News/Events

Freeing up Pension Cash [12th June 08]

I seem to have a lot of clients who are around 60 and have decided that they want to get their hands on the tax free cash lump sum available from their pension fund. Inevitably, I am then asked, I will have left , say, £200,000 to provide an income in retirement for myself and my wife and could you let me know what are our options?

It always seemed quite a straightforward question to answer as there was only one option – buy an annuity! But over the years the insurance market has been busy coming up with various options as annuity rates for converting the retirement fund to a pension have fallen fast.

I was horrified to come across a print out produced by Scottish Widows in 1995 showing how annuity rates fluctuated and the correlation with base rates over the previous 5 years. For a male life buying a pension with a guaranteed period of 5 years in August 1990, the annuity rate was 15.49% and by Jan 94 it had dropped to 10.39% but surprisingly rose to 11.55% by 1995. Today it is 7.6% so you would need now to have twice the fund value to get the same level of income!

So, the starting point relates to your approach to risk and this would give the same answer to the above if you do not wish to take any risk – buy an annuity. It is possible to build risk into this annuity policy by linking to an investment product with an aim to get the annuity to increase in the long term. But, it can fall if the investment backing the annuity is not as good as anticipated.

For those not in the best of health, there are impaired annuities that could enhance the annuity rate if you have a shorter than usual life expectancy and the same applies if you are a smoker or indeed live in certain post codes!

An annuity does provide therefore a guaranteed level of income and certainty for the future but it is totally inflexible as once set-up cannot be changed.

The normal alternative is to drawdown income from the pension fund known as pension fund withdrawal or now unsecured pension (USP) which was introduced in 1995. Very simply, the pension fund remains invested and a level of income is withdrawn with a maximum being dictated by the government. Here of course, we are moving into possible areas of risk. If the income withdrawn exceeds the investment return on the fund and the charges to maintain the contract, then the fund value will fall as well as potential future income. Having said that, one of the great advantages is that, should death occur before 75, there are options available to the then widow/partner. After 75, a different matter altogether as, currently, there is a potential tax charge of 82%.

I have a natural dislike of annuities due to their inflexibility but do like the new contracts coming onto the market. For example, there are now term annuities that provide an agreed level of income for, say, 5 years and then the circumstances are reviewed at that time. Or, several insurance companies are entering the market by offering certain guarantees with regards to income and capital values.

I have beaten the drum several times about taking advantage of the open market option when taking pension benefits but these days it is necessary to take qualified advice as this area has now become a complex and specialised area.

This article was written by Langtons - Published in the Western Morning News, Money, 12th June 2008