Question
I'm about to take my (final salary) pension and will soon be asked to decide how much of the 25% I wish to take as cash free cash, and how much of it to put back in the pot to improve my index linked monthly pension. With the extremely low annuity figures I can see, what other factors should I be considering in the decision to take the lump sum instead?Answer
It generally makes sense to take the maximum 25% tax-free cash entitlement from personal and money purchase pensions for the simple reason it's tax-free. It might be possible to generate a more tax-efficient income from the money compared to taking additional taxable pension income.
However, as you're in a final salary pension the decision is not quite so straightforward, as any tax-free cash taken will reduce your valuable inflation-linked pension income. I'd start by finding out the 'commutation rate' of your pension scheme - that is the amount of tax-free cash you'll receive for each £1 of pension you give up. For example, if the commutation rate is 12 then taking £12 of tax-free cash will reduce your annual pension by £1. The higher the rate the better.
You can then make a simple comparison of whether the tax-free cash could buy a comparable inflation-linked income (via an annuity) that more than offsets the sacrificed pension income. If it doesn't then taking extra pension in favour of tax-free cash is probably worthwhile (it's worth checking whether taking tax-free cash affects any spouse pension on your death).
But it'd also be sensible to factor in tax. For example, if your spouse is a non-taxpayer would you be better off taking tax-free cash and holding savings/investments or an annuity in their name to make the most of their personal income tax allowance? (versus you receiving taxable pension income). Or would it be advantageous to put the cash into ISAs ensuring a tax-free income?
Also bear in mind that if you take the tax-free cash to invest then this adds risk, whereas your final salary pension provides certainty that you'll receive an inflation-linked income.
I suppose the final thing to think about (albeit grim) is how long you expect to live. The longer you live the better value pension income (or an annuity) is. If your life expectancy is short then this would likely swing things in favour of taking tax-free cash now and, of course, vice-versa.
Best wishes for a happy retirement whatever you decide.
I'm about to take my (final salary) pension and will soon be asked to decide how much of the 25% I wish to take as cash free cash, and how much of it to put back in the pot to improve my index linked monthly pension. With the extremely low annuity figures I can see, what other factors should I be considering in the decision to take the lump sum instead?Answer
It generally makes sense to take the maximum 25% tax-free cash entitlement from personal and money purchase pensions for the simple reason it's tax-free. It might be possible to generate a more tax-efficient income from the money compared to taking additional taxable pension income.
However, as you're in a final salary pension the decision is not quite so straightforward, as any tax-free cash taken will reduce your valuable inflation-linked pension income. I'd start by finding out the 'commutation rate' of your pension scheme - that is the amount of tax-free cash you'll receive for each £1 of pension you give up. For example, if the commutation rate is 12 then taking £12 of tax-free cash will reduce your annual pension by £1. The higher the rate the better.
You can then make a simple comparison of whether the tax-free cash could buy a comparable inflation-linked income (via an annuity) that more than offsets the sacrificed pension income. If it doesn't then taking extra pension in favour of tax-free cash is probably worthwhile (it's worth checking whether taking tax-free cash affects any spouse pension on your death).
But it'd also be sensible to factor in tax. For example, if your spouse is a non-taxpayer would you be better off taking tax-free cash and holding savings/investments or an annuity in their name to make the most of their personal income tax allowance? (versus you receiving taxable pension income). Or would it be advantageous to put the cash into ISAs ensuring a tax-free income?
Also bear in mind that if you take the tax-free cash to invest then this adds risk, whereas your final salary pension provides certainty that you'll receive an inflation-linked income.
I suppose the final thing to think about (albeit grim) is how long you expect to live. The longer you live the better value pension income (or an annuity) is. If your life expectancy is short then this would likely swing things in favour of taking tax-free cash now and, of course, vice-versa.
Best wishes for a happy retirement whatever you decide.
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