Saturday, 13 February 2016
If someone offered you a choice between a tax free lump sum of £12,000 now, or an income of £1,000 per year for life, rising each year in line with inflation, which would you choose?
Tough choice? Well, many of you will have opted for the £1,000 per year for life. That’s a nice guaranteed income to have, right? And it is inflation protected too, so it will retain its buying power.
What about if the lump sum was £15,000? Or £24,000 ?
That’s a bit more difficult isn’t it! £24,000 now, or a guaranteed £1,000+ for life ………
This is exactly the choice that members of defined benefit (or final salary) pension schemes are asked to make when they reach retirement. They are offered the choice between a set income for life, inflation protected, or a lower income for life and a lump sum now.
Working out which option is best is NOT straightforward, but the vast majority of people just go for the lump sum. I mean, that’s how pensions work right? You take a lump sum when you retire, and you use it to buy some goodies and a nice holiday?
BUT for schemes which only offer a £12,000 lump sum for each £1,000 of income you give up, this is almost always a really bad idea. You would be far better off rejecting the lump sum and taking the higher income. Going for the lump sum can leave you tens of thousands of pounds worse off over your lifetime, and could leave you struggling to meet your household bills in retirement.
Members of public sector schemes (teachers, health workers, firemen, police etc) are particularly at risk of being offered small lump sums in exchange for sacrificing valuable income for life.
The choices you make at retirement will affect your financial situation for the rest of your life. Take some time to understand those choices fully, and get advice if you aren’t completely sure which is the best route to take.