How long does she need to live? Oh which scenario! :-)

TighterThanTwoCoatsOfPain

Hi guys... wonder if some maths genius can help!!

Sure i did this at GCSE maths but was struggling earlier!

The MIL is looking at retiring in the next couple of months. She has been given 2 scenarios and need sto decide which one to go for..

Number 1
Tax free Lump Sum = 20000
Annual Income = 6859

Number 2
Tax free Lump Sum = 36000
Annual Income = 5511


The annual income goes up by CPI so assume 2% ish?

Annual lump sum will be invested so assume 5% return?

Am trying to determine (morbidly!) how long she has to live before one is better than the other.. I think she will take the interest on lump some as additional income. At the minute i'm thinking the Lower lump sum scenario is better?

She is (only) 54...

Cheers guys!!

TighterThanTwoCoatsOfPain

Any pointers for websites with calculator which can help or chart the income?

From what i can gather i'm leaning towards the lowre lump sum at the minute but any other suggestions gratefully received...

EdInvestor

What sort of state pension is she going to get in due course?

The tax free age allowance is going up to about 10k by 2011, so if her state pension is largeish she would probably be better to take the larger lump sum.

In any case, it's usually better to take the larger lump as it's tax free while the pension income is taxed..

Andy_L

For every £1 of pension you give up you getting ~£12 in cash.(The difference in lump sums divided by the difference in pensions)

That suggests it's a public sector scheme which means it's increasing by RPI rather than CPI, can you check if it is as that drastically changes the situation.

dunstonh

What other income will there be? (bank interest, dividends, rental income, earned income, other pensions. Not including ISAs or investment bonds which are exempt).

The impact of tax on the options is going to alter the calculation. Hence why the other info needs to be known.

Also, the tax free cash. Will that be placed into investments, spent or put in a bank account?

TighterThanTwoCoatsOfPain

sry for late replies....its a teachers pension that she's taking early (fed up of how kids are nowadays apparently!) :-)

hmmmmm all questions obviously need to be considered carefully.... clearly not as straight forward as i hoped...(surprised i was this amatuer as quite nailed on with my own $$$)

They currently have shares which supply them with minimal income, although not huge amounts i dont think, and husband has own pension. Similar age (mid fifties)

on the state question, i honestly have no idea...

tax free cash would be invested, but they dont want to tie up in long terms, no access arrangements if they dont have to.

Andy - Wel done - how on earth did you deduce that? and is it a good thing or a bad thing? She said "inflation" which i took to being CPI. She could well be mistaken and its RPI, which i know tracks higher...

Reckon a trip to a local IFA may well be in order... trouble is i'm having trouble convincing those involved that it really does matter to get the decision right now! Left to own devices i reckon they'd draw straws for it and it drives me mad!

Cheers guys

Andy_L

The Teachers pension is RPI linked. Currently higher than CPI & thus a "good thing" from a pension increase point of view.

The 12-1 exchange rate (called commutation) is an "unfair" rate in that you can't go the other way and buy £1 of index-linked pension income for £12 out in the pension market. Although puting on my tax-payer hat it saves money if you can tempt people into doing it.

However the lump sum can be invested, possibly for tax free income unlike the pension, and gives you ability to fix the roof/buy a sports car

Retired_I.F.A.

The general rule of thumb which says take the highest tax free lump sum does not apply today to most final salary schemes. It still applies to money purchase schemes however because an annuity bought with the tax free lump sum added to the lower annuity offered by the scheme usually compares with the all annuity route but with less taxpayable. Tax is only due on the interest element of a annuity bought with cash whereas its payable on the whole of the annuity from the scheme.
Therefore the gross income was comparable but the nett favoured the tfc route.

Final salary schemes have no bearing on the interest rates of the day. The pension for cash ratio is typically 12:1 and though it can be altered in this case it remains.

You've given some details but not quite enough so below I've made a couple of assumptions as marked.

a 20000 tfc and £6859 p/a + rpi
b 36000 tfc and £5511 p/a + rpi

Therefore £16000 extra tfc comes at a cost of £1348 p/a + rpi

£1348 = £112 p/m initially (assuming the pension is paid monthly. in arrears or in advance makes very little difference)

To buy an annuity of 1348p/a + rpi fo a 54 year old female is going to cost a massive 45750 in which case the choice is obvious take the smaller tfc

Check out yourself please the annuity rates I've worked on here:
http://www.fsa.gov.uk/tables You can play aound with the options.

I entered...
You are : Female
Age when buying an annuity : 54
Smoker/all : All (I entered non but it made no difference)
Pension fund : £45,750
Single/joint life annuity : Joint
Guarantee : 10-year guarantee
Age of spouse : 57
Level of income for spouse 50%

That shows Canada Life and Legal and General as being the cheapest to give the £112 p/m needed (You need to do some intepolating to keep the 112 target so play aound with the purchase price)

Notes/ assumptions..
Actual figures may vary slightly depending on exact age.
10 year gaurentee assumed required (comparative teaches scheme may be five or 10 I forget now)
Spouses age + proportion (I've assumed the husband to be 3 yrs older and I think 50% is the teachers scheme)
Annuities illustated on that site are for annuities bought from pension funds companies may use different rates for annuities bought from cash ie the tfc. Although they may differ some I doubt it would be much.

I think you'll agree it's pointless making any futher comparisons such as investing the exta tfc and seeing what that would produce.

Even though on the surface this looks a no brainer I would still go see an IFA and let him check it out. I'm no longer authorised and my advice is worth no more than the drunk in the pub. With an IFA effectively saying the same you have the legal protection of the FSO should the advice for some reason be wrong.

If these figures you give are right I'd look into taking as much pension as is possible if I were her, if the cash is not needed of course. Maybe ask for some other options and compare as I have done before visiting an IFA.?

EdInvestor

Because she is so young, it would be essential that the tax free cash were invested in risk based assets long term ( eg dividend paying shares) not cash, if it were to match the pension.

Retired_I.F.A.

Shame I cant find the spreadsheets I once wrote with them I could calculate the yield an investment of the tfc would need to achieve the same level of income stripping the tfc fund out by normal life expectancy. However I reckon it'd have to be a pretty hefty yield when you consider that the annuity undelying gilt interest is what about 5% plus the mathmatical equivelent of mortality drag to that of say 1.5% = 6.5% if that needs 45750 then the rate on the tfc of 16000 = ?

Actually maybe this is an equivelent calculation...

45750*1.065^28=266796
16000*1.1057^28=266654

Thats interpolated close enough.

If that's a fair compaison then the question is ..

Would you invest 16k and expect to yield more than 10.57% nett fo the next 28 years? or would you rather have it handed to you on a plate guaranteed?

No brainer aint it?

benny5

Sorry to but in on this debate but I am about to choose directions on this very issue.

My situation is slightly different inasmuch as I am 58 (male) also F/S and have an offer of £32,500 cash in exchange for £1825 (RPI linked) that's almost 1/18.

Given that I am not totally dependent on either option, which one make the most sense financially. Up till now I was veering towards the cash.