While annuitisation used to be a one off event today's retirees have a lot more flexibility in how they take their retirement income. Bernard Footitt looks at the options
In the good old days, retiring and buying your annuity was a one time event, but this is no longer the case for many individuals. Pension fund withdrawal was established in the mid-1990s, and is now a mature market, and the pensions simplification era clearly established income withdrawal within the mainstream.
Many individuals now wind their work commitments down over a five, or even ten year period, and so need a facility that allows them to feed in their retirement income in slices. Income drawdown is often the method of choice for these people.
Typically they access their pension commencement lump sum (PCLS), for example, to clear outstanding debts; PCLS is often a substantial amount in cash terms, so they also use it for any income top-up needed to fund their immediate 'slow down' or even fully retired years. This allows them to leave their pension pot invested in, for example, SIPP drawdown or some form of money purchase occupational arrangement.
This is a generic way of phasing their retirement; however, there are some income drawdown arrangements that are marketed as phased drawdown. These allow regular retirement income to be drawn directly from the fund as a mix of PCLS and taxable income. This particular method helps those who reduce their work commitments and subsequent earnings and also wish to get out of, or reduce, their higher rate income tax liability.
The more traditional method of "buying annuities in slices" meant that a pension arrangement needed to be segmented so the individual could divest a specific number of segments to purchase an annuity income. The Finance Act 2001 did introduce new rules allowing new schemes and suitably modified existing schemes to allow part of the individual pension to purchase an annuity leaving the rest invested.
Many people have no choice but to fully retire typically at State retirement age with only the State retirement benefit to live on. However, many now qualify for at least one additional State benefit as a supplement to the basic pension.
On top of this, more and more people have a private pension pot to draw on as well. The majority of these are, however, quite small - ABI figures for pensions annuities purchased by fund size for Q3 2007 show that 89.7% were purchased with a fund of £49,999 or less and 78.7% with a fund of less than £30,000.
As stated earlier, the individuals most likely to buy their annuities in slices are the well off self-employed, company directors, and corporate executives. These groups typically have substantial pension pots backed up with a varied portfolio of income producing assets to fall back on.
The introduction of the unsecured pension option at A-Day meant that individuals wishing to phase in their retirement income over a number of years can do this more easily than before.
However, if they required total or partial security over the income required during this time, then secured pension in the form of a lifetime annuity is still the better option.
- Bernard Footitt is technical support manager (pensions) at Canada Life
Advantages of buying annuities in slices
- Retirement can be phased over a period of years under the individual's control
- The shape and size of retirement income taken can be changed under the individual's control
- If a lifetime annuity is purchased, differing death benefits, guarantee periods and % dependant's benefit (if appropriate) may be chosen
- At 75, a choice of either a lifetime annuity or alternatively secured pension may be chosen for the remaining pension funds (residual PCLS must be taken before the 75th birthday)
- On individual's death before the age of 75, the remaining pension funds can be returned to any beneficiary subject to the appropriate discretionary trust being in place
Disadvantages of buying annuities in slices
- The value of the remaining pension funds may fall as well as rise thereby giving no guarantee on the level of future income taken
- There is no guarantee that future annuity rates will be higher than those available now
- The value of the remaining pension funds added to the retirement income already set up may not achieve the same level of income that could have been secured with the whole fund at outset
- The prospect of future higher retirement income may not compensate the individual for not being able to enjoy a larger secure income at outset
- The individual will only receive the available PCLS benefit from the pension funds crystallised unless unsecured pension (income drawdown) is used to provide the desired amount of income.
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From 6 April 2019