Is it really worth you taking out a pension plan to eventually buy an annuity for your retirement income. And, why should the half of the population who cannot afford to save because their income is too low, subsidise the better off half of the population who can afford to save?
The tax relief on pension contributions and the value of the tax free lump sum cost the government around £30 billion a year in lost revenue in 2004-05 according to the Pensions Policy Institute (PPI), almost all of which benefits the better off half of society.
More importantly, should you invest in pensions with a view to buying annuities at all? We all need to save for our time in retirement and if your employer offers you a pension scheme to which he is making contributions, you would be somewhat foolish not to join.
There are some real drawbacks to saving in a personal pension and arguably there are better retirement options. Although you get tax relief at your highest rate on pension contributions, you can take only 25% of the fund at retirement as tax free cash. The balance must be used to purchase a pension annuity.
And you could take an alternative retirement option such as income drawdown and leave the fund invested after retirement, you are still obliged to purchase an annuity at age 75. And, if you die a year after purchasing your annuity, you could lose the entire fund unless you had arranged an option such as dependent’s pension or capital protection for your annuity.
There are ways you can pass on your pension fund to dependants via Alternatively Secured Pensions (ASP). But the government has recently clamped down on ASPs and it is not worth considering for the average pension saver with less than, say, £100,000 in their pension pot because the charges are high.
With the best annuity rates at around 7% for a male aged 65, and decreasing, you would need a lump sum of £500,000 to produce a reasonable retirement income of £35,000 a year. This is an awful lot of money to lose on death and your children might have something to say about the wisdom of you having saved in a pension. In addition, all retirement income generated by income drawdown or pension annuities is taxable at your highest rate paid.
There are alternatives to retirement options. For the vast majority of savers, putting away the maximum each year into an ISA is a valuable decision because although contributions to an ISA are not eligible for income tax relief, income eventually drawn from an ISA is tax free which is arguably just as valuable as the tax relief gained on contributions, and you are able to convert ISA investments into income bearing securities such as gilts and corporate bonds at retirement and all income taken from the ISA is tax free. In addition, you can withdraw your money from an ISA at any time, without penalty, and like a pension fund, the investments roll up free from Capital Gains Tax (CGT).
Given that the average pension fund at retirement is only £50,000, saving in an ISA makes quite a bit of sense. If the money is invested in a pension instead, the income it generates is just about enough to disqualify you from means-tested benefits like Pension Credit and Council Tax Benefit, now potentially worth several thousand pounds a year. But the value of the pension provided to you is no greater.
Very few people can afford to save more than £7,200 a year anyway. If the maximum ISA and PEPs amounts had been contributed since they were first introduced in 1987 you would have saved £165,600 including contributions for this tax year, 2009-10. Over that same time the FTSE100 Index has risen from 1,684 on 26th October 1987, to today’s level of about 4,000, even taking into account its dramatic drop from last year’s high we witnessed of just over 6,300.
So you could easily have a pension pot of £330,000 had you invested these amounts. But most importantly, you can take tax free income from these investments, and you will have total control of the money, and you won’t be forced to purchase an annuity, and you could easily have a large lump sum to leave to your dependants. Accepting all this, an ISA looks a much better bet for the average investor.
So, when you come to start looking at annuity quotes for your retirement planning, let’s hope you don’t regret not putting your savings into an ISA instead of a pension plan!
