman a lifespan of 87 years with a 75% chance of living to 80. I think this is one of the non-financial decisions - living now vs. future comfort and care.

hugheskevi said:

It is interesting to consider the breakeven points for a basic rate and additional rate taxpayer in retirement, net of tax ... for someone who is going to be a basic rate taxpayer in retirement, taking the taxed pension is financially better ... for a higher rate taxpayer, the lump sum starts to be attractive. 

Sequence of returns risk will be an important consideration, which this example assumes away as an issue but needs to be acknowledged. A lump sum may also be difficult to invest within ISA limits, this is likely to be much less of an issue with pension income.

Ideally flexibility would be provided for by separate DC pension which is perfect for such a purpose (especially if part of the same scheme as the DB pension, as in the LGPS, and so can be taken largely or entirely tax-free)

You would want to expand this to cover withdrawals from the lump sum and pension income based on personal preferences to see how that affected the breakeven points on different rates of return.

Thanks. Do you have a reference for this, or the source calculations?

I'm not clear what you mean by 'sequence of returns risk'?

For us the difficulty of investing a lump sum is a factor; not only because the lump sum is bigger than the ISA limit, but also because we're maxing our ISAs anyway, so we might end up paying tax on savings interest, or CGT.

I'm not clear what you mean by "flexibility would be provided for by separate DC pension" and "can be taken largely or entirely tax free"? We are considering a separate DC (AVCs / additional pension or SIPP) to mitigate the higher rate tax my partner would otherwise pay.

I think we need to do some calculations but are unsure how to do it and don't have access to an FA, particularly in the timescale my partner wants to work on! Have you any sources?

Dazed_and_C0nfused

I'm not clear what you mean by "flexibility would be provided for by separate DC pension" and "can be taken largely or entirely tax free"? We are considering a separate DC (AVCs / additional pension or SIPP) to mitigate the higher rate tax my partner would otherwise pay.

I think the potential to take more than 25% tax free from a separate DC pension is something that is specific to LGPS, I don't think there is anything available in the NHS scheme that has that benefit.

But higher rate tax relief and 25% TFLS is still quite an attractive proposition 🙂