Inflexible annuities behind drawdown popularity: Skandia
The poll of more than 600 financial advisers carried out by Skandia revealed the most common reason people choose income drawdown is because they do not want to give all their money to a life company via an annuity, according to 33 per cent of intermediaries.
The second and third most common reasons people opt for income drawdown both relate to income with 27 per cent of advisers saying the desire to take zero income was the primary driver and a further 24 per cent of advisers saying clients want the flexibility to change their income level during retirement.
About 16 per cent of advisers polled said the desire to retain control of their investment strategy was the most common reason people choose income drawdown.
The survey also suggested people in income drawdown were not wholly dependent on it to fund their retirement.
Advisers reported many clients having retirement income from additional sources including from other investments such as Isas, bonds and savings (49 per cent), annuities (20 per cent), final salary schemes (17 per cent) and buy-to-let property (14 per cent).
Less than 10 per cent of people are using income drawdown for all of their retirement income.
The majority of advisers (69 per cent) also said in general their clients had made no change to the level of income they were taking in response to the economic conditions of the last year, with 26 per cent reporting generally their clients were taking a lower level of income and 5 per cent reporting they were generally taking a higher level of income.
Peter Jordan, head of proposition marketing at Skandia, said: “Some people do not like the risk that their hard-earned pension savings will go to a pension provider if they die soon after buying an annuity.
“Others simply want control over their investment strategy and how they take income and for those people, income drawdown may be an appropriate alternative to an annuity because it provides greater flexibility to enable them to plan for the best outcome.
“Of course there are risks associated with income drawdown/pension drawdown and it is important people understand these. The outcome of income drawdown fundamentally depends on the performance of the underlying investments, as well as the level of income taken from the fund, so the investment strategy and level of income taken should be reviewed regularly to ensure it continues to deliver against expectations.
“However, there are also risks associated with annuities in that people might be locked into a low level of income if they are purchased at the wrong time and they will lose a significant amount of capital if they die soon after taking out the annuity.
“As with any financial product, investors need to assess the risks and suitability of both products before making a decision and the need for advice will be high.”
SIPP Retirement Options
When benefits are taken from a SIPP, a check of the fund value against the Lifetime Allowance will be triggered which is called a Benefit Crystallisation Event (BCE).
Benefits can be taken as follows:
25% of the fund may be taken as a tax free lump sum.
The balance of the fund (75%) may be taken as a pension, known as Income Drawdown SIPP . Pension can be taken between a maximum limit, 120% of GAD and a minimum limit which is nil. This means that a member could take their tax free lump sum and not take any pension.
The GAD factor is found using the Government Actuary’s Department tables and is based on the member’s age and the current Gilt yield.
Pensions will be reviewed at least every five years and with effect from 06/04/2007 can be reviewed annually if requested by the member. We are able to reset the five year period, provided the review is on an anniversary of the benefits being taken.
Benefits can currently be taken from age 50, however with effect from 6th April 2010 the retirement age under registered pension schemes increases to age 55.
The member must have taken all of their tax free cash before their 75th Birthday.
From Age 75
At age 75, the member has the option of purchasing an annuity or continuing to take benefits from the fund by entering into Alternatively Secured Pension (ASP).
ASP is based on a maximum pension of 90% of GAD (for a 75 year old irrespective of member’s age) and a minimum pension of 55% of GAD per annum.
ASP Pensions are reviewed annually and are based on the GAD factors for a 75 year old and gender even if the member is over 75 years of age.
Scheme Pension
A scheme pension is a pension paid to a scheme member by a registered pension scheme.
A scheme pension is a secured pension, and is now allowable under all registered pension schemes provided their rules allow it. We offer scheme pension using our Flexible Income Pension Plan (FIPP).
A scheme pension can be taken after the offer and refusal of an annuity and is available before the age of 75.
There are no maximum pension limits or any HMRC restrictions on the rate of pension escalation. There are anti-avoidance provisions, designed to prevent a scheme pension being pitched at an unsustainably high level initially.
A reduction in pension to less than 80% of the original pension paid to a member in the first 12 months, gives rise to an automatic unauthorised payments charge of 40%.
Dependants’ Benefits
Dependants’ benefits can be paid as:
o An annuity
o An unsecured pension, if the dependent is under the age of 75
o An alternatively secured pension, if the dependent is over 75 years of age
o A scheme pension – as long as the option of the annuity has been offered and declined
Retirement options Post 75
Retirement Options post 75
At age 75, the member has the option of purchasing an annuity or continuing to take benefits from the fund by entering into Alternatively Secured Pension (ASP).
ASP is based on a maximum pension of 90% of GAD (for a 75 year old irrespective of member’s age) and a minimum pension of 55% of GAD per annum.
These are calculated as follows:
Maximum ASP:
Fund Value x GAD Factor x 0.9
1000
Minimum ASP:
Fund Value x GAD Factor x 0.55
1000
ASP Pensions are reviewed annually and are based on the GAD factors for a 75 year old and gender even if the member is over 75 years of age.
Retirement options Pre 75
When benefits are taken from a SIPP, a check of the fund value against the Lifetime Allowance will be triggered which is called a Benefit Crystallisation Event (BCE ).
Benefits can be taken as follows:
25% of the fund may be taken as a tax free lump sum.
The balance of the fund (75%) may be taken as a pension, known as Income Drawdown. Pension can be taken between a maximum limit, 120% of GAD and a minimum limit which is nil. This means that a member could take their tax free lump sum and not take any pension.
The GAD factor is found using the Government Actuary’s Department tables and is based on the member’s age and the yield announced by them.
Pensions will be reviewed at least every five years and with effect from 06/04/2007 can be reviewed annually if requested by the member. We are able to reset the five year period, provided the review is on an anniversary of the benefits being taken.
Benefits can currently be taken from age 50, however with effect from 6th April 2010 the retirement age under registered pension schemes increases to age 55.
The member must have taken all of their tax free cash before their 75th Birthday.
At age 75, the member has the option of purchasing an annuity or continuing to take benefits from the fund by entering into Alternatively Secured Pension (ASP).
ASP is based on a maximum pension of 90% of GAD (for a 75 year old irrespective of member’s age) and a minimum pension of 55% of GAD per annum.
ASP Pensions are reviewed annually and are based on the GAD factors for a 75 year old and gender even if the member is over 75 years of age.
Get advice from a local IFA call 0800 043 0725
A better deal on income drawdown
By Mike Morrison | 00:01:00 | 27 November 2009
Clients who took income drawdown as the markets crashed are not necessarily locked in to the reduced income for five years, writes Mike Morrison of AXA Wealth, illustrating his point with a fictional case study.
Financial adviser David is visiting his father Victor to discuss retirement planning, in particular income drawdown – otherwise known as unsecured pensions (USPs).
Victor is in his early 60s and was made redundant nearly a year ago. He has two pensions: a money purchase scheme that he transferred into a personal pension some years ago, and a defined benefit (DB) scheme that is due to start paying out when he reaches 65.
Unfortunately, Victor and his wife have few other liquid assets and there is little chance of him getting a new job.
The drawdown route
David had advised his father to use his personal pension scheme to provide an income using income drawdown until at least age 65 when his DB scheme would start payment.
But circumstances conspired against Victor and by the time he completed all the necessary paperwork, his USP income was calculated just as the stock market hit a low for the year and when Government Actuary Department (GAD) rates were also low. So the income he could draw was severely restricted.
Although he has adjusted his spending, Victor feels constrained in his social life and is keen to increase his income even by a few pounds a week.
Bad timing
After a fish and chip lunch with his parents, David is sitting in the front room with the papers for his father’s pension. ‘We’ve been on a roller coaster ride in the last year or so, dad,’ he starts. ‘And I think we hit the worst point for a drawdown contract.
‘Markets were down, so the fund value for calculation was depressed. At the same time, gilts were low, which was reflected in GAD rates being low. This meant the amount of income you could draw each year was also depressed.
‘To put it in context, the FTSE index hit a six-year low and the gilt rates for GAD dropped to their lowest since drawdown began in 1995.’
Locked in or not?
‘Is there anything I can do to change this as I could do with a bit more income?’ says Victor. ‘I seem to remember that having started to draw an income, I am locked in to it for five years – is that right, son?’
‘Yes, sort of,’ says David. ‘Pensions simplification in 2006 changed the review process for income drawdown from triennial reviews to quinquennial reviews.’
Victor looks a little perplexed.
‘Sorry, dad, I mean three-year to five-year reviews.’
An opportunity to review
‘This is the norm, although if the scheme administrator will allow it, it’s possible to do an annual income review. This means on the anniversary of your plan we can rework the figures using the then-current fund value and up-to-date GAD rates and revise your income accordingly.’
‘Well, what’s happened in the last year? Has it got any better for me?’ asks Victor.
‘When we started the plan, the underlying gilt yield was about 3.25% and now it is about 3.75%, so not much change there,’ David replies. ‘However, when it comes to the fund value, the picture looks better.’
Capturing growth
‘As you know,’ David continues, ’I have always believed that an income drawdown needs some equity exposure for it to work. Do you remember those questions we went through to try to get some understanding of your attitude to risk?’
His father nods affirmatively.
‘Over the year we have reallocated a good proportion of your fund into equity-based investments,’ David continues. ‘In doing so, we have been able to capture some of the recent market growth.
‘When we started, the FTSE 100 index was just coming off its low level of 3,600 and for the last couple of months it has been around 5,000, so your fund has seen some benefit from this and has gone up a decent amount.’
Increasing the income
‘I’ve done some rough calculations based on today’s figures – although these may need revising a little bit nearer the date – and we should be able to increase your income by a good few hundred pounds a year. Enough, I think, for you to resume your position as a “regular” at the local hostelry,’ says David with a smile.
Victor chickles. ‘I am assuming my drawdown plan is with a company that will allow annual reviews?’
‘Of course,’ replies David. ‘I have always been of the view that five years is too long to lock in to a particular level of income, particularly in these tricky financial times, so I always like to build in some flexibility and this time it has been very useful.’
‘Thanks, son,’ says Victor. ‘I would have paid for that advice.’
‘If we weren’t related, I would have charged you,’ David replies with a grin.
Mike Morrison is head of pensions development at AXA Wealth.
For advice on income and pension drawdown call retirement solutions 0800 043 0725
Aviva adds funds to investment bond and pension range
Aviva is to add a number of funds to its investment bond and pensions portfolio from the end of November.
The firm is to add 31 funds to its investment bond portfolio while 28 funds will be added to its income drawdown, company and personal pensions range.
David Barral, marketing director at Aviva, said: “Aviva continually reviews the range of funds available through our portfolio bond and pensions range to make sure they have the quality, performance and choice to meet the needs of advisers and their clients to help them invest and save for their future.
“These additional funds strengthen our coverage of externally-rated funds and give advisers and their clients the opportunity to build an investment portfolio from a wider choice of sectors ranging from cautious and balanced managed to absolute return and specialist.”
Mr Barral said the addition of the funds would broaden the range of funds available to advisers and investors, helping them to tailor portfolios to individual needs.
For income drawdown advice call 0800 043 0725
Investing in commercial property with your Pension
A Sipp can be used to hold a wide range of investments from shares, gilts, unit trusts, investment trusts, insurance company funds and commercial property (but not private property). A SIPP can be used for income drawdown.
This is particularly useful for owners of small businesses, who can buy premises through their pension funds. There are attractive tax advantages in using the fund to buy commercial property. The rental income is received tax-free by the fund and when the property is sold, which must be before the pension is drawn. There is no capital gains tax.
Someone with their own business might decide to use the property assets – such as offices, factories, agricultural land and warehouses – as part of a retirement nest egg. In this case, they would pay rent directly into their own pension fund rather than to a third party – usually an insurance company.
For specialist advice on income drawdown or annuity rates call 0800 043 0725
Unsecured Pension
If you have not yet reached your 75th birthday you may take an Unsecured Pension (USP). As the name suggests, the income you get is not secured (or guaranteed) as it would be with an annuity. This is because you are not committing a fixed amount of your pension fund to an insurance company in exchange for an annual income for life.
You can decide, within limits set by the Inland Revenue, how much you take from your SIPP every year. You may increase your income, decrease it, stop taking it altogether or choose to purchase an annuity at any time. You may choose to take the whole or part of your fund into drawdown. Leaving some segments “unvested” changes the taxation of any benefits should you die or purchase an annuity before age 75.
Your income is calculated using the Government Actuary Department (GAD) set standard annuity rates based on your age, and investment gilt yields at the time you take your benefits – these are used as an equivalent to the annuity rates the insurance company would use. an annual income is calculated, based on the amount of fund vested to provide benefits, and you may choose to take between 0% and 120% of this amount every year as a pension.
The annual income level is set for the next 5 years. You may choose to review it more often, but you don’t have to.
Advantages of Unsecured Pension:
- No need to set a level of income now – you have flexibility to increase or decrease as your personal circumstances change.
- You can use some of your fund to provide an income and leave the rest invested in a tax free environment. This is especially useful if you are going to move into retirement gradually and don’t need a full pension yet.
- You retain control over the SIPP investments.
- You have control over when or if you purchase an annuity, not being forced to purchase when rates are low.
- More choice in how death benefits can be paid, including under some circumstances a lump sum taxed at 35% or even tax-free if some segments remain unvested.
Disadvantages of Unsecured Pension:
- You retain the whole of the investment risk, if your investments do badly it could affect your income.
- As you stay in your SIPP you will continue to pay the SIPP charges, in addition to charges for administering the drawdown and the reviews.
- You don’t have the security of a guaranteed income.
- Annuity rates may worsen in future.
- The higher the level of pension you take from your fund, the better the rest of the fund must perform to ensure your pension benefits are not eroded away in the future.
- You have to have a formal review of the pension every 5 years and this may mean that your benefits could reduce.
SIPP Options
The SIPP options are available under the Pru Flexible Retirement Plan and can be accessed through both the personal pension and income drawdown plans. It offers the following benefits for you and your clients:
- Full SIPP option
An extensive range of investment options with the ability to invest directly into commercial property, stocks, shares, unit trusts, OEICs and the Cofunds fund range. - FundSIPP option
Lower cost option for clients who only want access to funds from the Cofunds range (subject to investing in a maximum of 20 funds)
Depending on which of our two SIPP options you select, we offer the following client benefits:
- Access to an extensive range of investment options including commercial property
- Access to an extensive range of investment funds via the Cofunds fund supermarket, including special terms with a number of well-known fund managers.
- Low-cost execution only share dealing service through Stocktrade
- Ability to appoint an investment manager or stockbroker
- Immediate basic rate tax relief on contributions
- Outstanding SIPP administration provided by Suffolk Life including detailed annual reporting of SIPP assets and transactions
- Possibility to pay adviser fees from within the SIPP (with client approval)
- Protected Rights funds can be used to increase a client’s borrowing power for commercial property purchase. Clients can borrow an amount up to 50% of the net value of their FRP, including Protected Rights. Please note we cannot currently accept Protected Rights funds into our SIPP
- The SIPP options can be switched on or off at any time – we just adjust the fees accordingly
Kevin Stelfox, Retirement Solutions
Income Drawdown – A Case Study
John Bellamy is a wealthy client who has sources of income other than his pension. His wife Susan is significantly younger than him and he wants to ensure he maximises benefits to her.
John decides to transfer an old company pension with a value of £560,000 and 3 personal pensions totalling £140,000 into a FIPP (Flexible Income Pension Plan).
He does not need to take any benefits before age 75. At age 75, he decides to take his full tax free cash entitlement and move into ASP so that he can keep control of his fund.
When John is 79, he dies. Susan at this time receives a dependents pension from John’s FIPP. As she is only 52, and in good health when John dies, she decides to take a small income via Income Drawdown.
When Susan reaches 75 she wants to increase her income so that she can pass some money on to her children, reducing IHT on her death. Susan discusses her wishes with her Financial Adviser and is recommended to switch to Scheme Pension in order to maximise her income. After setting this up, Susan uses the ‘Gift out of Income’ rules to give money regularly to her children.
At age 84, Susan is diagnosed with a terminal illness and new actuarial calculations therefore allow her to increase her Scheme Pension income still further. Again, utilising the ‘Gift out of Income rules’ she uses her spare income to set up pension funds for each of her grandchildren, gaining further tax benefit.
She passes away aged 86 with very little left in her pension fund. A combined tax charge of 82% is applied and the remaining 18% is passed to her children.
Pension Drawdown or Unsecured Pension
This involves you taking up to 25 per cent of your fund as tax free cash, and leaving the remainder of your pension fund invested. In the meantime, you can take income as and when you need it from the fund, subject to certain Inland Revenue limits, but you are not obliged to take income each year. If you want, you can choose to take no income at all for as long as you like until age 75 when you are obliged to either buy an annuity or transfer the fund to an Alternatively Secured Pension or ASP.
The minimum income you can take from an unsecured pension is zero and the maximum is roughly 120 per cent of what a single, level annuity would pay someone of your age. Unsecured pensions replaced “income drawdown” when the new rules for pension simplification came into force on 6 April 2006.
The advantages of taking an unsecured pension
Taking an unsecured pension has a number of advantages including:
- income flexibility – each year the amount of income taken can be varied between the minimum and maximum limits. Income can also be taken monthly, quarterly, half yearly or annually.
- control over your investments – if the unsecured pension is set up through a self invested personal pension or Sipp, there is a wide range of investment options available.
- choice of death benefits – unlike annuities where the only death benefits available are from a joint life, guaranteed, or money back annuity, drawdown offers a choice of death benefits.
The disadvantages
When you buy an annuity, you give up control of your pension fund in return for a secure income. With an unsecured pension, you maintain control of the pension fund but your income will not be secure, so it is a much more risky option than buying an annuity.
There are a number of risks involved when you defer an annuity purchase by investing in an income drawdown plan. Understanding and knowing how to manage these risks is very important.
- Investment risk – the value of your investments can go down as well as up.
- Mortality drag – if you defer purchasing an annuity, you will miss out on the mortality cross subsidy. The extra return required to compensate for the absence of this subsidy is called mortality drag.
- Decrease in your annuity purchasing power – If annuity rates fall and the value of your pension fund does not increase sufficiently to compensate, an annuity purchased in later years will provide less income compared to purchasing an annuity now.
Income Limits
The amount of income that can be paid from an Unsecured Pension fund is determined by reference to tables produced by the Government Actuary’s Department (GAD). The maximum income in any one year is roughly equal to 120 per cent of what a level, single life annuity would pay someone of your age, while there is no minimum income requirement. This means that you can choose to take no income each year if you so wish.
To ensure that the income limits from drawdown are in line with annuities, the limits are calculated by reference to current gilt yields. GAD produces a set of special tables based on a range of interest rates.
Income Flexibility
Income can be varied each year so long as it is kept within the GAD limits. Income withdrawals can be paid monthly, quarterly, half yearly or annually and can be in advance or arrears.
Five-yearly reviews
There is a compulsory review of unsecured pension arrangements every five years to ensure that the pension fund can sustain future income payments. At the review, the minimum and maximum income limits are set for the next five years.
Pension Drawdown – Death Benefits
For many people, the more flexible death benefits are the most attractive feature of drawdown. Conversely, the most negative part of an annuity is the absence of any lump death benefit (unless you have purchased a joint life, guaranteed or money back annuity). On the death of the policyholder before age 75 there are three options:
- Take a lump sum death benefit – a surviving spouse or dependant may take the remaining pension fund as a capital sum, less a 35 per cent tax charge. The lump sum payment will be free of IHT, providing the correct trust has been set up.
- Continued taking unsecured pension – a surviving spouse or dependant may continue taking income withdrawals.
- Annuity purchase – a single life annuity can be purchased for the spouse or dependant.
Quick Guide to Income Drawdown
With income drawdown, unlike a traditional pension annuity, the pension fund is not used to purchase a guaranteed income. Instead the pension fund is reinvested in a range of assets and a variable income is taken from this fund.
The level of income that can be taken from income drawdown plans is limited by the Government Actuary Department (GAD). Income drawn from the fund must be within the maximum and minimum limits set by the GAD. Income drawdown is a short to medium term alternative to buying an annuity.
Once a person reaches the age of 75 it is compulsory for them to take out an annuity policy.
As the value of the pension fund can go down as well as up income drawdown is considered to be more risky than traditional annuities. There is a further risk in that in the future annuity rates may be lower and so by not purchasing annuity rates now there is a possibility of losing out.
To find out if Income Drawdown is suitable for you visit IncomeDrawdown.org.uk or call 0800 043 0725