Lanark wrote:fourtwentyfour wrote:How do I work out whether to take the pension as offered, or to change the lump sum into monthly amounts?
The sums for these numbers are going to be based on your predicted lifespan, so to do any comparison, first work out how many years that is likely to be.
Then total up X number of years times the monthly payments.
The income option will probably look like more money than the lump sum, but dont forget you could invest the lump sum and earn interest.
Mostly it will come down to the tax advantages of taking money now vs later. If your pension income is likely to be above the personal allowance, then taking a lump sum will allow you to save some tax. You can usually take up to 25% of the amount built up in any pension as a tax-free lump sum.
One reason you might not want to take a lump sum is if the income option is index linked and you expect that indexation to outperform any investments you might make with a lump sum. This is kind of unknowable but you can get a rough idea by looking at past performance.
As has been mentioned these old DB pensions often came with a lump sum of something like 3 x the pension as part of the standard benefit.
This will often be less than the 25% tax free lump sum entitlement which was introduced in 2006* and the scheme member would then have a choice as to whether to increase the lump sum to 25% by converting some of the annual pension payment into the money paid out as a lump sum this is known as commutation. Unfortunately the commutation factor, the amount of extra lump sum you get for each one pound of annual pension you give up, is usually pretty poor value for money. This varies from scheme to scheme but for public sector scheme is usually set at 12 in the scheme rules which is very poor value. Hence unless you have an urgent need to take the full 25% as a tax free lump sum or don't think you have much longer to live you may well be better off not using commutation and just taking whatever lump sum the scheme provided as standard.
When it comes to judging whether your commutation factor is any good, Tully says: 'Anything below 15:1 is poor in today's environment. Anything above 20:1 is good, 15:1 to 20:1 is OK - I would think not great but acceptable,'
* Though in a few schemes under certain circumstances the lump sum mandated by the scheme is actually greater than 25% and special arrangements were put in place to protect that entitlement in the 2006 legislation.