The recent announcement by the government that you will no longer have to purchase an Annuity with your pension fund was welcomed by most investors.
The changes could improve flexibility, but exactly what has been announced? Who will benefit? and what should you do now in preparation for the changes?
What has been announced?
There have been two major changes; firstly the requirement to buy an Annuity at age 75 has been removed. This was moved to age 77 as a temporary measure in the last budget but will now go completely.
This will mean investors can stay in Income Drawdown or continue to purchase Fixed Term Annuities past the age of 75, opening up the possibility of leaving surplus pension funds to family members. With an Annuity of course, this is not possible.
The second major change is for those who take advantage of the new rules and do not purchase an Annuity. There will be increased flexibility in how you draw and income from your pension, this will take one of forms:
“Capped drawdown” which will allow limited annual withdrawals from age 55 for the whole of retirement
“Flexible Drawdown” allowing unlimited lump sums to be taken from the pension, providing that you have enough other income to meet a Minimum Income Requirement (MIR), which in turn proves that you will not fall back onto the state at some point in the future
The exact level of the MIR is currently being consulted on; the final level is likely to be set reasonably high and will therefore exclude many individuals; the government will not want investors raiding their pensions and then relying on the state.
The government has indicated that it believes only 8,000 people will be eligible for Flexible Drawdown. Given that in 2008 459,868 new Annuities and 29,234 Income Drawdown plans were taken out (Source: Association of British Insurers) it is likely that only a small proportion of investors will benefit.
It will also be important to know what income is allowable when calculating the income against the MIR.
Many experts believe that only guaranteed income that has annual increases to combat inflation will be allowable. If you therefore have an existing escalating Annuity, State Pension or Occupational Pension Scheme then you should be well placed, however if your income comes from investments then it is unlikely that this will count.
Who will benefit?
The change will be of most benefit to those that would like additional flexibility in how income is paid from the pension and what happens to any residual money when they die.
If you want a guaranteed income for life then these changes probably will not benefit you in any great way and an Annuity is still likely to be the best route.
Furthermore if your pension fund is small it is likely that an Annuity will still be the only practical option available to you.
However, if you want more flexibility in how you take your income or want additional options on your death, the new rules may well help.
Whether you are eligible for “Flexible Drawdown” will very much depend on the level that the MIR is set at. If the level is set too high then only a small percentage of investors will benefit. The government has already indicated that only a small proportion of those people that buy an Annuity or Income Drawdown plan are likely to be eligible.
“Capped Drawdown” could help many more people who want income flexibility. For example those who have other sources of income, or who’s working hours vary from month to month and year to year.
For those who disliked Annuities, because of the limited benefits available on death, using a Fixed Term Annuity or Income Drawdown plan in conjunction with the new rules will allow them to pass on unused pension funds to their beneficiaries.
The changes may also be of benefit to others such as members of final salary schemes who may be able to take a greater lump sum, having taken the minimum amount possible from the pension to meet the MIR.
What should you do now?
This really is the $64,000 question; it certainly cannot be answered here in full, as each individual’s circumstances are unique to themselves, however it is possible to give some broad ‘rules of thumb’.
The proposed changes, whilst welcome, will leave many in limbo until April 2011 when the final rules will be confirmed.
Taking advice and speaking to a suitably qualified Independent Financial Adviser is a must now as the options have just got wider and more complicated.
When considering how to draw an income from your pension and whether to delay the decision to purchase an Annuity you will now need to consider other factors, in addition to those you would normally think about. For example:
- Whether income is needed now and if you have other sources to tide you over until you make
a decision about your pension
- Is your pension fund of a sufficient size to be able to consider other options such as Income Drawdown or a Fixed Term Annuity?
- Are you likely to purchase an Annuity anyway? If so the cost of delay, your pension will be paid to you for a few months less if you delay, could be an important factor
- Are you likely to take advantage of the new post 75 IHT rules? How important are lump sum death benefits to you?
One problem with delaying is a piece of European legislation known as Solvency II due to be introduced in 2012.
Solvency II is designed to reduce the risk that an insurer cannot meet its claims and provide regulators with early warnings if solvency does become depleted. However as a result of the legislation financial institutions that provide Annuities will have to retain more cash in their reserves and invest the money that they receive to purchase Annuities in a more conservative way.
Many in the industry believe it will lead to a reduction in Annuity rates due to the constraints it will place on the companies who offer Annuities.
It is perfectly possible to see a situation where a person wanting to retire delays the purchase of an Annuity until after April 2011 only to find that purchasing an Annuity is still the right thing to do but that rates have dropped in the meantime as firms prepare for Solvency II. To compound the bad news they will also have lost out on a few months worth of income which they would have had if a decision had been made sooner.
Confused? We don’t blame you.
The wrong thing to do is to wait, take no action and make decisions based on headlines and newspaper articles.
Think over what you want, plan a cash flow showing your income and expenditure, think over what you want to happen on your death; it is only once you have done this can you start to think about how you achieve these goals with the pension you have worked so hard to build up.
Of course we can help you with all this planning, from an initial discussion; through to planning a cash flow and helping you make decisions that are right for you.
There are options you can take now that will provide you with an immediate income, yet will allow you to benefit from future rule changes.
If you are coming up to retirement unfortunately for you at no time in the history of UK pensions has the decision how to take an income from your pension been more complex, but call us, we are here to help.