Roxburgh Group Annuities & Income at Retirement Planning
Whether retirement is a long way off, or just around the corner it's important to think about how much income you're going to have. And as you approach retirement, you'll also have to decide how you'd like to receive the money from any pensions you've been saving towards. The most popular way of securing an income for life is by converting your pension fund into an annuity.
This involves paying a lump sum from your pension fund to an annuities provider, who'll convert it into an income for you for the rest of your life - no matter how long you live. The exception is if you have a final salary (defined benefit) pension scheme, in which case you'll automatically receive money from your pension when you retire.
Regulations no longer require you to buy your pension annuity by your 75th birthday, however, this will still depend on scheme rules or the contract terms of your pension scheme. If the funds remain invested in a pension fund after your 75th birthday there could be a tax charge, if you were to die or take a lump sum due to serious ill health, before you choose to secure a pension annuity.
With Profit or Unit Linked Annuities
A with-profits or unit linked pension annuity guarantees to pay a regular income usually for life linked to the investment performance of an Insurers With-Profits Fund or selected unit linked fund. With Profits and Unit Linked Annuities lets you choose your starting income from within a set range and includes a Secure Level - an amount they will guarantee to pay you which has the potential to increase but can never go down.
Any annuity purchased will depend on a number of influencing factors such as age, health status, frequency of payments, spouses or dependants pension needs and inflation protection. Product providers often change their terms therefore it is essential that you shop around and use the ‘open market option’ facility to ensure you get the best deal for you.
Open Market Option (OMO)
With most pensions you automatically have what's called an 'open-market option' (OMO). This means you don't have to take the pension offered to you by your pension provider, but have the right to take your built-up fund to another provider to get a higher annuity rate.
Using the OMO is usually a good idea. However, some providers offer a guaranteed annuity rate on pension funds built up with them – this could be a far higher rate than any currently available, so check your position before you take your fund to a new provider.
With income drawdown, you take an income direct from your pension fund while leaving it invested.
Income drawdown gives you considerable flexibility over how much income to take. In a standard ‘capped’ drawdown scheme you can choose to take no income at all, or up to 120% of the limit set for your age by the Government Actuary's Department (GAD). This extra 20% amounts to a fifth more pension income. You can choose at any time to stop drawdown and buy an annuity instead.
If you die during income drawdown, your heirs can inherit the remaining fund. The remaining fund can be paid to them as annuities, or as income from the fund, both of which are taxed. Alternatively, it can be taken as a cash sum less 55% tax.
From April 2011, the government has relaxed the rules on pension withdrawals for those who are eligible to enter Flexible drawdown. Rather than capping your pension income in line with GAD limits, Flexible drawdown allows you make any withdrawals you like. To be eligible for this type of drawdown, you must meet the newly established Minimum Income Requirement (MIR).
To meet the MIR, you must already be in receipt of pension income of at least £20,000 a year (the minimum income), from other registered pension schemes (such as employer final salary schemes, lifetime annuities) and/or state pension. Payments from your drawdown scheme don’t count towards this.
The risks of income drawdown
Going into income drawdown and staying invested beyond 75 carries serious risks. Though there may be short-term rises in annuity rates, on the whole they have fallen heavily over recent years and could drop further in the future. This could mean that you will have to buy at a lower rate if you eventually buy an annuity. You also miss out on the income you could have gained in the meantime.
Remember that annuities are based on a cross-subsidy, where people with poor life expectancy subsidise those who live longer than expected. If you retire at 60 but buy an annuity in your early 70s, you miss out on the cross-subsidy from all those who've died in the meantime.
There is a risk your pension fund's value could fall faster than expected. This is partly because of the inevitable capital risk associated with investments, and partly because as you take an income from your fund, the remainder has to work that much harder.
There is also the impact of charges to consider. Once you've bought an annuity, you don't have to worry about charges anymore. With income drawdown, you have investment management charges for your investments, administration charges for your drawdown plan, and also the cost of periodic reviews to work out how much income you can take.
Because of what's at stake, income drawdown is only suitable if you have a larger pension fund, and preferably some other income.
You might choose to keep your money invested and take out an 'income drawdown' plan, until you're ready to buy your annuity. This involves drawing an income direct from your pension, and is generally for people with larger funds or other sources of retirement income that may be willing to take a higher degree of risk with their money. It also enables people with certain types of pension plans to put off buying an annuity and to take income direct from their pension fund.