DB lump sum protection option - no brainer?

leosayer

I intend to start my DB pension next year when I turn 57, 3 years before the scheme's normal retirement date).

The latest early retirement quote I received gives me the following commencement options:

• Option 1 - £27.5k per year with no lump sum

• Option 2 - £22.2k per year + £148k per year lump sum

• Option 3 - £27.5k per year + £233k lump sum (taken from linked DC scheme) *

Option 3 uses scheme specific lump sum protection, requiring retirement from DB and linked DC scheme at the same time. The DC pot is currently £380k , so taking the £233k lump sum would leave around £147k fully crystallised (subject to market movements).

I also have an uncrystallised SIPP worth £170k which I plan to use for income this year.

Both my wife and I are entitled to full state pensions at 67.

We plan to spend around half of the lump sum, investing the rest in ISAs to supplement DB and SIPP income if needed. I don't anticipate being a high rate tax payer at any point.

Option 3 appear to be the clear choice with only a couple of minor drawbacks:

• Any unspent lump sum will be subject to IHT, but pension pots are also due to fall within IHT scope from 2027 anyway

• I’ve planned to mitigate tax on income and gains using ISAs, my wife’s starter rate for savings, and possibly low-coupon gilts

Is there any reason I should consider the other options?

Edited to add strikeout and for spacing

Dazed_and_C0nfused

With option 1 who gets to keep the £380k 😳

leosayer

Dazed_and_C0nfused said:

With option 1 who gets to keep the £380k 😳

With option 1, the £380k will remain in my DC pot available for drawdown.

DRS1

I also have an uncrystallised SIPP worth £170k which I plan to use for income this year.

You plan to take the whole £170k as INCOME in a single year?

Even with a £233k lump sum from the main scheme you can still take a bit of the SIPP as a tax free lump sum.  But the rest would put you in the 45% tax bracket.

Secret2ndAccount

I think you should give due consideration to Option 2. It's a very good commutation rate.
The attractiveness of Option 3 is down to the enhanced TFLS. Instead of 95k TFLS you get 233k, so you save 28k in tax. The downside is you are forced to draw out 233k in cash, and it will take you years to get that back into ISA's. Is there a danger you would be forced to keep the money in less attractive investments, or to pay tax on interest?
Contrast this with Option 2. The TFLS is 148k. Take away 28k and set it side to pay the extra tax (vs Opt. 3) somewhere down the line. That leaves you with 120k. With today's annuity rates you could roughly purchase back the 5.3k in annual pension that you are giving up. It would depend what spousal provision you wish to make, and what inflation matching your DB offers (capped at 2.5% or 5% or uncapped?). But the annuity would roughly be equivalent to the lost pension. So option 2 is roughly equivalent in value to Option 3, but offers much more flexibility as to how you choose to deploy the money. You don't have to buy an annuity, but you could if you wanted to later.
Decide what you would like to achieve with these various pensions, and you might find that Option 2 more closely matches that than Option 3. If that's the case then go for it - the cost is little or nothng.

PropertyGuru_Wannabe

I Agree with Secret2ndAccount. Option 2 is the clear best choice and the others do not even come close.

leosayer

DRS1 said:

I also have an uncrystallised SIPP worth £170k which I plan to use for income this year.

You plan to take the whole £170k as INCOME in a single year?

Even with a £233k lump sum from the main scheme you can still take a bit of the SIPP as a tax free lump sum.  But the rest would put you in the 45% tax bracket.

No, I will take around £50k taxable income.

Apologies for the ambiguous wording

leosayer

Secret2ndAccount said:

I think you should give due consideration to Option 2. It's a very good commutation rate.
The attractiveness of Option 3 is down to the enhanced TFLS. Instead of 95k TFLS you get 233k, so you save 28k in tax. The downside is you are forced to draw out 233k in cash, and it will take you years to get that back into ISA's. Is there a danger you would be forced to keep the money in less attractive investments, or to pay tax on interest?
Contrast this with Option 2. The TFLS is 148k. Take away 28k and set it side to pay the extra tax (vs Opt. 3) somewhere down the line. That leaves you with 120k. With today's annuity rates you could roughly purchase back the 5.3k in annual pension that you are giving up. It would depend what spousal provision you wish to make, and what inflation matching your DB offers (capped at 2.5% or 5% or uncapped?). But the annuity would roughly be equivalent to the lost pension. So option 2 is roughly equivalent in value to Option 3, but offers much more flexibility as to how you choose to deploy the money. You don't have to buy an annuity, but you could if you wanted to later.
Decide what you would like to achieve with these various pensions, and you might find that Option 2 more closely matches that than Option 3. If that's the case then go for it - the cost is little or nothng.

Thanks so much. I'd never considered the relative commutation and annuity rates.

I'll have to spend some time getting my head around this.

My wife and I had already build our ISA allowances over previous years using flexible ISAs and our offset mortgage, so I'm happy there will be no tax / investment compromises with the lump sum.

My main concern is not compromising our spending from now until state pensions at 67 because by then, guaranteed income should cover our spending needs.