A major turn-off for people investing in private pensions, is having to buy an annuity and there are two good reasons behind this. Firstly, many people don’t know what an annuity is and the pre-retirement seminars I do as a www.pensionsadvisoryrservice.org.uk volunteer are being rewritten to address this. Another reason is that annuity rates are rubbish compared to income rates obtainable with other forms of investment.
For example, if your pension fund is worth say, £100,000 when you take your benefits, then you can take £25,000 as tax-free cash - renamed under Pension Simplification rules as Pension Commencement Lump Sum! YCMIU*. You cannot get your hands on the other £75,000. You can get the income from it but not the capital. In practice, what this means is that you sell the £75,000 to the insurance company that gives you the best rate. In a recent example, the LEVEL annuity rate obtainable for a male aged 65 was 6.9 per cent p.a. so he would have got this money for the rest of his life but inflation would have eroded its value over time. The problem here is that this rate is only slightly more than what you can get via an IFA in a low risk income fund where you keep you capital. So if you have the choice of say, 5 per cent a year where you keep your £100,000 and 6.9 per cent a year where you lose your capital, which one would you choose?
The income from both is taxable, albeit in slightly different ways but that detail can be left for now.
But the good news? Annuity rates generally improve as you get older. Latest age for buying an annuity from a pension is 75 which has been unchanged for decades. Life expectancy has probably increased by 10 years since it was first introduced. The tax rate payable upon death after age 75 for unused funds was an eye-watering 82 per cent under the previous government – generously reduced to 55 per cent with the coalition. A new consultative document is out for you to have your say on this rather important matter or you might wish to ask your own adviser what he/she thinks? http://www.hm-treasury.gov.uk/press2810.htm
You may be wondering why bother saving for a pension at all? Well there are still several good reasons:
1) If you are self-employed, your own pension pots are likely to be safe from creditors in the event of bankruptcy or having an IVA - Individual Voluntary Arrangement
2) the tax-free growth can be very valuable over the long term compared to a fund where the income/capital growth is taxable
3) your pension funds are not liable to Inheritance Tax. Unless you are daft enough not to nominate any beneficiaries – contact me or your adviser for an explanation here.
4) Accessibility to your pension funds can be a two-edged sword. Very tempting to dip into your pension pot to: have a second honeymoon, help your children, do a loft conversion or a hundred other worthy things.
If you think you home is your pension, go and lie down in a dark room until the feeling goes away. Eating your home is only practical IF your home is much bigger than you need when the children have flown the nest. After selling up and moving to a smaller home, you can then invest the lump-sum left over for income. Equity Release to give eating your home its proper name, is based on annuity rates which is where we came in. Unless you are in your 80s or in poor health, you may find the rates or terms offered disappointing.
- YCMIU = you couldn’t make it up