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Should you take the maximum tax free lump sum?

In another of our financial MOTs, Shane Stack advises a GP who asks whether he should take his maximum tax free lump sum from the NHS pension scheme when he retires

In another of our financial MOTs, Shane Stack advises a GP who asks whether he should take his maximum tax free lump sum from the NHS pension scheme when he retires

Retirement - or should I say (as you may still be working) taking your benefits from the NHS pension scheme (NHSPS) - is a milestone when it comes to financial planning.

For those of you considering taking your pension in the next few years, you should consider all of the options available to you and in particular how much tax-free cash you should take.

The revised rules since April of this year will allow you to commute some of your pension for a greater tax free lump sum on a 12:1 basis.

Let's look at an example of a 60 year old GP being quoted a standard pension of £50,000 per annum plus a lump sum of 3 x £50,000 i.e. £150,000

By using the calculator on the NHSPS website we can establish that this GP can opt to take a lower pension of £40,179 per annum, plus a maximum lump sum of £267,852

Therefore an additional £117,852 lump sum is exchanged for £9,821 per annum of pension i.e. £1 of pension is exchange for £12 of lump sum.

In simple terms it would appear that if this GP lives beyond 72 (which statistically is the case for most 60 year old GPs) he is better off not taking the extra cash.

However you need to take other factors into account, such as the indexation of the pension, i.e. it will rise each year with inflation.

You also need to consider the main reason why you might choose to take the extra cash (it is tax free – that's one very good reason!).

If it is assumed that the pension increases at, say, 3.5% per annum and a net investment return of a similar rate is added to the lump sum, after deduction of higher rate income tax from the pension it would be approximately 32 years before the cumulative net pension exceeded the invested lump sum.

The actual outcome would, of course depend on the rate of inflation, income tax rates and allowances and investment returns.

However, it is not unreasonable to assume that in the longer term investment returns may be achieved ahead of the rate of inflation.

And a wide range of investment options are available.

Take the following example.

If the lump sum is invested in a basic rate tax paying spouse's name, and a tax paid "income" of 5% per annum is taken (depending upon the level of risk you take your capital may be eroded by this income) you could have an extra £5,892.60 per annum.

This is equivalent to £9,821 per annum gross for a higher rate tax payer!

So you could end up with exactly the same total household net income, but with access to a lump sum of £117,852!

Bear in mind however that £5,892.60 per annum is level – in other words you may not be able to increase it.

Additionally, you could use the lump sum for inheritance tax planning, still allowing you continued access to the income.

Opting to take the lower pension does NOT mean your spouse's pension will be reduced. It will be the same - i.e. in this example £25,000 per annum.

In summary consider all the advantages and disadvantages of taking the extra cash.

Advantages Disadvantages

1. Access to greater lump sum which gives you freedom to use it for holidays/investment/inheritance tax planning/paying off debts

Potentially less pension received the longer you live. Income from your pension is guaranteed, your investment return is not.

2. Can be tax advantageous, more so, if all or the bulk of the commuted pension would have been subject to higher rate tax Less tax efficient for basic or borderline tax payers

3. For those with shorter life expectancy you could get more from your "pot"

4. A bird in the hand……..!

Shane Stack is a partner at Medical Money Management, specialist Independent Financial Advisors to the Medical Profession and a Director of Medical Money Management (GIB)Ltd.


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