Pension, annuities, the Budget and life’s big gamble

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Pension, annuities, the Budget and life’s big gamble

I’m well aware that we in financial services often seem to live and breathe pensions, savings, investments and tax… and for most people this is a necessity not an interest. This week my peers and I have been quite taken aback by the changes to pensions, annuities and ISAs. Assuming the proposals are approved, this means significant improvements for clients, but not without risks.

So What?… meet Mr & Mrs Cash from Wimbledon

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Let’s suppose a healthy, non-smoking married couple Mr & Mrs Cash are both 65 years old,  and live in the leafy suburbs of south west London in Wimbledon (SW19). They want an income of £30,000 a year and would like this to rise by 3% a year to keep pace with inflation. They want this income, even if one of them dies, continuing at the same rate until finally both have left this mortal realm.

Annuities are so poor at present that £100,000 buys only £3,359.04 a year, so as the Cash’s need £30,000 a year initially, they would need a pension pot of £892,857 to provide this, excluding any requirement for tax free cash. Now that you have picked yourself up off of the floor…a joint life 100% spouse’s annuity with a rising income today has a best annuity rate of 3.36% (and by today, I mean I got this quote online today).

Life’s Gamble…

So now the “interesting” part, which is where the educated guesswork begins and the gamble with life really gets exposed. Remember that the annuity I have shown will last for the lifetime of the couple, income will be £30,000 a year and keep pace with inflation (provided inflation is 3% or less). Once the couple die the annuity stops, there is nothing left.

The alternative for this couple, with a fund of £892,857 wanting £30,000 a year increasing by 3% a year is to convert their pension into a flexible Drawdown pension, keeping the money invested. Let’s suppose the investment grows at 6% a year on average (3% above inflation). It NEVER runs out. In fact by the time they are 100 the fund is worth £1.9m having had a total income of £1.8m out over 35 years (by the way their income in that year… 35 years from now is £81,957… which in real terms is £30,000 today. Yes the investment will fluctuate in value, but we are, in this instance only wanting a modest income from it each year.

Its all in the gene’s..

Ok, so back to life’s big gamble…. How long will Mr & Mrs Cash live? The average UK female aged 65 will live another 20.62 years which is longer than the average male who has 18 more years according to the ONS figures. Let’s assume this is a couple that due to diet, lifestyle and good genetics live longer – to 90 (that’s 25 years). To do this they would need £512,153 in a portfolio, which grows at 6% a year. This would then run out at 90. Nothing left, nada, gone, zilch.

My point being that a much smaller pension pot is required (with these assumptions) its about 58% of the fund you would need to do the “same thing” when buying an annuity. I say “same thing” as of course if the couple live beyond 90 the annuity continues to pay out, the pension has all gone.

Not living long enough

Equally if both of them die “prematurely” at say 78, then the annuity finishes, there is nothing left. If the money is in the pension, there is a balance which can be passed to beneficiaries. Today this would suffer a 55% tax charge, but if I’ve understood the proposals, this will reduce to income tax rate levels. This is still to be clarified, but either way there would be money left in the pension (£1.2m by my maths). Let me say that again… there is £1.2m (one point two million) left rather than nothing.

The advantage an annuity provides is that it is guaranteed for life, so you know what you are getting. This can be a very good thing in the right circumstances. But it’s a one time decision and if you don’t live long, one might suggest that it was terrible value for money, it is only in year 22 that the total income that you would have had over 21 and a bit years  would surpass your original capital investment… making one or both of you 87 essentially before you’ve “had your money back”. This is all down to low annuity rates, which are due to interest rates, inflation, economics and life expectancy… things that you and I can influence very little.

Should we trust people with their own money?

Of course the danger of access to a pension is now being discussed in the media, there is justifiable concern that people may simply take their fund and blow it all at once…. on a nice car? Remember that this is taxable income, so any amount over £150,000 would be taxed at 45% and once its gone its definitely gone with no further help from the Government. There are concerns, and yes some people will blow it. However, from next Thursday, this feature is only available if you have £12,000 a year in guaranteed income (in your own name) currently you need £20,000. This amount does include your State pension and any other employers pension. So a lot of people will qualify, but of course not all by any means. Those with small pensions will not be able to use this feature, but they can use “capped drawdown” instead, which has also been improved, but clearly those with smaller pensions probably need more certainty for their own budgeting.

So where is the catch? well, between you and me….. I imagine that the cost of residential care will now be raiding many people’s pension pot in a rather more aggressive fashion, so spouse’s be warned… have your own pension pot.

Of course there are many more options and you could always decide to use the fund to buy an annuity at a later date (annuity rates tend to improve with age) and careful maths needs to be done and dreaded terms like “critical yield” may become a familiar term to many pensioners in the future. This is why reviewing your financial planning regularly (annually) with a us is really important and of course we can demonstrate the options and their consequences. So get in touch.

Dominic Thomas: Solomons IFA

Pension, annuities, the Budget and life’s big gamble2017-01-06T14:39:39+00:00

What is the best way to save for retirement? Part 2

Solomons-financial-advisor-wimbledon-top-bannerThis is the second in the series “What is the best way to save for retirement?”

The Alternatives to the Big Annuity Gamble

Thanks to some new(ish) rules, you don’t have to buy an annuity. In fact to be clear, just because your pension is set to mature at 60 or 65, does not mean that you have to take it then anyway. You can decide to take money out of your pension from the age of 55. Doing so beforehand will break the pension rules and get you into serious problems with HMRC. So don’t be tempted by firms promising “pension release” or “pension liberation” this is a load of rubbish and you are being lied to, it’s a scam to get money out of your pocket (or rather pension pot).

Delayed gratification

Ok, so you could defer taking the annuity. Why would you? Well because you reckon you don’t need the money now and annuity rates should rise the older you get (because you have left time to live). This is a truism. True in theory, but in practice over the last 20 years annuity rates have fallen from around 15% to around 5% for a variety of reasons which I won’t bore you with (you and I cannot do anything about it anyhow).

Have your cake and eat it..forrest gump

You could phase your retirement, taking a slice of the pot (much like cutting a cake). As before, 25% of the slice will be tax free, the remainder is used to buy an annuity. The balance (rest of the cake) remains invested and hopefully growing. You can take slices gradually, or just take the balance when you want, same principles applying. Why do this? Well you might be gradually stopping work and want to plan how you take your income and in particular how your income is taxed – so it can be a helpful tax planning tool.

Drawing what you want

Another option is to go into “DrawDown”. This is where you can take the tax free cash bit, and then income. The balance is left invested. Not much different from phased retirement, but meaning that you could take all of the tax free cash now. The amount of income you can take is restricted based upon, wait for it, quango speak coming “GAD rates” this is a rate set by the Government Actuarial Department, who figure out a rate for everyone. It changes, but its not far off the same as an annuity. Alternatively, if you are lucky enough to have guaranteed income of £20,000 from pension sources, then you can do whatever you like with the balance of the pot, take it all out at once, or over the rest of your life. You have to prove you have £20,000 a year mind you. Once its gone..well its gone. This is a really useful feature, but doesn’t apply to most people (who do not meet the £20,000 a year requirement).

Temporary annuities

A newer and evolving option is temporary annuities. These are really DrawDown pensions, but paying an income for a fixed period, typically 5 years. The remaining fund is invested and usually has a guaranteed level of growth (which means using derivatives) so that you can elect to buy a full annuity or do the same again at the end of the term. I have lots of reservations about anyone in the investment world guaranteeing anything, but it is an option.

Life is like a box of chocolates…

All of these options give you more choices. Invariably you have more control over how and when the income is paid to you. As a result you can do some tax planning to hopefully keep your taxable income within your control. You are also keeping your options open that should your health worsen you could then buy an enhanced annuity, or worse if you die, the balance of the fund is passed along to your spouse or possibly your estate, depending of tax charges being met and some other rather dull criteria that we don’t have time for here.

So these are all options. You aren’t being forced to buy an annuity, you can control the income. Tomorrow I will look at other options to pensions – other ways of investing to achieve the same result, income in retirement.

Dominic Thomas: Solomons IFA

What is the best way to save for retirement? Part 22017-01-06T14:39:41+00:00
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