Pension Myths and Misunderstandings

YBR

https://forums.moneysavingexpert.com/discussion/comment/82180556#Comment_82180556

It may be a Myth, but to mitigate risk of it shrinking, this features in my worst-case planning scenario!

retiringin26

https://forums.moneysavingexpert.com/discussion/comment/82180699#Comment_82180699

Might there be scenarios where commutation at a poor rate could be OK for some people? e.g a life limiting illness and no living dependants to benefit from death benefits, and you want to have a good time in your remaining months/years with an enhanced lump sum?

hugheskevi

https://forums.moneysavingexpert.com/discussion/comment/82181188#Comment_82181188

It is more likely for individuals taking their pension quite late, eg, at State Pension age or later, and particularly for those who will be higher rate tax payers after taking their pension. There are also plenty of other possible scenarios.

Most of the schemes offering 12:1 will be public service pension schemes. The typical rules associated with the lump sum will be:

1. A fixed 12:1 commutation rate that does not change with age. So it is awful for a 55-year-old, but not so bad for a 67-year-old commencing their pension.
2. A 5 year guarantee period, so if the member dies within 5 years of taking pension, a lump sum is paid equal to what they would have got in 5 years less what has already been paid
3. No effect on survivor pension whether a lump sum is taken or not

There are different terminal illness rules, so someone with less than 12 months to live has other options available.

Assuming 20% basic rate tax is payable, it will take 15 years to get the amount back from net annual pension that was taken in lump sum, ignoring inflation uplifts of annual pension and investment returns from the lump sum. It is 20 years for a higher rate taxpayer.

So someone who thinks they will not survive for 15 years may prefer the lump sum despite the poor rate. However, it is questionable how many will genuinely be in this position - life expectancy is very hard to predict even beyond 12 months, let alone many years. The ONS calculator shows both a 60 year old male and female have odds well above 75% of surviving 15+ years. Even at 67 it is well above a 50% chance of surviving 15+ years. So acting on an assumption of death within 15 years will in many cases be extremely uncertain at best, and against the odds at worst. #

The odds at age 67 of surviving 20+ years are well-balanced for a male, and a female is likely to live longer. However, individuals who are higher-rate taxpayers in retirement are going to be much wealthier than average, and that in itself will increase their expected lifespan above the average.

Also, although there is a risk of dying within 15 years, there is also the risk of surviving beyond 15 years, potentially well beyond. The pension is the all-round safer option, but might not be the right choice.

Then there is the argument that money is better spent earlier in retirement than later when less active. That is valid, but probably points toward a planning failure, when building up a tax-advantaged DC pot during working life would have been far more efficient than decimating the value of their DB pension at retirement. Still, that might or might not be the case, but it is irrelevant as the individual is in whatever position they are in and should optimise around that. Particularly if they have children and want to fund a house deposit, they may have a strong need for money now and not so much for money later.

So yes, plenty of reasons why someone might decide to take a poor commutation rate, some valid, some not, some risky, and some sensible but resulting from suboptimal pension planning in the past.

Marcon

However well intentioned, I think this thread looks more likely to cause further confusion and misunderstandings rather than debunking 'myths'. Many 'myths' being posted here seem to be personal opinions(!), and very few of those posting give clear, comprehensive explanations of the 'reality'.

Maybe time to close the thread before it spawns its own new crop of alternative/additional myths…? There are already quite enough in existence…

BikingBud

A throwaway comment in the original thread does need to be expanded upon:

In response to the thought that a DC pension pot is “my money” there are many ill informed posters on here who really believe that their DB pension is also a pot of their own money.

I have my own understanding:

• DC pot is my money. I have control over where it might be held/invested and I can draw down as to my own wishes. As always there are restrictions that apply to what I do with my money, some might severely inhibit the cash I can generate and this is where the nuance lies.
• DB pension is not a pot but an agreement to pay me an income for life, sometimes with a lump sum at commencement. It might also have conditions/benefits regarding indexing and survivor benefits but there is no pot that can be realised.
• Both types will be subject to tax in various forms depending upon other income steams and when the funds are generated. Given the football effect on pensions, that treatment will most certainly change and is therefore a risk that should be mitigated.

But perhaps if the intent is to myth bust then a much clearer or authoritative statement could be provided.

Perhaps the best route might be to close this thread and ensure the Acronyms Thread is updated with relevant and accurate notices, Wiki like.

Marcon

But perhaps if the intent is to myth bust then a much clearer or authoritative statement could be provided.

Completely agree. It's worrying how many people are 'thanking' answers which are doubtless well meaning, but a long way from complete and accurate…

zagfles

https://forums.moneysavingexpert.com/discussion/comment/82181188#Comment_82181188

Would probably be better to transfer it out in cases like that and get a pot at maybe 20:1 or better

QrizB

I wonder if the OP might want to edit their original post and add in any other myths that they think should be included?

Andy_L

https://forums.moneysavingexpert.com/discussion/comment/82181517#Comment_82181517

You can't transfer out of an unfunded public sector scheme (which is almost at all of them), unless it's to another DB scheme

Marcon

https://forums.moneysavingexpert.com/discussion/comment/82181517#Comment_82181517

That could suggest to a novice that a pot has a commutation rate…