Tax Free Lump Sums - which is best to take first?

LavenderBees

Hi my Lovelies.

This is my pensions spreadsheet working out weekend, so this may be the first of a few queries, and I'm hoping to pick your collective brains if you don't mind.

So far I have calculated estimated costs going forward to 85 assuming 5% inflation each year - does that seem sensible?

Now I am wanting to calculate the most tax efficient way to take my pension income. I currently have the following (which may or may not increase depending on how quickly I jump ship!)

I have a DB pension I can take from next month at 60 and 2 x DC pensions I can take whenever. State pension for me kicks in at 67 so I'm trying to fund 7 years. 

TFLS are around £42k (DB) and £34k and £10k for the DC pensions (current employer pot).

I think that if I started with my DB pension TFLS and monthly amount, I could fairly comfortably make that last approx 4 yrs , pretty much mirroring my current earned monthly income after taking into account tax, pension contributions and NI. I believe these 4 years would all be utilising tax allowance and TFLS so would be tax free (whoop whoop!)

Then I get stuck on what I should be doing with my 2 pots - how do I work out what's best? -

1. To combine the two? If I can work out the relevant fees etc, I am thinking it best to combine them in the lowest fee management? and leave the pot to keep growing though am unlikely to be able to afford to add any extra to them once I give up my job 
  
2. Would there ever be an argument for keeping the 2 pots separate once I finish work?   

3. Is there anything to stop me paying the largest pot into my current work pension pot to save on fees before I retire (if indeed, as I suspect the fees are less)? 

4. Hopefully, the DC pot or pots will continue to grow whilst I use my DB Pension, and I am calculating 4% growth  in my spreadsheet, which will hopefully be reasonable

5. Am I being overly optimistic if  calculate State Pension increases yr on yr of 4%, while I leave the personal allowance at £12570?

It's all just a minefield of ifs and buts, rolls eyes. 

I think if I can get to where I have a reasonably simple spreadsheet that covers as many expenses  as possible with a clear plan of attack on which pension TFLS to take first, then I can adjust figures to then include any nice to have things like car/holidays/meals out while I am compos mentis and relatively healthy.

Really appreciate any input from you much more knowledgeable people.  Thanks so much!

    

El_Torro

Have you considered not taking the tax free lump sum from your DC pensions? That way you can withdraw more money from them every year, with some of it being tax free. 

For your DB pension is it possible to take no tax free lump sum, or a reduced one, and more monthly income? 

Generally speaking it isn't a great idea to take a lump sum if you can avoid it. Unless you need that money for something specific. 


You say you are estimating 5% inflation each year and 4% investment growth. I think this is pessimistic, though it's better to be pessimistic than optimistic in this situation. You also think the state pension will grow at the same rate as inflation. I think it's fine to assume this, even if as the law currently stands it will probably increase faster than inflation. Nothing stopping the current or future UK government from changing that though.

Albermarle

With the two DC pots you need to actually check the fees, rather than guessing.
Although sums are relatively small in pension terms, so a small difference in fees is not going to make a huge difference.
However when you come to withdraw from these pensions, it will be simpler if they are combined first.
Also you need to look at how they are invested, which is more important than the fees

Marcon

LavenderBees said:

Then I get stuck on what I should be doing with my 2 pots - how do I work out what's best? -

1. To combine the two? If I can work out the relevant fees etc, I am thinking it best to combine them in the lowest fee management? and leave the pot to keep growing though am unlikely to be able to afford to add any extra to them once I give up my job 
  
  

3. Is there anything to stop me paying the largest pot into my current work pension pot to save on fees before I retire (if indeed, as I suspect the fees are less)? 



It's all just a minefield of ifs and buts, rolls eyes. 


    

Finding out the facts would be a good place to start. I'm always surprised by how many people post here looking for 'what's best to do' and then have lots of 'not sure....assume...think...' when it comes to things they can establish, such as fees. You'll make your own life so much simpler if you establish the real position and then start form that, rather than the current slightly shaky foundations.

Most modern DC pension contracts have fees based on the total value of the pot, so simply putting both pots into one isn't automatically going to give you a saving. A few schemes operate like that, but not many - and you need fairly substantial sums to benefit.

El_Torro said:

Generally speaking it isn't a great idea to take a lump sum if you can avoid it. Unless you need that money for something specific. 

...but keep in mind that a DB pension only gives you one chance to tax free cash - at the time you start to draw your benefits - whereas DC schemes which support phased drawdown give you repeated opportunities.

DRS1

I confess I am confused about your assumptions on inflation investment return and increases to the state pension. 5% for inflation could be right could be very wrong (not that long ago it was 10% for a year).  It is a thing which gets discussed on here and some people think it is easier to just work in todays figures.
But when you say 4% investment return do you mean 4% flat or 4% above inflation?  Most people would assume it is 4% above inflation.
When you say 4% for the state pension that surely can't be 4% above inflation but if it is 4% flat then you are assuming it will be less than inflation.  Maybe it should be but the triple lock is supposed to give higher increases.

On the DB lump sum there is nothing wrong with taking it (and you seem to have a very good reason for doing so) but you may want to consider how it works.  Is the lump sum automatic or do you get it by commuting part of your pension?  If the latter then what is the commutation rate?  A common one is 12:1 (ie give up £1 of pension for £12 of lump sum) and that is considered a poor rate which is why people would say don't take a DB lump sum.  Worth looking into.

LavenderBees

Marcon said:

LavenderBees said:

Then I get stuck on what I should be doing with my 2 pots - how do I work out what's best? -

1. To combine the two? If I can work out the relevant fees etc, I am thinking it best to combine them in the lowest fee management? and leave the pot to keep growing though am unlikely to be able to afford to add any extra to them once I give up my job 
  
  

3. Is there anything to stop me paying the largest pot into my current work pension pot to save on fees before I retire (if indeed, as I suspect the fees are less)? 



It's all just a minefield of ifs and buts, rolls eyes. 


    

Finding out the facts would be a good place to start. I'm always surprised by how many people post here looking for 'what's best to do' and then have lots of 'not sure....assume...think...' when it comes to things they can establish, such as fees. You'll make your own life so much simpler if you establish the real position and then start form that, rather than the current slightly shaky foundations.

Most modern DC pension contracts have fees based on the total value of the pot, so simply putting both pots into one isn't automatically going to give you a saving. A few schemes operate like that, but not many - and you need fairly substantial sums to benefit.

El_Torro said:

Generally speaking it isn't a great idea to take a lump sum if you can avoid it. Unless you need that money for something specific. 

...but keep in mind that a DB pension only gives you one chance to tax free cash - at the time you start to draw your benefits - whereas DC schemes which support phased drawdown give you repeated opportunities.

Yes, I totally agree! I would be doing nothing without the facts. But I had to start somewhere and the spreadsheet is starting to tease out questions. Good point on the DB pension, thank you. 

LavenderBees

El_Torro said:

Have you considered not taking the tax free lump sum from your DC pensions? That way you can withdraw more money from them every year, with some of it being tax free. 

For your DB pension is it possible to take no tax free lump sum, or a reduced one, and more monthly income? 

Generally speaking it isn't a great idea to take a lump sum if you can avoid it. Unless you need that money for something specific. 


You say you are estimating 5% inflation each year and 4% investment growth. I think this is pessimistic, though it's better to be pessimistic than optimistic in this situation. You also think the state pension will grow at the same rate as inflation. I think it's fine to assume this, even if as the law currently stands it will probably increase faster than inflation. Nothing stopping the current or future UK government from changing that though.

Thank you! I am currently waiting on uptodate figures for my DB pension so will see what it looks like taking into account what you mentioned above. 

I can certainly see the benefit of not taking TFLS as more of the money would stay invested for longer  - appreciate that feedback

I'd rather be realistic to be fair, but so much feels is out of my control

LavenderBees

Albermarle said:

With the two DC pots you need to actually check the fees, rather than guessing.
Although sums are relatively small in pension terms, so a small difference in fees is not going to make a huge difference.
However when you come to withdraw from these pensions, it will be simpler if they are combined first.
Also you need to look at how they are invested, which is more important than the fees

Yes, they are both similar in risk scoring and invested in totally different things. The passively managed current work pension is currently doing slightly better, but there doesn't seem much in it. I need to find out more about the larger pot fees and how it is being managed for sure. Thanks so much for commenting. Food for thought! 

Bostonerimus1

El_Torro said:

Have you considered not taking the tax free lump sum from your DC pensions? That way you can withdraw more money from them every year, with some of it being tax free. 

For your DB pension is it possible to take no tax free lump sum, or a reduced one, and more monthly income? 

Generally speaking it isn't a great idea to take a lump sum if you can avoid it. Unless you need that money for something specific. 


You say you are estimating 5% inflation each year and 4% investment growth. I think this is pessimistic, though it's better to be pessimistic than optimistic in this situation. You also think the state pension will grow at the same rate as inflation. I think it's fine to assume this, even if as the law currently stands it will probably increase faster than inflation. Nothing stopping the current or future UK government from changing that though.

Yes I've often wondered how many people don't take the TFLS all in one go and just use it in drawdown to reduce their annual income tax bill.

MarlowMallard

Based on the numbers given it looks like the DB is slightly more "valuable" than the DC, so it's important to understand this DB fully . Is there an early-retirement penalty for taking at 60, or if normal age is 60, is there a late-retirement bonus if you delay to e.g. 63/65 ?    Is it CPI-linked ?  Is the TFLS "automatic" or can you trade pension for more/less TFLS, and if so what's the factor (aka commutation ratio ) ? 

LavenderBees

MarlowMallard said:

Based on the numbers given it looks like the DB is slightly more "valuable" than the DC, so it's important to understand this DB fully . Is there an early-retirement penalty for taking at 60, or if normal age is 60, is there a late-retirement bonus if you delay to e.g. 63/65 ?    Is it CPI-linked ?  Is the TFLS "automatic" or can you trade pension for more/less TFLS, and if so what's the factor (aka commutation ratio ) ? 

Thanks so much for these questions...dare I say I have no idea, but will find out! I really wish pensions understanding was taught somewhere/somehow.

I think I am missing a brain somewhere as my spreadsheet seems to show that I never touch my DC pension pot or need to sell my wee (paid for) house to help fund my retirement after I get my state pension. I know I have cut my costs to a minimum but even so, surely that can't be right... if it is, I stop work on my birthday next month lol. I'll take a break and another look tomorrow.

But wouldn't that just be the best birthday 60th present ever!