Commute Some of a DB Pension, Pros and Cons
Discussion
In about 3 months from now, I’ll turn 60. That’s the bad news. The good news is that a couple of pensions will begin payment, a deferred Armed Forces pension and a preserved DB pension from the Civil Service.
The forces pension is all under AFPS-75, so it’s very simple. I’ll get a tax free lump sum of 3 times my annual pension and then be paid a monthly pension for life, indexed annually in accordance with the CPI. That’s it, no option to commute under that scheme.
A recent benefit statement from the Civil Service came with a surprise. An option to commute up to 25% of the pension value for a tax free lump sum and a reduced monthly pension. I wasn’t aware this was an option before now. I don’t remember reading about it any previous literature I’d received from Civil Service Pensions. (Maybe I just wasn't paying attention.) In any case I need to make a quick decision whether to commute or not. I’ve laid out the pros and cons as I see them below, but I’d appreciate the help of the good people on this board in case I’ve missed anything.
I was only employed for a short time by the Civil Service (it wasn’t a great job) so the pension is small. I don’t mind using the actual figures.
Gross pension £1836 pa
Maximum lump sum available £7870
Penalty for taking the lump sum is £655 pa leaving a reduced pension of £1181 pa
The ‘Commutation Factor’ is 12 meaning for every £12 taken as a lump sum, the annual pension is reduced by £1.
Don’t Commute
Pros - Security. It’s the boring, safer option. Higher monthly payment for life, indexed every April in accordance with CPI.
Cons - Lost opportunity to invest the lump sum for better returns. Higher income tax bill due to larger pension.
Commute up to the maximum
Pros - Invest the lump sum for better returns either in an ISA or a pension and receive tax relief. Lower income tax due to reduced pension payment.
Cons - Investment risk. Reduced monthly pension. Reduced widows pension if I die.
Basically I see it that by taking a lump sum, you gain more control of your finances, the possibility of better returns but with the added penalty of more risk and a loss of pension security.
I’ll just add that I don’t need this money now. I’m still working and for the past few years I’ve been maximizing contributions into my company pension scheme, which brings me within the lower income tax bracket. If I do commute, I’d just add to this pension fund or put it in an ISA. I don’t think there’s any danger of me exceeding the overall pension Lump Sum Allowance (LSA) of £268,275.
So, do you think I've missed anything? Is there anything else I should consider?
The forces pension is all under AFPS-75, so it’s very simple. I’ll get a tax free lump sum of 3 times my annual pension and then be paid a monthly pension for life, indexed annually in accordance with the CPI. That’s it, no option to commute under that scheme.
A recent benefit statement from the Civil Service came with a surprise. An option to commute up to 25% of the pension value for a tax free lump sum and a reduced monthly pension. I wasn’t aware this was an option before now. I don’t remember reading about it any previous literature I’d received from Civil Service Pensions. (Maybe I just wasn't paying attention.) In any case I need to make a quick decision whether to commute or not. I’ve laid out the pros and cons as I see them below, but I’d appreciate the help of the good people on this board in case I’ve missed anything.
I was only employed for a short time by the Civil Service (it wasn’t a great job) so the pension is small. I don’t mind using the actual figures.
Gross pension £1836 pa
Maximum lump sum available £7870
Penalty for taking the lump sum is £655 pa leaving a reduced pension of £1181 pa
The ‘Commutation Factor’ is 12 meaning for every £12 taken as a lump sum, the annual pension is reduced by £1.
Don’t Commute
Pros - Security. It’s the boring, safer option. Higher monthly payment for life, indexed every April in accordance with CPI.
Cons - Lost opportunity to invest the lump sum for better returns. Higher income tax bill due to larger pension.
Commute up to the maximum
Pros - Invest the lump sum for better returns either in an ISA or a pension and receive tax relief. Lower income tax due to reduced pension payment.
Cons - Investment risk. Reduced monthly pension. Reduced widows pension if I die.
Basically I see it that by taking a lump sum, you gain more control of your finances, the possibility of better returns but with the added penalty of more risk and a loss of pension security.
I’ll just add that I don’t need this money now. I’m still working and for the past few years I’ve been maximizing contributions into my company pension scheme, which brings me within the lower income tax bracket. If I do commute, I’d just add to this pension fund or put it in an ISA. I don’t think there’s any danger of me exceeding the overall pension Lump Sum Allowance (LSA) of £268,275.
So, do you think I've missed anything? Is there anything else I should consider?
I guess take a stab in the dark on how long you think you'll live based on general health and family history and then pick one accordingly.
Not really much in it is there.
For me if I could use the money now for kids/grandkids and the difference in monthly income wasn't going to make a huge difference then I'd probably lean towards taking the extra lump sum.
Guess if you'll be over the income tax threshold when you're fully retired then you'll save a little bit of tax that way.
Not really much in it is there.
For me if I could use the money now for kids/grandkids and the difference in monthly income wasn't going to make a huge difference then I'd probably lean towards taking the extra lump sum.
Guess if you'll be over the income tax threshold when you're fully retired then you'll save a little bit of tax that way.
Yeah, it's not a huge amount so there probably isn't much in it , as you say.
Life expectancy? I've no knowledge of family history but I'm in very good health and will be disappointed not to live into my 90s. However, I appreciate that most of us have an average life expectancy. Putting my age and sex into a basic calculator shows I'll shuffle off this mortal coil aged 84.
I don't know what's best, so I might just opt to take around £3-4K as a lump sum and leave the rest in the pension.
No kids or grandkids so it's mine, ALL MINE! (although the wife might want some as well.)
Life expectancy? I've no knowledge of family history but I'm in very good health and will be disappointed not to live into my 90s. However, I appreciate that most of us have an average life expectancy. Putting my age and sex into a basic calculator shows I'll shuffle off this mortal coil aged 84.
I don't know what's best, so I might just opt to take around £3-4K as a lump sum and leave the rest in the pension.
No kids or grandkids so it's mine, ALL MINE! (although the wife might want some as well.)
You haven't mentioned the fact that the pension is subject to tax as part of your normal income, whereas the lump sum is tax free. Also, as your pension is reduced (it is not a "penalty") you are liable to less income tax on that reduced pension.
It's the tax advantage that is usually considered to be the principle reason for taking the cash.
R.
It's the tax advantage that is usually considered to be the principle reason for taking the cash.
R.
xeny said:
The Leaper said:
You haven't mentioned the fact that the pension is subject to tax as part of your normal income, whereas the lump sum is tax free.
.
Is it this simple? Doesn't changing the size of the lump sum change the tax liability of the pension as income?.
Yes Xeny, the less taxable income you receive in the form of pay, pensions, dividends, interest, etc. the less tax you should pay overall and that is something to consider when giving up part of a pension for a tax free lump sum. However, we all need a certain level of income and security in later years and that's the crux of the matter. Give up some of the security of a guaranteed pension for a reduced pension payment plus a lump sum which you have to manage yourself.
Investing the lump sum in an ISA is one solution. You can draw on it tax free.
Investing it in a DC pension fund is another. You'll get added tax relief when paying in and when you draw it down you can do so in a tax efficient manner by utilising the 25% tax free element.
A big factor in your decision is the commutation rate used.
The public sector schemes are notoriously stingy using a factor of just 12. Private sector schemes typically use closer to 20 or even higher (I see some schemes using over 30). The lower the factor, the more pension you have to give up to get the same lump sum.
Presumably you already get some lump sum (ie it’s an old style Civil Service scheme of 1/80ths pension plus 3/80ths lump sum in addition)? Whether commuting more is right for you depends on a lot of factors: life expectancy, your tax rate in retirement, what you plan on doing with an extra lump sum, do you have other sources for the lump sum, …
(Edited to add: commuting usually only affects your pension and not the reversionary spouse’s pension. I’m pretty sure that’s the case with public sector schemes too, but do check.)
The public sector schemes are notoriously stingy using a factor of just 12. Private sector schemes typically use closer to 20 or even higher (I see some schemes using over 30). The lower the factor, the more pension you have to give up to get the same lump sum.
Presumably you already get some lump sum (ie it’s an old style Civil Service scheme of 1/80ths pension plus 3/80ths lump sum in addition)? Whether commuting more is right for you depends on a lot of factors: life expectancy, your tax rate in retirement, what you plan on doing with an extra lump sum, do you have other sources for the lump sum, …
(Edited to add: commuting usually only affects your pension and not the reversionary spouse’s pension. I’m pretty sure that’s the case with public sector schemes too, but do check.)
Edited by Zigster on Monday 18th November 15:39
Zigster said:
A big factor in your decision is the commutation rate used.
The public sector schemes are notoriously stingy using a factor of just 12. Private sector schemes typically use closer to 20 or even higher (I see some schemes using over 30). The lower the factor, the more pension you have to give up to get the same lump sum.
Presumably you already get some lump sum (ie it’s an old style Civil Service scheme of 1/80ths pension plus 3/80ths lump sum in addition)? Whether commuting more is right for you depends on a lot of factors: life expectancy, your tax rate in retirement, what you plan on doing with an extra lump sum, do you have other sources for the lump sum, …
(Edited to add: commuting usually only affects your pension and not the reversionary spouse’s pension. I’m pretty sure that’s the case with public sector schemes too, but do check.)
No there's no lump sum coming from the Civil Service unless I commute some of the pension. Mine is called the Premium scheme - 1/60th of my final salary per year of membership.The public sector schemes are notoriously stingy using a factor of just 12. Private sector schemes typically use closer to 20 or even higher (I see some schemes using over 30). The lower the factor, the more pension you have to give up to get the same lump sum.
Presumably you already get some lump sum (ie it’s an old style Civil Service scheme of 1/80ths pension plus 3/80ths lump sum in addition)? Whether commuting more is right for you depends on a lot of factors: life expectancy, your tax rate in retirement, what you plan on doing with an extra lump sum, do you have other sources for the lump sum, …
(Edited to add: commuting usually only affects your pension and not the reversionary spouse’s pension. I’m pretty sure that’s the case with public sector schemes too, but do check.)
Edited by Zigster on Monday 18th November 15:39
Reversionary spouse pension? Is that what is now called an 'Adult Dependant Pension'? (The reduced pension my wife will get if I drop dead). You don't think commuting part of the pension for a lump sum will affect this? I must say the statement I received last week isn't very clear on this. Yes, I should check to make sure.
Given the small amount of lump I'd be inclined to leave it in and take the max pension. Isn't the Civil Service pension index linked? If so the more you have the more the increase.
I had a final salary pension and actually didn't need the lump sum but I worked out it would take me 15yrs to accrue that amount had I not commuted and taken the max sum. I also had a small FSAVC that has paid out similar to your CS projection a few years after I retired. I had to buy an annuity with the money so decided on taking the max lump sum out of it, a bird in the hand and all that, but with hindsight I should have left it.
I'm now just waiting for another pension to be finalised and pay out, and then a 7yr gap for state pension.............
I had a final salary pension and actually didn't need the lump sum but I worked out it would take me 15yrs to accrue that amount had I not commuted and taken the max sum. I also had a small FSAVC that has paid out similar to your CS projection a few years after I retired. I had to buy an annuity with the money so decided on taking the max lump sum out of it, a bird in the hand and all that, but with hindsight I should have left it.
I'm now just waiting for another pension to be finalised and pay out, and then a 7yr gap for state pension.............
Yes, the pension is index linked every April to the previous September's Consumer Price Index - CPI. I think the figure for this year is 1.7%.
Certainly, the prospect of drawing the full amount for (hopefully) the next 20 to 30 years is tempting. Not bad for just a couple of years of employment!
I don't need the lump sum either and besides, I'll be getting a bigger lump sum from the Armed Forces Pension Scheme. I'm just looking at the possibility of investing the lump sum and beating the loss of pension with the investment return.
Quick sum: -
To make £655 on an investment of £7870 would need an initial annual return of 8.33%. And then there is CPI to take into account.
Of course if I added the lump sum to a DC pension fund I'd get tax relief, giving me £9837 to play with, so I could accept lower investment performance.
Is it worth all this hassle for a small sum? Possibly not.
Certainly, the prospect of drawing the full amount for (hopefully) the next 20 to 30 years is tempting. Not bad for just a couple of years of employment!
I don't need the lump sum either and besides, I'll be getting a bigger lump sum from the Armed Forces Pension Scheme. I'm just looking at the possibility of investing the lump sum and beating the loss of pension with the investment return.
Quick sum: -
To make £655 on an investment of £7870 would need an initial annual return of 8.33%. And then there is CPI to take into account.
Of course if I added the lump sum to a DC pension fund I'd get tax relief, giving me £9837 to play with, so I could accept lower investment performance.
Is it worth all this hassle for a small sum? Possibly not.
Just looked at your numbers and it does stack up that it’s not cash on top. I should have checked before I assumed it was the old cash on top scheme.
“Reversionary” - sorry, that is jargon. You’re right that I meant the pension payable to your spouse (or adult financial dependant) after your death. Just checked here and it confirms taking a lump sum doesn’t affect the spouse’s pension.
https://www.civilservicepensionscheme.org.uk/knowl...
“We may also pay a pension to your spouse, civil partner or other adult dependant based on 37.5% of your pension (before you gave any up for a lump sum) with increases in line with the cost of living.”
“Reversionary” - sorry, that is jargon. You’re right that I meant the pension payable to your spouse (or adult financial dependant) after your death. Just checked here and it confirms taking a lump sum doesn’t affect the spouse’s pension.
https://www.civilservicepensionscheme.org.uk/knowl...
“We may also pay a pension to your spouse, civil partner or other adult dependant based on 37.5% of your pension (before you gave any up for a lump sum) with increases in line with the cost of living.”
JoeBolt said:
Quick sum: -
To make £655 on an investment of £7870 would need an initial annual return of 8.33%. And then there is CPI to take into account.
Of course if I added the lump sum to a DC pension fund I'd get tax relief, giving me £9837 to play with, so I could accept lower investment performance.
Is it worth all this hassle for a small sum? Possibly not.
Don’t forget the £655 is taxable so £524 after basic rate tax. Which brings the return in your calculation down to 6.7%. Still doesn’t feel like a good deal to me, but I’m always a bit shocked that the public sector schemes continue to use such a crappy commutation factor.To make £655 on an investment of £7870 would need an initial annual return of 8.33%. And then there is CPI to take into account.
Of course if I added the lump sum to a DC pension fund I'd get tax relief, giving me £9837 to play with, so I could accept lower investment performance.
Is it worth all this hassle for a small sum? Possibly not.
JoeBolt said:
Yes Xeny, the less taxable income you receive in the form of pay, pensions, dividends, interest, etc. the less tax you should pay overall and that is something to consider when giving up part of a pension for a tax free lump sum. However, we all need a certain level of income and security in later years and that's the crux of the matter. Give up some of the security of a guaranteed pension for a reduced pension payment plus a lump sum which you have to manage yourself.
More I thought that if you opt for a smaller TFLS then a larger part of the pension income was tax exempt?Zigster said:
Just looked at your numbers and it does stack up that it’s not cash on top. I should have checked before I assumed it was the old cash on top scheme.
“Reversionary” - sorry, that is jargon. You’re right that I meant the pension payable to your spouse (or adult financial dependant) after your death. Just checked here and it confirms taking a lump sum doesn’t affect the spouse’s pension.
https://www.civilservicepensionscheme.org.uk/knowl...
“We may also pay a pension to your spouse, civil partner or other adult dependant based on 37.5% of your pension (before you gave any up for a lump sum) with increases in line with the cost of living.”
That's good news. Thanks for clearing that up.“Reversionary” - sorry, that is jargon. You’re right that I meant the pension payable to your spouse (or adult financial dependant) after your death. Just checked here and it confirms taking a lump sum doesn’t affect the spouse’s pension.
https://www.civilservicepensionscheme.org.uk/knowl...
“We may also pay a pension to your spouse, civil partner or other adult dependant based on 37.5% of your pension (before you gave any up for a lump sum) with increases in line with the cost of living.”
Zigster said:
JoeBolt said:
Quick sum: -
To make £655 on an investment of £7870 would need an initial annual return of 8.33%. And then there is CPI to take into account.
Of course if I added the lump sum to a DC pension fund I'd get tax relief, giving me £9837 to play with, so I could accept lower investment performance.
Is it worth all this hassle for a small sum? Possibly not.
Don’t forget the £655 is taxable so £524 after basic rate tax. Which brings the return in your calculation down to 6.7%. Still doesn’t feel like a good deal to me, but I’m always a bit shocked that the public sector schemes continue to use such a crappy commutation factor.To make £655 on an investment of £7870 would need an initial annual return of 8.33%. And then there is CPI to take into account.
Of course if I added the lump sum to a DC pension fund I'd get tax relief, giving me £9837 to play with, so I could accept lower investment performance.
Is it worth all this hassle for a small sum? Possibly not.
xeny said:
JoeBolt said:
Yes Xeny, the less taxable income you receive in the form of pay, pensions, dividends, interest, etc. the less tax you should pay overall and that is something to consider when giving up part of a pension for a tax free lump sum. However, we all need a certain level of income and security in later years and that's the crux of the matter. Give up some of the security of a guaranteed pension for a reduced pension payment plus a lump sum which you have to manage yourself.
More I thought that if you opt for a smaller TFLS then a larger part of the pension income was tax exempt?Pensions are taxed just the same as any other income aren't they? My personal allowance will be eaten up by my salary initially.
JoeBolt said:
Gross pension £1836 pa
Maximum lump sum available £7870
Penalty for taking the lump sum is £655 pa leaving a reduced pension of £1181 pa
Do you need £7,870 for something urgent right now?Maximum lump sum available £7870
Penalty for taking the lump sum is £655 pa leaving a reduced pension of £1181 pa
The annual amount doesn’t sound a lot, but I’m assuming it will be index-linked. You could think of the monthly amount as a bit of spending money on top of your “real” pensions. I have a similar small pension (DC in my case) and I’m glad to get the monthly amount alongside the larger pension income, I look at it as a sort of regular bonus
No Mike, I don't need the lump sum. I'm still working and I'll be getting a bigger lump sum from my deferred Armed Forces pension soon.
The pension is index linked to the CPI. It's a small pension from a couple of years working in a not so great job in the civil service, so you might well be right. Treating it as bit of monthly spending money for the next 20-30 years (hopefully) could well be the best option.
The pension is index linked to the CPI. It's a small pension from a couple of years working in a not so great job in the civil service, so you might well be right. Treating it as bit of monthly spending money for the next 20-30 years (hopefully) could well be the best option.
JoeBolt said:
I'm not sure I understand you. Are you referring to the personal tax allowance? Currently £12,570
Pensions are taxed just the same as any other income aren't they? My personal allowance will be eaten up by my salary initially.
My understanding is 25% (loosely and subject to the ~£268,000 limit introduced a couple of budgets ago) of the value is tax free, the rest is taxed at your marginal rate. The more you take as a tax free lump sum, the more tax you are potentially liable for (depending on personal allowance) as you receive pension payments each year.Pensions are taxed just the same as any other income aren't they? My personal allowance will be eaten up by my salary initially.
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