Income in Retirement
There have been many innovations and changes in legislation over recent years. These have served to expand the flexibility when using your accrued pension savings and, at the same time, made life more complicated due to the array of options and considerations that need to be taken into account.
Your FAC independent financial adviser will help you to decide where to take income from, how to take that income and identify the investment and taxation pitfalls that you might need to be aware of.
Download your free FAC guide to retirement options here or for truly unbiased independent financial advice from an FAC adviser, feel free to call us in confidence on 01726 814935.
Annuities
An annuity is simply a series of payments made at selected intervals in return for a pension fund. The level of payment is dependent upon age, sex, annuity rate, size of fund and options selected. Annuity rates tend to mirror interest rates since they are related to the returns earned on Fixed Interest Gilt Edge Securities. There are many different types of Annuities and these are covered later on in this section.
Lifetime Annuities
Advantages
• You will receive a guaranteed income for life, and you can elect for your spouse/beneficiaries to receive a guaranteed income or a lump sum less tax upon your death.
• Tax-free cash is available at outset.
• There are no additional charges applied to the contract once in force. All charges are taken at outset and are reflected in the annuity rate offered.
• The contract is simple to understand, there is no need to review the contract and there is minimal paperwork needed to start the payment of benefits.
Disadvantages
• The selected income level is fixed and cannot be varied in response to changing personal financial circumstances (excluding potential future increases applied for at outset).
• There is no opportunity of participating in future investment returns.
• Any options to provide benefits on death must be selected at outset and will result in a lower initial pension payment. These selected benefits cannot be altered in the future.
Enhanced Life / Special Situation Annuities
Individuals in poor health (or those with a known medical condition) may apply for higher annuity rates due to their shorter life expectancy – this may be subject to a medical examination. Some individuals may be offered enhanced rates due to their lifestyle or physical condition, i.e. smokers or clinically obese.
More recent developments have seen the introduction of Special Situation Annuities, which can be based on occupation and postcode. For example a bricklayer in Yorkshire may be given a higher rate than a stockbroker in Surrey.
In all other respects, these annuities are the same as a Lifetime Annuity.
These annuities are most likely to suit individuals who want absolute guarantee on their pension payments and are eligible for the higher rates. They therefore suit individuals with low attitudes to risk and security, although they may also be suitable for individuals with a high attitude to risk but are in ill health.
Investment Linked Annuity
An investment linked annuity is likely to be either with profits or unit linked. The initial pension and future income levels are dependent on the performance of the underlying investment funds.
Often the investor is allowed to assume a future rate of growth. The higher this assumed rate the greater the initial income, however if the actual growth does not match this rate then the amount of pension payable will decrease.
Advantages
• You will receive an income for life, and you can elect for your spouse/partner to receive an income or lump sum less tax upon your death.
• Tax-free cash is available at outset.
• The contract is relatively simple to understand and there is minimal paperwork needed to start the payment of benefits.
Disadvantages
• The selected income level is not guaranteed and is subject to future investment returns.
• Charges will probably be higher than under a ‘Traditional Annuity’.
• Any options to provide benefits on death must be selected at outset and will result in a lower initial pension payment. These selected benefits cannot be altered in the future.
Third Way
Against a background of increased volatility in stock markets, perceived poor rates being offered for Lifetime Annuities, concerns regarding future inflation and the fact that people are now living longer, the retirement market was in need of a new type of product. These new plans are generically known as ‘Third Way’ products and they have proved popular in other countries. Essentially they fit in between a Lifetime Annuity and a Drawdown Pension plan as they offer the chance to still participate in stock market growth but with guarantees attached to either income, capital or both.
Whilst each specific product does differ in its features, the ‘Third Way’ pension is usually structured in one of two ways:-
Annuity – this option is commonly structured as a fixed term, value protected annuity plan, typically running for 5 years at a time, with the option to include guarantees to protect maturity values or the level of income. Unlike a traditional lifetime annuity, these products tend to offer the ability to alter income levels between certain limits and importantly, also allow the facility to provide a lump sum on death.
Drawdown Pension – the second type of Third Way plan is structured as a Drawdown Pension plan but with the option to apply a guarantee to the initial investment so that your fund value will never fall below what you originally paid into the plan. Some plans also allow all or a portion of any growth in the plan’s value to be locked in and a new minimum guaranteed level is then set. Finally, the option to select a guaranteed level of income is also commonly available.
Under both of the above options, you can choose to immediately take a tax-free cash lump sum and then, instead of buying an annuity, leave the remainder of the fund invested in a tax-efficient environment.
If the income is not guaranteed it may vary between set limits, and will be reviewed at some point between 1 year and 3 years depending on the product chosen. The range of income typically can be anything between nil and 100% of the income that could be paid by a single life annuity and will be based in the main on your fund size, age, sex, assumed investment returns and your expected longevity.
The maximum limit is broadly equal to 100% of a single life annuity that you could have purchased at that point. Where a guaranteed level of income is chosen this tends to be a fixed amount although increases may be possible.
Advantages
• You are able to take all of your tax-free cash lump sum entitlement at outset.
• Unless a guaranteed income is selected, you do not have to receive a set income but are able to vary it to suit your personal circumstances, up to a maximum limit, to supplement other sources of income.
• You are able to mitigate your liability to personal income tax in certain years.
• You have the potential to benefit from good investment performance in a tax-efficient environment and to exercise control over your own investment portfolio.
• You are able to add a safeguard in the form of a guarantee to limit any drop in your fund value and some products allow gains to be locked in.
Disadvantages
• High income withdrawals may not be sustainable during the deferral period
• Taking withdrawals may erode the capital value of the fund, especially if investment returns are poor and a high level of income is being taken. This could result in a lower income when the annuity is eventually purchased and could also affect the long term financial security of your spouse/partner.
• The investment returns may be less than those shown in the illustrations.
• Annuity rates may be at a worse level when annuity purchase takes place. Although annuity rates generally increase with age, they have fallen dramatically during the past 15 years.
These are complex cases and should not be considered without professional advice. Call us on 01726 814935.
Flexi-Access Drawdown (FAD)
This is one of the new methods of taking pension benefits introduced in April 2015. In many ways it is like previous options of drawdown but with unlimited withdrawals.
This form of arrangement allows access to your entire pension fund. The first 25% of the fund can be drawn as a tax free lump sum with the balance being taxed as income, although no taxable withdrawals need be taken if the funds are not required.
Primary Advantages
- The tax-free lump sum can be taken without committing to any other income or withdrawals
- Withdrawal levels can be varied
- The fund can remain invested – so it could grow further
- The fund can be passed on in the event of death
Primary disadvantages
- The flexi-access drawdown contract could fall in value
- Any ongoing income is not guaranteed and could go down
- Flexi-access drawdown requires ongoing monitoring of the plan and may incur additional charges
- Without careful planning you could end up running out of money
- If you take a taxable withdrawal you will not be able to pay more than £10,000 per year into a personal pension arrangement
This is a complex area and one which is best avoided without professional advice and planning. Your FAC independent financial adviser can guide you through the options and assist you in planning for a realistic income stream and comfortable retirement.
Call us on 01726 814935.
