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Phased drawdown rather than a pension annuity?

January 6th, 2009

Rather like income drawdown, phased drawdown offers you an alternative to having to commit your reduced size pension fund to purchase a poor value pension annuity contract.This type of plan was primarily introduced for those individuals who wish to retire gradually and to ‘phase’ the taking of their retirement benefits.

This arrangement uses a combination of Income Drawdown and tax-free cash to provide an income. At the plan’s commencement your pension fund is invested in a portfolio of investments in a similar way to income drawdown. Part of your pension fund is encashed to supply you with an income, which in the first year is made up of a tax-free cash sum (alone) or a combination of tax free cash and drawdown income. As and when further income is required by you, additional funds can be encashed to provide you with this.

As an option to purchasing a Drawdown income, you could purchase a pension annuity. This type of arrangement is known as Phased Retirement. Each time you buy a pension annuity, you can purchase one of any design.

When you require your income, you select the amount you wish to take and then the pension fund pays this out to you in the form of a combination of tax free cash and income. You can make further income withdrawals from your fund when you require them. Maximum levels of income are, however, subject to overall limits set by HM Revenue and Customs (HMRC).

This type of arrangement will provide you with an income in a tax efficient manner and can also provide higher levels of benefits in the event of your premature death than either a pension annuity purchase or full income drawdown.

Please note that this type of arrangement is complicated and specialist advice should be taken. However, for many it is seen as a good alternative to committing a pension fund to an annuity purchase.

Income drawdown rather than a pension annuity?

January 6th, 2009

With pension fund values suffering and annuity rates on the decline income drawdown (pension drawdown or drawdown) is being seen by many as an alternative you have to buying a pension annuity when you reach retirement age. Income drawdown allows you to start drawing an income from your pension fund while the fund itself remains invested. Admittedly, It is usually relevant to those with larger pension pots, perhaps £100,000 or more, and with other assets available.

Normally, at retirement, you take a tax-free lump sum from your pension fund, up to 25%, and then use the rest of the fund to purchase a pension annuity from a life insurance company. This effectively turns your pension fund into a pension income for time you are in retirement, for the rest of your life.

You might prefer not to purchase a lifetime annuity straight away and therefore give yourself more flexibility. One alternative you have is income drawdown. If you are under 75, this will give you an income from your pension fund by using an income withdrawal facility or a short term annuity. The remainder of your pension fund remains invested.

You can still take up to 25% of your pension fund as tax-free cash, then you start taking a regular income from what is left of your fund. This income is subject to tax. There is a maximum level of income available to you, but no minimum. The maximum is broadly equivalent to 120% of the amount you would otherwise have got from a single-life lifetime annuity.

Whilst you draw your income, the rest of the pension pot remains invested in a favourable tax environment. Note that you will be taking an income from a fund that remains invested in asset-backed investments, such as the stock market, therefore fund values or the income levels available from it are not guaranteed and may go down as well as up.

The amount of income you withdraw from the plan must be reviewed every five years by your provider. This to ensure it continues to be set below the limits imposed by HMRC. You can withdraw any income from your fund, provided it is within these limits.

You can stop the plan at any time and use your remaining pension fund to buy a short-term annuity or a lifetime annuity.

Note that if you should die before age 75, and you have not yet bought a pension annuity, your pension fund can be left to your remaining partner and any dependants. They will have some options available to them, some more tax efficient than others.

Income drawdown plans are complicated arrangements, therefore seek out professional advice. They are not suitable for everyone, and are usually unsuitable if you have no other income or assets to fall back on, or, indeed, if you have a smaller pension fund. Taking one out also depends on the amount of risk you are prepared to accept. However, for many, income drawdown is seen as a credible alternative to spending a reduced pension fund on a poor value annuity.

Pension annuity rates going down again

January 6th, 2009

Level pension annuity rates for women, inflation-linked pension annuity rates and rates for smokers have all come down over the past three to four weeks. The best level annuity rate fell ever so slightly for women, with Norwich Union cutting its previously market leading annuity rate of £6,760 per annum to £6,540 leaving Aegon Scottish Equitable at the top of the annuity rate table with an unchanged £6,678.96. In the meantime, leading rates for men have held their ground.

RPI-linked pension annuity rates have fallen slightly for men and women, with Prudential remaining  top of the table despite cutting starting annuity incomes for men from £3,997.32 per annum to £3,932.52 and for women from £3,662.16 to £3,592.80.

The best annuity rates for smokers also fell, with Reliance Mutual cutting male rates from £8,205.36 to £7,935.48 and female rates from £7,840.08 per annum to £7,561.20. They remain top, but as runner up annuity provider, LV=, did not cut rates, the margin is narrowing.

Annuity rates have actually been holding up well, relatively, given the large cuts in the Bank of England base interest rate toward the end of 2008. The fact that annuity rates are reducing is no great surprise and they may well continue to be in gradual decline during 2009, driven mostly by movements in corporate bond yields. However, annuity rates are still higher than one year ago.

Just how safe is an annuity?

January 5th, 2009

Many people have expressed concerns about the safety of a pension annuity contract in the current economic climate, i.e. what happens if the financial institution who has provided the annuity fails? There are different types of annuities to consider here:

First, we have standard annuities or non-profit policies. This means that payments are guaranteed as long as the company behind them is solvent. There is no investment risk in this type of annuity contract.

Secondly, we have an investment linked annuity such as a with profits annuity, unit linked annuity or flexible annuity, where the payments are not guaranteed and can go up or down depending on investment returns experienced. With these, should the annuity provider be declared insolvent and unable to pay your pension annuity, you would be covered by The Financial Services Compensation Scheme (FSCS). The amount of compensation is 100% of the first £2,000 plus 90% of the balance of the claim. This policyholder protection is triggered if an authorised insurer is unable, or likely to be unable, to meet claims made against it.

The conclusion: protection if you have an investment related annuity, and none if you don’t.

Your pension annuity falls as Government pensions grow

January 5th, 2009

Members of Parliament have seen the value of their Government pensions grow, and grow well above the rate of inflation even as private workers’ personal pension funds have shrunk. Apparently, Jack Straw has the biggest ministerial fund, worth around £300,000. Official figures unearthed by the Lib Dems show that the value of Government ministers’ retirement funds, funded by us, has risen by 10%  this year. This at a time when typical personal pension funds have fallen by as much as 25% as stock markets tumble and interest rates fall.

Indeed, some senior ministers are entitled to pension funds worth more than ten times the average workers’ private pension fund. That average being only around £25,000. Thanks to falling pension annuity rates, such a pension fund will today buy an annual annuity income of a little over £1,600.

Ministers do contribute to their pension funds, but the largest contribution does come from the Treasury, which pays 26.8% of a minister’s salary into the fund.

The figures, taken from Whitehall departments accounts, show ministerial pension funds have a “cash equivalent transfer value” of around £7.4 million.

How about Leigh Lewis, the senior civil servant at the Department of Work and Pensions. His pension fund rose by £314,000 from £1,567,000 to £1,881,000.

Many pensions experts have warned of a growing “pensions apartheid” dividing public sector workers with well-funded final-salary pension schemes and private-sector staff with less generous retirement (typically personal pension) schemes.

Surely it can’t be right that we have such a ‘pensions gap’, and that we, as taxpayers, are funding it!