As the retirement market continues to innovate there are an increasing number of products designed to give investors real fl exibility. Neil Marsh highlights how Hornbuckle Mitchell's FIPP can help clients.
Lifetime annuities dominate the retirement income market to the point that many of those reaching retirement falsely believe they have little alternative but to opt for this most unpopular of products. The truth is that the choice available to retirees who have built up pension savings outside final salary schemes has probably never been so wide. Financial advisers specialising in retirement income solutions are in a golden period with a market set for strong growth for years to come.
While clients may be disgruntled by perceived lack of choice, the main issue for advisers is probably how best to navigate through the established options while still keeping abreast of the new ones coming onto the market.
Retirement ain't what it used to be
The closure of fi nal salary schemes is pushing people into taking responsibility for their own pension provision. People are also facing more years in retirement than ever before. The market is set for many more years of change as clients look for ways to tailor their income solution to their own individual circumstances. Their goal may be to squeeze out extra income, to avoid inheritance taxes, to keep control of their funds for longer, or to ensure they leave as little in their fund as possible on their deaths.
Hornbuckle Mitchell has created a new product to fi t perfectly with the changing aspirations of the modern retiree. The Flexible Income Pension Plan (FIPP) is designed to 'do what it says on the tin' by offering the full range of retirement income options in one cost-effective wrapper administered by a highly regarded specialist in the self-directed pension market. The options include unsecured pension (USP), alternatively secured pension (ASP), scheme pension or to fund annuity purchase.
As the client's needs change, so they can seamlessly switch from one solution to another more suited to the new phase of retirement.
Uniquely, the plan includes the opportunity for any individual to switch into drawing their income through scheme pension, a longestablished option for small self administered schemes (SSAS). This is discussed later in more detail along with the intriguing possibilities this route makes available to clients and their advisers. The vast majority of people with money purchase pension arrangements have the choice of retiring from age 50 (rising to age 55 from 2010) with the next major age 'obstacle' not arriving until age 75. In reality, 'retirement' is more likely to occur from the late 50s to the mid 60s because, since A-Day it is possible to have taken pension benefi ts - perhaps in the form of some tax-free cash - while still continuing to work and pay into a pension.
Many of these will be fit and healthy and keen to enjoy a decade or more of active retirement before moving into a more passive stage. Healthy lives annuity rates for 60-65 year olds have fallen sharply in recent years and many retirees, especially those with larger pension pots, perceive them as poor value, instead preferring to keep their money invested for growth, drawing down income through USP arrangements. Income drawdown is also likely to appeal to the growing number who have built up pension assets through self invested personal pensions and who already have experience of controlling their investments.
Using the Hornbuckle Mitchell FIPP for income drawdown gives access to the full range of investments allowed under current rules including quoted and unquoted shares, bonds, managed funds, commercial property. There is also the option of 'phased' income drawdown which gives some flexibility over the income taken while in USP. All or part of the tax-free cash entitlement can be taken without having to take income. Income itself is limited to 120% of Government Actuary's Department (GAD) rates on equivalent annuities.A retiree can at any time switch from USP into a lifetime annuity or into scheme pension. The move into a lifetime annuity is irreversible, so USP can be useful way of timing the move to suit the client's circumstances.
In the real world we expect many clients to start considering the move away from USP as they approach age 75 when USP must cease. There has been a lot of excitement about alternatively secured pension (ASP) because its introduction ended the requirement for compulsory annuitisation, but in many cases scheme pension may be a better option.
Annuity purchase even at age 75 remains unpopular with those who do not need the guaranteed income or who feel the returns offer poor value. This could include people in poor health, those with much younger spouses, or those who have successfully invested in incomeproducing assets such as commercial property and do not want to be forced to sell at an arbitrary age.
While many pension providers - even those offering SIPPs - do not offer ASP as an option, clients can access it through the Hornbuckle Mitchell FIPP. Like USP, ASP allows holders to keep control of their investments and to defer annuity purchase while potentially leaving some of the fund to heirs. But the income limits are less generous - between 55% and 90% of the equivalent annuity. This could mean an immediate income drop compared to USP and the GAD figures are not adjusted upwards over time. Effectively a 75 year old in ASP always remains that age when determining income available. Once in ASP, a client can later move into scheme pension or buy an annuity.
ASP had the potential to be a huge success because in its original form it allowed pension wealth to be cascaded down the generations. After its creation came a rapid U-turn with the decision by the Government to tax at a penal rate of up to 82% any money left in the fund on the death of the holder, unless it is gifted to charity. This should not detract from ASP being considered a useful option for many people, despite the Government's shameful attempt to impose restrictions on its use based on religion.
This brings us on to scheme pension which has existed as an option for many years but has only recently become available for individuals through innovators such as Hornbuckle Mitchell. Its strength is that the income that can be taken is based on the individual's own circumstances rather than on an external factor such as equivalent annuity rates or GAD fi gures. An actuary calculates the income based on the client's age, mortality expectation, fund size and performance, potentially allowing a far greater income than would be available from an annuity or ASP.
The table shows the extra income potential of using scheme pension compared to ASP, using a notional £500,000 pension fund and assuming 7.5% annual growth. The annual income for a male aged 75 in good health (expected to survive a further 14.9 years) could be £53,224 under scheme pension compared to £45,900 from ASP. If in very poor health (just over eight years' life expectancy) the scheme pension income rises to £80,528 while the income from ASP remains at £45,900.
By age 85, the same size fund could deliver annual income of £92,441 to a male in good health (6.7 years' life expectancy) or £133,808 if in poor health (4.3 years' life expectancy). The ASP income on the same £500,000 fund is still pegged at £45,900 as for the 75-year-old.
These large differences in income available come down to the simple fact that ASP rules specifi cally aim to prevent people from running their fund down to zero, while scheme pension income can be tailored to ensure the fund is as close to zero as possible when the client dies. If poor health does strikes, the actuary can review the scheme pension income to refl ect the new life expectancy. The higher income available from scheme pension can be used, under 'gifts out of income' rules, as an effective way to minimise future inheritance tax.
Following the pre-Budget report of October 2007, the penal 82% tax rate on unused pension assets on death for ASP will also apply to scheme pension, but the point is that scheme pension is about depleting the fund as much as possible leaving the bare minimum subject to tax.
Scheme pension can also include a guaranteed payment term of 10 years so that payments to a spouse or anyone else of the client's choosing can continue after the holder's death. This doesn't guarantee the value of the income - that will depend on the fund size and fund performance during the 10 years. Unlike an annuity, the administrator is not trying to make a profi t on the fund but rather works for the client to ensure the maximum possible is paid out.
The Hornbuckle Mitchell FIPP is designed to be a 21st Century product aimed at meeting the needs of the modern consumer looking above all for choice, investment flexibility and value for money.
Neil Marsh is managing director of Hornbuckle Mitchell
For more information about how the Hornbuckle Mitchell FIPP can help your clients go to www.hornbuckle.co.uk or 0845 345 2555 and ask for the technical team.
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