Pension lump sum

[Middlechild3]

I'm about to trigger a pension (Civil service db)I wanted max monthly income so was going to take minimum lump sum. I assumed people who took big lump sums did so to pay off mortgage, buy cars etc. Am I missing a trick here? Should I take a larger lump sum (tax free) and pay myself out of it each month? I'd pay basic rate on my annual pension as I originally planned it to take it, Could I save on paying tax if I did this for the next few years? It seems too simple, is there something I'm missing?

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It’s impossible to know.
You don’t know when you will die.
You don’t know future tax rates.
If you invest the tax-free lump sum, you don’t know the return on investment.

The pension company does not know those things either but they are very good at guessing. They also pool the risk, so when they guess wrong they have some people who died earlier than they guessed and others who died later, so the more they paid out was offset by the reduced payout for those who died.

If you take the higher lump sum, have a purpose for it. Do not leave it in an account which pays some interest as that interest can be taxable. Don’t sit it in an account that pays no interest, as the real value goes down due to inflation.

How much pension income are you giving up in exchange for the lump sum, and therefore after how many years would the lump sum run out if you used it for the extra income? Sometimes it's as short as 12 years, in other schemes it may be more like 20 years.

Are you in good health and likely to live longer than this? Do you have other savings/pensions in the background to use for other income or capital spending in the future?

You can book a one to one with civil service pensions. It costs about £70 (from memory).

I hadn't thought about the longevity part thanks

There have been rumblings that the Government may stop or reduce the tax- free lump sums... but you should really take professional financial.advice.

I'll be going for the minimum lump sum (also civil service). Mortgage was paid off years ago, no home improvements etc in the offing. I like the idea of getting a decent monthly income for the rest of my life, and having a decent little nest egg too.

Which Civil Service scheme?

I assume Classic which accumulates in 80ths and pays a lump sum by default rather than one of the early noughties schemes that accumulate in 60ths and a lump sum means foregone income.

It may make some difference to how numbers work for @Middlechild3

Personally, and I'm not a mortgage or financial advisor, I'd always take the lump sum. A bird in the hand is worth 2 in the bush. If you were to die next week that money will still be there whereas survivors benefit is about 1/3 of that (in my scheme anyway).

Also, you don't need a huge pension when you are older, chances are it will go on a care home anyway, but having it when you are younger will mean you can do fun things and go on holiday etc. Plus when you hit state pension age, it will bump up your pension anyway.

That's how I'd approach it anyway

If you take the maximum lump sum allowed it’ll be tax free which is why it appeals to a lot of people. So if you take a smaller one you’re not maximising your tax free cash.

Thats said it’s weighing up what your needs are and if income is more important to you then maybe there’s an argument to take more pension but this would be taxed as income.

Ultimately no one online can you give you advice on your needs and it would be best to consult with a financial adviser.

The commutation rate for increasing lump sum is only 12 to 1 which is very poor, so you would have to live an additional 12 years to get your money back, maybe a year or two more if you factor in the lump sum is tax free.
Unless you have a life limiting condition or need the money I would take normal pension, especially as Civil Service pensions are linked to CPI. They really are gold plated in that regard.
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Don't forget that if you take a lump sum and don't spend it, it will earn interest or grow due to investment return. If your lump sum is £100k, you can put it in an ISA and invest some, and even in an instant access account you'll be looking at around 4%, likely a little more over time if invested. So that's a few thousand per year to top up your income.

But advice would be a very good idea, from someone who properly understands DB pensions. If it is the case that you can get tailored advice from Civil Service pensions for £70, that's definitely worth taking.

I have a DB pension with Nat West. I will be taking my max lump sum when I'm 58. I don't "need" the money, in so much as the mortgage will be paid off, but I figure that it's best to take the maximum amount that I can tax free. Also, I can place that in an NS&I bond and it's IN MY HAND - If I don't spend it, my kids can inherit it. A bird in the hand is worth two in the bush, and all that.

I SO agree with this! You can pop it into an NS&I and it's yours. Spend it or kids can inherit it, but it's in your hands.

£100k invested at 4%, will over a 5 year period grow to £122k.

I am also in a DB scheme (not LG) and I took the minimum lump sum and maximum monthly payment.

You need to know the commutation rate for a start and whether it is 'good' or 'bad'. Generally LGPS have a poor commutation rate but they do vary, i.e. you are better off with the bigger monthly payment.

I chose lower lump sum and larger monthly payment because

• I didn't need the lump sum at that time
• I am better off with the guaranteed inflationary increase in my monthly payment Vs trying to chase rates / growth myself
• plus I am an optimist so hope to 'beat' the return by living longer than the commutation expects!

The pension board on MSE is good for me gathering views on this sort of question (best to include actual numbers), I find you get a more (head) financially driven answer Vs on MN where you (sadly) get more heart driven answers.

My focus was the monthly income as it lasts for life and goes up with inflation - I expect to live long enough for it to be worthwhile. Your lump sum would be taxed over a certain point as will your monthly income; even spending is taxed via Vat at 20%.
You can work out the different scenarios for your own circumstances - my pension would cover my monthly bills if I wasn’t working so I’m satisfied with my decision.

I would calculate the effect of 30 years of index linked pension increases that would be applied to the lesser pension and the higher pension if you didn't take the lump sum (assuming your pension works like that).

I'd probably prefer to have larger annual increases on a larger pension (=Larger pension each year) if I didn't need the lump sum, rather than smaller annual increases on a smaller pension.

Presumably also you don't need to take the full lump sum, you can take only what you need i.e. fix the roof, and convert the rest as a pension.

First of all look at your budget and decide if the minimum pension covers all your outgoings. And then if you would actually have a surplus and how much. This will then allow you to consider your options of reducing the annual pension.

Also take your state pension into account.

The commutation factor is 12 but the pension you give up would have been taxed at 20% so it is effectively a commutation factor of 15.

I took the higher lump sum as I want to carry on working in a part time job for the foreseeable future so didn't see the point in paying the extra tax. Also intest rates are quite good atm.

I am planning on doing the opposite to you. My reasoning is that shift workers don’t live as long as other people so I may as well take the big lump sum and share it with my children rather than take the bigger monthly pension, which I may not draw for long if I don’t live for a long time.
I imagine you are not a shift worker if it’s a civil service job but that’s my thinking.

Obviously MN is just various peoples opinions and you would be wise to take financial advice from a professional.
That said… I’ll be taking the max lump sum - I’m in not very good health so don’t expect to live to a ripe old age, am divorced with adult children so if I die the money dies with me, and would like a few £££ to have a good holiday or 2 after many years of financial struggling as a single parent.

It totally depends on your situation but it makes sense for a lot of people to take the lump sum and invest in an isa so they don’t get taxed on it. If you’re already maxed out on isas it won’t apply to you.