Civil Service Pension legacy lump sum to max out or not

atalantalass

I have service in classic plus and alpha. I'm a year or so away from 60 and leaning towards taking the lot and retiring at 60. What I'm struggling with is working out the pros and cons of taking a larger or smaller lump sum from the legacy scheme part of my pension. I've seen threads from a few years ago now about this but I'm not sure if anything has changed and how best to weigh-up the options and model the differences. The earlier threads mentioned the break-even point but I'm not sure what that means and how to calculate it. I know a bigger lump sum, although tax free, means a lower pension and pension is taxable but a colleague said it's a no brainer to take the max lump sum but I'm not convinced its that straightforward. Jeez, I feel really dim. Grateful for comments / advice/pointers towards relevant docs on how to compare or model.  

QrizB

Almost everyone on this board (where we generally understand pensions) willsuggest that you take the smallest lump sum and the biggest pension.

If you decide to take a larger lump sum, I will thank you on behalf of all the UK's taxpayers for your sacrifice for the greater good.

Dazed_and_C0nfused

atalantalass said:

I have service in classic plus and alpha. I'm a year or so away from 60 and leaning towards taking the lot and retiring at 60. What I'm struggling with is working out the pros and cons of taking a larger or smaller lump sum from the legacy scheme part of my pension. I've seen threads from a few years ago now about this but I'm not sure if anything has changed and how best to weigh-up the options and model the differences. The earlier threads mentioned the break-even point but I'm not sure what that means and how to calculate it. I know a bigger lump sum, although tax free, means a lower pension and pension is taxable but a colleague said it's a no brainer to take the max lump sum but I'm not convinced its that straightforward. Jeez, I feel really dim. Grateful for comments / advice/pointers towards relevant docs on how to compare or model.  

Assuming you will get £12 for each £1 of pension given up it's not really a great offer unless you are desperate for the lump sum.

That £12 is tax free. But is a one off payment.

The £1 you have given up is inflation proofed so normally increases on a yearly basis.  Might just be 1.7% like this year.  But it was 10?1% and 8.5% in recent years.

And you could be getting that £1 for 30+ years.

An expensive way to get your extra lump sum really.

atalantalass

QrizB said:

Almost everyone on this board (where we generally understand pensions) willsuggest that you take the smallest lump sum and the biggest pension.

If you decide to take a larger lump sum, I will thank you on behalf of all the UK's taxpayers for your sacrifice for the greater good.

Good to know I've come to the right place and most folk on here understand pensions. I'd like to try to understand more too. And I'm feeling a bit silly for not seeing immediately why that is the best option. Can you explain what the reasons are and what the factors are to consider? 

QrizB

You're taking your pension at 60, and an average 60-year-old can expect to live for another 25+ years.

For each £12 of lump sum, you're giving up £1 of pension. After basic rate tax that £1 of pension is 80p.

Assuming you live for the average period, you're giving away £25 (before tax) or £20 (after tax) in exchange for £12. That doesn't seem like a very good deal to me.

Reasons for taking the larger lump sum:

- You're in poor health with a limited life expectancy

- You owe money to Bullet Tooth Tony and he's threatening to BBQ your cat

- You're planning a blow-out round-the-world adventure to kickstart your retirement, can't raise the funding any other way and will still have enough retirement income for a comfortable existence well into your 90s.

atalantalass

QrizB said:

You're taking your pension at 60, and an average 60-year-old can expect to live for another 25+ years.

For each £12 of lump sum, you're giving up £1 of pension. After basic rate tax that £1 of pension is 80p.

Assuming you live for the average period, you're giving away £25 (before tax) or £20 (after tax) in exchange for £12. That doesn't seem like a very good deal to me.

Reasons for taking the larger lump sum:

- You're in poor health with a limited life expectancy

- You owe money to Bullet Tooth Tony and he's threatening to BBQ your cat

- You're planning a blow-out round-the-world adventure to kickstart your retirement, can't raise the funding any other way and will still have enough retirement income for a comfortable existence well into your 90s.

So neither of the first two reasons apply but I wondered whether if I needed to raise funding for some reason it might be more difficult on a pension rather than earning a salary and that could be a reason for maximising the lump sum? Also in Scotland, where I am, the tax thresholds are lower. I will have income from a rented property too which means I will be in the higher bracket for as long as I have the rental income.  

Cobbler_tone

You will get some people who say you should take the max lump sum, or take no lump sum, regardless of the impact. 
It 100% comes down to the commutation (exchange of pension to get the cash) rate and your personal circumstances as outlined in the previous post. If you can work out roughly (in any scheme) when you are expected to 'lose out' then it can make the decision a bit easier. If you haven't got any particular need for the lump sum and limited other pensions, then getting the highest guaranteed pension (for life) will provide that extra peace of mind. Even if you do want a bit of cash...for a holiday or to buy a car etc, it may be sensible to fund for elsewhere, or raise the funds another way and pay it back.
It is a decision that most people face with a DB pension and the appeal of tax free cash is understandable, which is fine if you can afford and understand the impact. I'm 12-18 months out and still not sure what I'll do, or a bit of both, although my rate sounds better (19 as opposed to the 12 mentioned here) and will involve a lot of numbers from a few places on a spreadsheet. If you can live comfortably and the material impact is negligible, there isn't really a right or wrong answer. Even if it was deemed a wrong answer, the one thing no-one knows is our end date, which is the only way to know the definite answer to that decision in financial terms. I doubt any 95 year old keeps a spreadsheet of how much better off they are, although it may have been integral of keeping a roof over their head. So in some circumstances it can be a really important decision to get right for you.

For a really basic calculation put both figures, the low pension (with the lump sum at the top) and high pension (with no lump sum) in two columns. Increase each one by 3% a year (you don't know what inflation will be). If you sum them up you will see when the larger pension's total overtakes the smaller one. 

Hopefully you are armed to educate your "no brainer" colleague who may not fully understand it, or who knows Bullet Tooth Tony whose APR is awful. 

MarlowMallard

Here 12:1 is  a pretty poor commutation ratio, and purely financially it's better not taking lump sum unless (a) you have substantial spending plans in the next few years that won't wait, e.g. blowout holidays, home renovation or mortgage to clear ,  or (b) you or spouse are likely to receive a significant inheritance by age 75-80 so you won't have to worry after that. 

On the other hand, if the reduced pension is still "enough", it is tempting to take the lump and blow it in your 60s... then if you die at 70 you have had more fun than otherwise; if you live past 80 you have lost money, but you have won by living past 80. 

In my case, the commutation ratio was 18, the extra pension might tip me into 40% tax, and both (a) and (b) apply so it was an easy decision to take the max lump sum. 

Cobbler_tone

MarlowMallard said:

(b) you or spouse are likely to receive a significant inheritance by age 75-80 so you won't have to worry after that. 

I have never and never will account for any inheritance in my financial planning. Partly because I don't want to think about it but also a lot can happen in that area. Maybe a tad different if you are being handed the keys to the family manor. 
I personally find it best to plan for the future without thinking about it, nor needing it. 'Likely' is the key word in that statement.

atalantalass

MarlowMallard said:

Here 12:1 is  a pretty poor commutation ratio, and purely financially it's better not taking lump sum unless (a) you have substantial spending plans in the next few years that won't wait, e.g. blowout holidays, home renovation or mortgage to clear ,  or (b) you or spouse are likely to receive a significant inheritance by age 75-80 so you won't have to worry after that. 

On the other hand, if the reduced pension is still "enough", it is tempting to take the lump and blow it in your 60s... then if you die at 70 you have had more fun than otherwise; if you live past 80 you have lost money, but you have won by living past 80. 

In my case, the commutation ratio was 18, the extra pension might tip me into 40% tax, and both (a) and (b) apply so it was an easy decision to take the max lump sum. 

Thank you neither (a) to any significant extent or (b) realistically apply for my circumstances.  Wondering why there would be different ratios? Is that just a difference of different pension schemes? Is your scheme not a civil service pension scheme? Sorry I feel such a dimwit with all of this.

german_keeper

Congratulations, you have already gone miles further in your thinking than the vast majority of your colleagues, in my experience. The lump sum commutation issue cropped up from time to time when I was at work and many didn't get past "well it's the right thing to do, everyone says so." Sometimes they moved on to "it's tax free" and sometimes "you could drop dead anytime." But very rarely did it go any further than that.

As well as all the points mentioned by other posters I would also add a couple more as in my view the commutation decision shouldn't be made in isolation. It should be seen as part of a bigger picture in retirement planning. So do you have a spouse/partner and what is their pension provision? And what is your state pension forecast and your spouse/partner's?

So for example if you decide a better equalisation of income pre and post SPA is important to you that may put a tick in the commutation box. That has probably been the major factor driving decisions me and my wife have made. And next February when she is 60 and will claim her private sector DB pension we may well take the maximum lump sum even though the commutation rate of 16.5/1 isn't particularly good. At SPA we will have more money than we have ever had with 2 state pensions, my Civil Service pension and her DB pension albeit at a reduced rate. So the DB lump sum is available to be spent between 60 and 67 if required.    

Really sorry if I am throwing more things at you when you are struggling to get your head round everything!!