Help with pension calculation

By THIS IS MONEY
Updated:

 

I am in a final-salary pension scheme and paying AVCs. Due to a change to my pension scheme I now have to decide whether to increase my contributions by 3.25% to get the same amount of pension at 60 or take a reduced pension at 60. Alternatively I could stay working until 62 to get the original amount of pension.

Would I be better off increasing my AVCs instead of paying additional pension contributions and then get a larger lump sum from the AVCs?

I calculate that at 60 my pension would be £1,580pa less if I do not increase my pension contributions but my lump sum would be £17,000 more if AVCs increased instead. At 62, when I expect to retire, I would get £1210pa less pension but my AVC lump sum would be £21,000 more.

As the lump sum is non taxable and the pension would be taxed, which way would I be better off? My pension would rise with inflation each year up to 5% cap. What is the likely return on savings if I invested the lump sum and each year took the difference in pension from the lump sum investing the rest? I am 49 years old. EB, Sunbury-on-Thames

Danny Cox, Chartered Financial Planner with IFA Hargreaves Lansdown, replies: In simple terms, you have calculated that you are being asked to pay 3.25% more to avoid losing £1,580 of pension per annum or you could pay this 3.25% into the AVC which would enable to you get £17,000 more tax free cash but at the expense of income.

The key question is whether, over time, the income stream will be worth more than the capital.

If we put this another way - could the £17,000 generate for you £1,580 per annum gross, an equivalent rate of return of 9.2%?

You should also bear in mind that the pension of £1,580 per annum will be index linked and have some spouse's benefit on your death. It is therefore more valuable if you are married and both you and your husband are in good health.

If you wanted to 'buy' this income stream on the open market it would cost you around £30,000 and, based on average life expectancy, it will be in payment until you are around age 85. This makes the £17,000 you would get as an alternative look less good value for money. But you would always have the capital.

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