12 Dec What would you prefer £700,000 now or £23,000 per year in retirement?
Many people with defined benefit pensions have been persuaded by media attention and record high transfer values to think about whether they want to trade a guaranteed pension for a lump sum.
If you do not want or need the pension there maybe reasons to consider a transfer, but please don’t let the fragilities of being human rampage through your financial planning unchallenged – give yourself a good talking to and get some help from a professional adviser in working though the figures.
It’s fascinating to me how prone we are as human beings to wafty thinking. We are susceptible to emotional reactions that just aren’t supported by facts. The numbers tell us we are likely to get more in the long run by taking the pension but we are duped by a “while stocks last” sales techniques. Our powerful reaction goes something like this:
I would rather it was in my bank than theirs
There is so much I could do with that money now and who knows if I will even be alive to spend it later
My transfer value is guaranteed until next week. I must decide by then or risk getting less.
The book Thinking Fast and Slow by Daniel Kahneman provides some insight into the phenomena which he describes as:
Endowment Effect- placing additional value on things perceived as “mine”
Present Bias- over valuing the immediate reward at the expense of our long-term future
Scarcity Effect- immediate action is required to avoid missing out
If we accept, we are pre-disposed as human beings to making the above mistakes we can discipline ourselves to revisit our thinking with a different emphasis before making a big decision:
If it’s in my bank I must take responsibility, bear the costs and suffer the consequences of managing the money. Am I likely to do it better than the experts?
I will lose £130,000* by taking it early. Think how much I could buy with the extra money.
The cost of providing my pension changes, but I can access a lump sum equivalent to the pension at any time.
There are some circumstances where it will be financially advisable to exchange a guaranteed income for a lump sum. Here are a few examples:
I am not expected to live a normal lifespan
The pension provides for a family and I don’t have family
I already have enough income in retirement and would rather leave a legacy from my children
The actuaries who calculate the size of the lump sum available if you sacrifice your guaranteed pension are bound by tight rules that must not disadvantage members of the pension scheme. They can’t give any particular member more or less than the value of their benefits. It is a fact that a transfer quotation must represents fair value. If you decide to take the money, then you are highly unlikely to be able to replace the benefit with the resulting fund without a very good dollop of luck.
*The numbers in this blog are based on a 55 year old with scheme benefits payable from 65 and life expectancy of 85. Current value of benefits at normal retirement age £23,000. Revaluation pre and post retirement assumed to be 3%. The transfer value is realistic estimate based recent scheme valuations of retained benefits cash equivalent transfer values.