Should I retire early if my final salary pension suffers an actuarial reduction?
If a final salary pension scheme member claims their pension early before the scheme retirement age, the pension and lump sum (where appropriate) is actuarially reduced to pay for this early payment. The member may have the option to buy out this reduction and take full pension benefits.
If the member is 55 or over, they can usually ask to access their retirement benefits before normal retirement age, which is the age they are eligible to claim retirement benefits without actuarial reduction. Their benefits will be actuarially reduced for the lifetime of the pension.
Are you being penalised by taking your pension early? Well, not really. If a pension adjustment is made on actuarial terms, it is intended to be cost neutral to the scheme relative to how the actuary assesses the cost of keeping the pension promise.
If you retire early and take an actuarially reduced pension you will receive a lower pension, but for a longer period of time. In order for you to work out whether it is worth it or not, you need to estimate your date of death, consider your tax position and calculate for yourself how penal is the actuarial reduction. These are not simple questions for the average man or woman to answer.
The good news is that your financial planner should be able to help you make the right decision by demonstrating two ‘what if scenarios’ using the cash flow planning software, which all good financial planners use:
- The first scenario is to assume that you retire at your normal scheme retirement age;
- The second scenario assumes an early retirement age together with the actuarially reduced pension.
The resulting two cash flow scenarios can then be compared on one split screen. The scenario that produces the highest cash flow is the one that should be followed.
It will be virtually impossible to say for sure which scenario is best as none of us know how long we are going to live. In my last blog I mentioned a date of death calculator called “findyourfate”, where you are asked a series of questions in order to predict the date you are going to die. I wouldn’t rely on it too heavily, as it is only intended to be a bit of fun. Nonetheless, it gives as good estimate of your date of death as any.
As long as the pension scheme’s actuarial reduction is a fair one, the key issue will be your tax position. The higher your personal Income Tax rate, the less advantageous it will be to take your early retirement pension and vice versa. With a top Income Tax rate of 45% and an effective Income Tax top rate of 60% on income between £100,000- £120,000 alone, your actuarially reduced pension could become severely reduced through taxation.
So, if you need advice on whether or not to take an actuarially reduced pension please contact us first. You know it makes sense.