Everyone says that the pension freedoms to be inaugurated next April are a gilt-edged opportunity for advisers to help people make sense out of all the new choices they have.
In fact, a recent survey we conducted indicated that 91 per cent of advisers believed the new rules will boost demand for financial advice. While this is encouraging news, the challenge is how to explain to clients that your advice is valuable.
To this end, I’d like to share an idea that can boost retirement income by thousands, if not tens of thousands: state pension deferral.
Under current rules, retirees who defer taking their state pension can receive a 1 per cent uplift to their income for every five weeks of deferral. This amounts to a rather significant 10.4 per cent boost in state pension every year.
Deferring state pension, whilst utilising private pension savings over a short time to cover necessary expenses, has the effect of increasing the amount of lifetime guaranteed income, making it a genuine alternative to buying an annuity – the default solution for over 90 per cent of pensioners.
Deferring state pension has the effect of increasing the amount of lifetime guaranteed income, making it a genuine alternative to buying an annuitySome examples
Two case studies illustrate the value this piece of advice can provide.
Client A, aged 65, has monthly outgoings of £1,000 and therefore wants a secure income from his pension of £12,000 a year. He has a £6,000 state pension and £4,130 of final salary pension.
As a result, he needs an extra £1,870 of inflation-linked income and has £60,000 in a personal pension. To buy an index-linked annuity would cost the client £55,000, leaving him with £5,000 in tax-free cash.
Alternatively, he can defer his state pension and draw £7,870 (the amount required to top up his final salary income to meet outgoings) from his private pension for three years. Assuming inflation is 3 per cent, this would use £25,000 of his fund.
After three years, with the deferment increase and assuming the same 3 per cent inflation, his state pension will have risen to £8,600. With the final salary income, he’ll have more than he needs to meet his outgoings and is left with £35,000 in his private pension - of which he can take £15,000 as tax-free cash anytime he likes.
It could have cost him close to £1,000 in commission to buy an annuity without paying for any advice, an amount that would probably cover the fee for a good IFA specialising in the ‘at-retirement’ stage to help facilitate this solution.
Client B, aged 62, is divorced and is in a similar position with a £6,000 state pension, £4,130 of final salary pension and a pension of £80,000 from her divorce settlement. She too wants an extra £1,870 inflation linked pension to cover her essential outgoings.
It costs her £65,000 to buy an inflation-linked annuity, leaving her with £14,000 as a tax-free sum. Just like Client A, it costs £25,000 to defer State Pension for 3 years and provide the same income.
Client B therefore saves £41,000 relative to buying an annuity with £20,000 as a tax-free sum and a further £21,000 in her pension fund as a longer-term saving pot.
Another option is to try and beat state pension deferral using investments, but in order to achieve this you would need to earn returns of over 10 per cent per annum for the client, which is challenging to say the least.
April 2016 changes
For those who reach state pension age before 6 April 2016, state pension deferral can be a hugely beneficial option. Even if they have already started taking the state pension, clients can still suspend drawing it and benefit in the same way.
The terms for the payouts to increase at 10.4 per cent per annum for each year of suspension, or deferral will not change in April 2016 for those who are already over state pension age at that time.
For clients retiring after April 2016, the new rate of state pension deferral of 5.8 per cent is far less generous, but still better value than buying an annuity on current rates. It is important not to dismiss this option out of hand when the time comes.
Naturally, there are challenges in finding ways of extracting enough pension money before the April 2015 changes to fund deferring state pension, but it is possible to use the current rules to do so and there are providers who will take the money to allow it to be paid out.
In addition, caution needs to be exercised with those in very poor health, as they may not live long enough to benefit, but then you know that anyway. Whilst enhanced annuities might be an option, they don’t always provide good value and retirees often need to think more about their dependents than themselves too.
Moreover, and in some cases, state pension deferral will still offer better value than buying an annuity for individuals in this situation.
Alan Higham is retirement director at Fidelity Worldwide Investment