Buying Extra Pension?

[Rightflyer]

Hi guys,
There exists a possibility to buy extra pension. I've been through the online calculators on the pension providers website and run the numbers in my spreadsheets, but...
We need some second opinions.

Scenario

Female (healthy, from a long lived family, mother just passed away at 94)
53 y.o.
Pension available at 67 y.o.
Defined benefit government pension, indexed to inflation
No heirs

This is a part-time position which she will not work at until 67.
In effect we are looking at buying a pension with money already earned... not having to work and pay for another 14 years.

Lump sum cost per £100/year of extra pension is £1214.00

Running the numbers, NOT accounting for inflation gives me an annualized return of 2.82% for 37 years (to age 90).

We are currently 90% equities/10% cash in our total portfolio. No other pensions...

Given that the pension is safe and inflation proofed, it seems like a good alternative to bonds...


What do you think?
We need help from the big (collective) brains here.
Any feedback is most welcome.



 

[MrUpwardlyMobile]

You may want to clarify that you’re in the UK.

[Rightflyer]

You may want to clarify that you’re in the UK.

Done.

I'd still be happy for anyone to chime in... the general idea is the same in most countries, if not the details.

[sokoloff]

I find it to be a slightly bad choice to buy additional pension under those terms, but it depends heavily on your discount rate for the future. (Money in 14 years is worth less than money today, but by how much?)

I created a quick Sheets sheet that ignores inflation (because the pension is inflation adjusted, you can do the math entirely in "today's money"), but you still discount the future for three reasons:
1. Risk that the payer will be insolvent, may curb the payouts for some other reasons, may institute means-testing or punitive taxation of pensions for people "who don't need it", etc.
2. Risks that the buyer will die earlier than predicted.
3. Gains foregone by investing in alternative vehicles.
4. (Possibly,) you might value money at age 67 more than at age 92, in terms of being able to travel and enjoy the fruits of the money. (This is a less extreme version of 2, so I didn't count as a fourth point.)

In this analysis, assuming the inflation adjustments are "acceptable" to you, you can ignore inflation, so don't add that into the discount rate.

You are also to be able to pass on to heirs the likely surplus in any investment account, but not in a pension.

For these reasons, I chose a discount rate of 3%, which makes it a breakeven proposition at age 93.

https://docs.google.com/spreadsheets/d/1lSm3MtbNyQd1spGi7dKrtsEK6rIYcdXmelxTEbJXHsc/edit?usp=sharing

To the extent that you consider buying in under these terms, I think you're giving up a sum of money overall, but may be buying "ease" or piece of mind, so think of this as an insurance purchase of sorts. It's not wrong to buy insurance, but it does cost you money overall and one should probably not buy excessive amounts of it.

[bill1827]

Congratulations on having a DB pension, there aren't many left nowadays.

You seem to be a bit premature in considering this; generally you buy additional pension with a lump sum just before you take the pension, in about 14 years time. This sort of additional pension is, in effect, an annuity and I think you'll find that the rates that you're offered will change, so in 14 years the rate will likely be different.

Considered as an annuity, it looks quite a good rate at about 8.2%. A single life level annuity for a 70 year old is about 6.3% at the moment; the same with 3% p.a. increase is about 4.6%, CPI linked would be even less.

Whether to do it or not depends on the size of the basic pension (do you need more income?); your attitude to risk; whether you will need access to the capital in the future, because the capital will be lost to you.

FWIW, I had this option when I retired some years ago and took it, even thought the rate was much worse than yours. It's worked for me, but I'm somewhat risk averse and no alternative low risk investment was available.

[MustacheAndaHalf]

In the U.S. pensions are offered with and without survivorship benefits.  For a married couple, survivorship benefits can provide peace of mind.  May be worth talking over with your spouse, which can help narrow the options a bit.

[Rightflyer]

I find it to be a slightly bad choice to buy additional pension under those terms, but it depends heavily on your discount rate for the future. (Money in 14 years is worth less than money today, but by how much?)

I created a quick Sheets sheet that ignores inflation (because the pension is inflation adjusted, you can do the math entirely in "today's money"), but you still discount the future for three reasons:
1. Risk that the payer will be insolvent, may curb the payouts for some other reasons, may institute means-testing or punitive taxation of pensions for people "who don't need it", etc.
2. Risks that the buyer will die earlier than predicted.
3. Gains foregone by investing in alternative vehicles.
4. (Possibly,) you might value money at age 67 more than at age 92, in terms of being able to travel and enjoy the fruits of the money. (This is a less extreme version of 2, so I didn't count as a fourth point.)

In this analysis, assuming the inflation adjustments are "acceptable" to you, you can ignore inflation, so don't add that into the discount rate.

You are also to be able to pass on to heirs the likely surplus in any investment account, but not in a pension.

For these reasons, I chose a discount rate of 3%, which makes it a breakeven proposition at age 93.

https://docs.google.com/spreadsheets/d/1lSm3MtbNyQd1spGi7dKrtsEK6rIYcdXmelxTEbJXHsc/edit?usp=sharing

To the extent that you consider buying in under these terms, I think you're giving up a sum of money overall, but may be buying "ease" or piece of mind, so think of this as an insurance purchase of sorts. It's not wrong to buy insurance, but it does cost you money overall and one should probably not buy excessive amounts of it.

Thanks sokoloff for your good input.

Re: 1) and 3). As the pension is backstopped by the federal government I believe the risk low and the comparative investments would be government long bonds... i.e. very low real returns (after inflation).

Re: 2) Yes, this is always a real risk. However, we have no heirs and their are survivor benefits.

You hit the nail on the head about it being insurance.
It would be peace of mind to have a steady stream of inflation linked income for her... especially as I expect I will predecease her.   

[Rightflyer]

Congratulations on having a DB pension, there aren't many left nowadays.

You seem to be a bit premature in considering this; generally you buy additional pension with a lump sum just before you take the pension, in about 14 years time. This sort of additional pension is, in effect, an annuity and I think you'll find that the rates that you're offered will change, so in 14 years the rate will likely be different.

Considered as an annuity, it looks quite a good rate at about 8.2%. A single life level annuity for a 70 year old is about 6.3% at the moment; the same with 3% p.a. increase is about 4.6%, CPI linked would be even less.

Whether to do it or not depends on the size of the basic pension (do you need more income?); your attitude to risk; whether you will need access to the capital in the future, because the capital will be lost to you.

FWIW, I had this option when I retired some years ago and took it, even thought the rate was much worse than yours. It's worked for me, but I'm somewhat risk averse and no alternative low risk investment was available.

thanks bill... very helpful.
Yes, we (she) kinda fell into the DB pension. It started as a volunteer position which led quickly to a very basic part-time wage. When I noticed the pension deduction on her first payslip we researched it and lo and behold she had been automatically enrolled in a govt DB pension plan. It feels a little like winning a lottery honestly.

The price goes up for the buy-in at 66 to £1811 per £100 pension.

The truth is she is not planning in working there for more than a few more years. I do not believe you can buy more pension once you have left employment.

She has no other pension income at all.
All of our other investments are in equities or private equity so this would be the only low risk income...

[Rightflyer]

In the U.S. pensions are offered with and without survivorship benefits.  For a married couple, survivorship benefits can provide peace of mind.  May be worth talking over with your spouse, which can help narrow the options a bit.

Yes, there are survivor benefits (25% of the pension) and a lump sum death grant (3 x initial pension).

We're assuming I will go (die) first so the pension (it is hers) will be more a peace of mind in that scenario.

[sokoloff]

3. Gains foregone by investing in alternative vehicles.

Re: 1) and 3). As the pension is backstopped by the federal government I believe the risk low and the comparative investments would be government long bonds... i.e. very low real returns (after inflation).

For many (most?), the next 14 years of alternative investments would not be government long bonds, but rather stocks. In the overwhelming majority of 14 year periods, stocks have outperformed government-backed bonds, so to the extent you invest now and would have (even partially) held stocks in the interim, you're paying a price.

You seem to have a good handle on it, and the price might very well be acceptable/attractive, but it's probably not 0.

[Rightflyer]

3. Gains foregone by investing in alternative vehicles.

Re: 1) and 3). As the pension is backstopped by the federal government I believe the risk low and the comparative investments would be government long bonds... i.e. very low real returns (after inflation).

For many (most?), the next 14 years of alternative investments would not be government long bonds, but rather stocks. In the overwhelming majority of 14 year periods, stocks have outperformed government-backed bonds, so to the extent you invest now and would have (even partially) held stocks in the interim, you're paying a price.

You seem to have a good handle on it, and the price might very well be acceptable/attractive, but it's probably not 0.

Sorry, I see what you are saying now.
I was looking at the discount rate and what a super safe investment would be.

I agree that we would leave it in the markets if we didn't do this...