A lump sum lesson on teacher’s pension

I am approaching 54 quicker than I’d like. Could you explain why I have only four months to take the 25% lump sum from my teacher’s pension and keep the rest invested? I don’t think I’m going to retire yet but I’m starting to think about the time when it arrives and investigating all the options for when I do.

JH by email

Relax. Unless you have a serious financial emergency you should do nothing. On April 6, the minimum age for anyone to take a pension jumps from 50 to 55.

Tom McPhail at adviser Hargreaves Lansdown said: “It generally won’t make sense to take the pension early unless income is needed now or there is a specific financial need such as university fees or house purchase.”

Those earning over £150,000 a year may gain from taking their pension ahead of the removal of higher-rate relief in 2011 — that needs professional advice. But you are not in that bracket and say you do not intend to retire now. Anyway you will be 55 in just over a year, so you would be free to do so then.

The Teachers’ Pension Scheme website is misleading. Its ready reckoner calculates two figures: what it calls “your pension” and “your lump sum in addition”, as if the lump sum is a bonus on top of your pension. It is not. It comes out of your pension savings and so reduces your regular income.

You do not have to take a lump sum and I would reject the deal this scheme offers because for every £1 income you surrender it will pay only £12. For someone your age, £18 or even £20 would be fair. At £12 you would in effect be giving the scheme a lifetime 8.3% return on the money it proposes handing you. If you want to pay off a loan costing you over 8%, the lump sum begins to make sense.

But the teachers’ scheme offer still reeks of Dotheboys Hall.

I have an M&G High Yield Corporate Bond fund in a Pep that I have had since December 1998 when I invested £6,000 at the suggestion of an adviser. Its value has gone up and down and is now approximately £10,000. I don’t receive an income, so I assume any dividend is put back into the bond. Much as I have tried to understand this investment, I am still not sure how it works. I don’t know whether it is a good investment for me as I am retired and don’t want to lose capital. Is it best to keep this bond, sell or reinvest in something else? Can it be transferred to an Isa?

SM by email

You have made the classic mistake of investing in something you don’t understand. Although you don’t give your age, I assume that your adviser recommended the M&G bond fund as a more cautious investment than equities for someone approaching retirement.

It has been well managed by Jim Leaviss, one of the City’s top bond fund managers but — as you may have noticed last year — the price can sink alarmingly. So if you want no risk, you are in the wrong place. However, ensuring you do not lose money means keeping cash in a bank or building society, where its purchasing power will shrink. There are no easy answers.

Your fund owns a collection of corporate bonds issued by the likes of EMI, Virgin Media and Nordic Telephone. Like an equity fund, much rests on the manager’s skill. A corporate bond is a loan to a company in return for regular interest payments. At the end of its pre-set term — typically five to ten years — the company returns the investor’s original stake. However, a bond fund has no fixed term: when one bond matures it invests in another.

High-yield corporate bonds such as M&G’s pay higher interest than most because of the greater risk of default. If the company hits problems it may stop interest payments or not return your money. This fund pays 5.88%, while safer government bonds (gilts) of similar length yield 3.5% or less. M&G said: “This fund carries a higher risk of capital loss than a normal corporate bond fund. However, this is offset by the potential for higher income.”

The main current issue with high-yield bonds is the impact of the Bank of England’s quantitative easing programme. This was designed to buy such assets, driving up their price, which in turn drives down the yield and the cost of borrowing. As quantitative easing has apparently worked, it may be reversed — depressing bond prices and raising interest rates. Corporate bond funds will then suffer.

Peter McGahan at Worldwide Financial Planning said: “Is this the right fund for you? Not likely. Whether you measure it by risk, consistency of return or potential, it fails badly. Better are Investec Monthly High Income, yielding 8.67%, or Threadneedle High Yield Bond, paying 8.4%.”

Hannah Edwards at Killik, the broker, said: “My advice is also to buy Cazenove’s UK Absolute Target fund, which is slightly higher risk but should position the portfolio more robustly for the long term if the objective is capital growth.”

There is no problem moving from a Pep to an Isa, as on April 6, 2008, all Peps automatically became Isas.

E-mail your questions to wealth@sunday-times.co.uk. Unfortunately, we cannot reply to or deal with every e-mail

Times Recommends

• How to sell your home in a downturn
• How to boost your spending power
• Unemployment benefits explained