Your IndustryOct 8 2014

Retirement income options right now

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In the run up to the changes planned for April 2015, people who want to retire are allowed to crystallise their fund and take their 25 per cent tax free cash, but they do not have to secure an income with the rest of the fund until after the changes come into force.

However if they need an income, Dominic Grinstead, managing director of MetLife UK, says they have the following options:

1) Annuity: a guaranteed income for life, which is usually fixed with limited death benefit options. Can be investment/inflation-linked or can offer higher income for medical or lifestyle conditions.

2) Capped drawdown: income taken as and when needed from the fund, which remains invested, subject to a maximum amount which has now increased to 150 per cent of the equivalent single annuity rate.

3) Flexible drawdown: the Budget reduced the amount of secure pension income required in order to access flexible drawdown to £12,000 a year (including state pension). Once qualified for flexible drawdown, the remaining pot can be accessed freely.

4) Unit-linked guarantee: a guaranteed level of income for life bought with part of a pot, with a remainder remaining invested and providing top-up income that is subject to investment performance.

5) ‘Third-way’ products: including fixed-term or deferred annuities.

6) Triviality/small pots: for smaller pensions pots, the trivial commutation rules allow up to £30,000 of total pension savings to be taken as cash, or for up to £10,000 to be taken from up to three funds.

The retirement income product they select now will depend on their needs, their aspirations for retirement, and whether they have alternative sources of income, says Mr Grinstead.

But ultimately your clients can also always do nothing right now and defer taking an income until the rules change in April 2015.

Using other assets and investments to cover expenditure before utilising the pension funds allows the whole pension to remain invested within a tax efficient arrangement for growth, says Richard Williams, director of The Annuity Bureau from JLT.

Of course, under new rules on after-death taxes announced this month, from April any fund passed on - even if crystallised - before the age of 75 will not be taxed, and beneficiaries can even take income or withdrawals, including the full fund, tax free.

Over the age of 75 the death charge has also been abolished, but subsequent payments from the fund are taxed at marginal rate, while lump sums will be charged at a flat rate of 45 per cent - with the intention of lowering this to marginal rates from 2016-2017.

The rules apply to money purchase pensions, value protected annuities and even to lump sum payments to beneficiaries from defined benefit schemes where the scheme member dies after the age of 75.

Mr Williams warns delaying taking your pension means investment returns may be less than anticipated and therefore the fund value and resulting pension commencement lump sum (PCLS) and income may be less than it is currently.

Taking it all pre-April

Those who have small pots may well want to consider taking their money as a lump sum, says John Perks, managing director of LV Retirement Solutions.

While they may need to consider whether they have an investment strategy for making the money last the length of their retirement, Mr Perks says for many this cash may have valuable short-term uses as well, for example paying off debt or key purchases.

Annuities pre-April

As pointed out by MetLife’s Mr Grinstead, despite many heralding the death of annuities the option remains for clients that need income now and that are concerned over the effects of inflation to purchase a lifetime annuity, fixed-term annuity or investment annuity.

LV’s Mr Perks agrees: “With people generally spending longer in retirement, many are concerned about the impact inflation will have on the purchasing power of their savings.

“An investment-linked annuity can help to mitigate the impact of inflation. We believe that investment-linked annuities will become the default annuity for those in good health, rather than standard annuities.”

A key downside of a conventional annuity is these contracts cannot be changed once started, except during a cancellation period. From next April, under new rules announced in the Summer by the government, income from a lifetime annuity can be reduced to allow for more flexible ‘lifestyling’.

The new rules will also allow guarantees to be set for longer than ten years to ensure payments for a set time to beneficiaries, though this would have an impact on rates.

Drawdown pre-April

Clients could also move to a drawdown contract, phased or in full, Mr Williams points out.

With capped drawdown, Mr Williams says income can be varied each year depending on the policyholder’s requirements and the maximum income withdrawal may initially be higher than available from an annuity under the higher allowance announced at the Budget.

Another upside of this option is the maximum withdrawal limit reduces the risk of depleting the fund, Mr Williams says.

A key consideration that may push others to go into capped drawdown prior to April is that while the product will effectively be rendered obsolete, exiting schemes are being ‘grandfathered’ into the new regime.

This means they will retain the higher annual allowance of £40,000; under the new flexible drawdown option this will be reduced to £10,000 to close a ‘loophole’ that would have allowed people to ‘recycle’ their tax-free cash allocation.

Capped drawdown means the remaining pension funds are invested, which may lead to a higher level of future income and your client is not committing to current annuity rates. Plus their pension pot can be passed on to their nominated beneficiaries on death, Mr Williams adds.

But Mr Williams warns the maximum annual permitted withdrawal may fall in the future - and he says taking maximum income withdrawals will have a negative effect on future maximum income limits.

Phased retirement

Phased retirement can be used in conjunction with annuity purchase or drawdown. Under phased retirement, the PCLS entitlement is taken in stages rather than fully at the outset.

Benefits are crystallised whenever PCLS is required such that 25 per cent of the crystallised value is paid out as PCLS and the other 75 per cent is used to purchase an annuity or moved into a drawdown (crystallised pension) pot.

The rest of the pension pot remains in the pre-existing uncrystallised pension pot. This is similar to how the new ‘uncrystallised fund pension lump sum’ option will work from April.

Mr Williams says the advantage of phased retirement is your client is only taking small PCLS payments when required, eliminating the need to set up a new savings or investment vehicle for the unneeded PCLS amount.

PCLS withdrawals can be taken in years when taxable income withdrawals are not preferable, Mr Williams says, and uncrystallised pension benefits can be paid out to a beneficiary as a lump sum without any tax charge on death prior to age 75.