A GUIDE TO YOUR RETIREMENT OPTIONS Traditionally, there used to be only one option when it came to investing the money you had saved for retirement. You had to use your entire pension fund - less any used to provide tax-free cash - to buy a conventional lifetime pension annuity. Over recent years, as a result of changes in legislation, more modern and flexible alternatives have appeared - alternatives that allow you to take control over your future. You now have a number of different options and this guide explains them in some detail to ensure that you understand and are content with the advantages and disadvantages of these. It may transpire that, due to your personal circumstances and/or the size of your pension fund, some of the options may not be available or are obviously unsuitable.
What Are Your Options ?
Buying a Conventional Lifetime Annuity/Secured Pension. Buying an Asset Backed Annuity Buying a Fixed Term Annuity Phased Retirement buying Annuities. Income Withdrawals / Unsecured Pension. Phased Income Withdrawals / Unsecured Pension. Combining a Conventional, Asset Backed and / or Fixed Term Annuity with Income Drawdown
In conjunction with your adviser, by considering each of these options in turn, together, we should be able to identify the most suitable choice for you and ensure that your retirement income will be tailored to meet your needs over the coming years.
Buying a Conventional Lifetime Annuity / Secured Pension Historically, the most common way to take retirement benefits under Pension Plans is to take the maximum tax-free cash sum available and use all of the balance of the Fund to buy a conventional lifetime Annuity. A lifetime Annuity is a level or increasing income for the rest of your life and is taxed in the same way as salary. This Annuity gives you payments at stated intervals until your death. You give your Pension Fund either to the Pension Provider with which you have built up your Funds or to another on the open market to purchase as large an income as possible for the rest of your life. There are a number of types of conventional annuity which include guaranteed and impaired life Annuities. The cheapest Annuity you can buy, i.e. one that will give you the highest starting income in return for your Pension Fund, is one that pays a level income for the rest of your life. However, when you die no further income is payable even if you die after receiving only a few income payments. At a cost you can add extra benefits to your Annuity at the outset and these can include a guaranteed period of, say, five years, which will ensure income payments continue for the fixed period after you buy the Annuity, even if you die before then. You are able to purchase an escalating Annuity which will mean that your income increases in payment and may keep pace with increase in retail prices. Where married, it is usually decided to build into the Annuity a spouse‟s Pension that will continue to be paid in the event of the Annuitant‟s death. Typically, the Pension could be reduced by half or a third if the Annuitant predeceases his/her spouse. Guaranteed Annuities simply purchase an income based on the Annuitant‟s age, normal life expectancy and the level of Gilt and fixed interest yields from which Annuity rates are based. These guaranteed Annuities can be improved upon for „impaired lives‟, which are subject to medical evidence, and this is an area where there could be an improvement in the basic Annuity rate.
Finally, there are “Guaranteed Annuity Rates” that are written into many old Retirement Annuity and Personal Pension Plans that provide potentially higher Annuity rates than current terms. Annuity rate levels affect the amount of pension that can be bought. Your pension fund will buy a larger pension if annuity rates are high than if they are low. Annuity rates have fallen along with interest rates and Gilt Yields over the last few years and this has resulted in a reduction of the purchasing power of annuity contracts. There is a long term trend in annuity rates which shows them falling over the last twenty years.
Advantages of a Conventional lifetime Annuity
You have immediate access to all of your tax-free cash. You can choose between a level or increasing income for life, which cannot fall with the rest of your fund. This means you have no exposure to investment risk. The income is guaranteed to be payable for at least the rest of your life. Your Pension income can be guaranteed for a certain period so that your income will continue to be paid for balance of the fixed period after your death. Depending on how long you live, you may get back more than you used to buy the Annuity in the first place. They are relatively simple plans and usually do not involve ongoing planning.
Disadvantages of a Conventional lifetime Annuity
Annuity rates may not be favourable when you buy your Annuity. The pension you receive is dependent upon annuity rates at the time of purchase - which are currently low in historical terms. (it is of course not possible to determine in advance whether this is a good time to buy an annuity or not as only history will show us the answer to this question). The level of income is fixed at outset, even though your future income requirements may change. These may involve changes in your personal circumstances, such as widowhood, a change in your marital relationship, any improvement in annuity rates that may be generated by fading health, or any inheritances you may receive. Your pension cannot be altered in value (except for any contractually agreed increases in payment) to take account of fluctuations in supplementary sources of income or to take account of the effect of inflation. Once entered into this style of annuity gives no further options – it is an irrevocable decision. You cannot access any of the value invested to reinvest in any other form of pension product. This option may represent poor value for money should you die early and do not opt for value protection. Options selected at outset which are a cost may not be used in practice, e.g. if you choose a spouse‟s or partner‟s Pension option and your spouse/partner predeceases you, then the cost of this benefit has been wasted.
Buying An Asset Backed Annuity Asset backed annuities are Investment-linked Annuities that invest in Unit-Linked investment Funds or With Profit Funds and the levels of income received are linked to how well the investments perform - with good investment conditions they may produce an increasing level of income. Asset backed annuities are like a conventional annuities in many respects. You will need to make some decisions that are irreversible such as whether you wish to include a spouseâ€&#x;s pension. But the income that you receive each year will also be influenced by investment returns as they are passed on by the pension provider. Hence they involve some investment risk which means that your income could be less than would be provided via a conventional annuity. Nevertheless, potentially there may be sufficient investment reward to produce an income that is higher than a conventional annuity. In order to establish the starting level of income it is necessary to make an assumption as to what the investment returns achieved are likely to be (the bonus rate declared by the With Profit fund and the growth rate achieved by the Unit Linked funds) Depending on the assumption made, the initial amount of income received from a with-profits or unit-linked annuity may consequently be lower than that from a conventional annuity. The greater the level of assumed return achieved, the higher the starting level of income. The higher the level of assumed return, the greater the risk that income may fall in the future. There is usually some form of worst case scenario income level built in as well that means that your income cannot fall indefinitely; but this is sometimes around the 50% mark; way below what the conventional annuity income that you could have secured. For some people they will see risk and only risk. Probably the conventional, no risk annuity, will be more appropriate. For others they can see the reward potential. Trying to rationalise the amount of reward required to start to make this option viable is not straight forward. An annual growth rate is required year by year just to match the pension income that a conventional level annuity would provide. On average a return of around 5% p.a. is required to match the conventional annuity. If returns are consistently below this the income will be below that produced by a conventional annuity. If the returns are consistently above this then income will be above that produced by a conventional annuity. Asset backed annuities are a genuine option for some clients but that does not mean they are right for everyone. Ultimately, only time will tell whether an asset backed annuitant is a winner (better than conventional annuity income) or a loser (worse). What we can be certain of though, is that if you want no investment risk once you have turned your pension fund into pension benefits then this is not right for you since there is a risk that the income level selected may fall. Furthermore, the amount of income received is likely to fluctuate (this may involve an increase or a decrease compared with the income received in the previous year).
Advantages of an Asset Backed Annuity
You have immediate access to all of your tax-free cash. You can choose between a level or an increasing income for life with the rest of your fund. Your Pension income can be guaranteed for a certain period so that your income will continue to be paid for balance of the fixed period after your death (subject to the risks outlined above). Depending on how long you live, you may get back more than you used to buy the Annuity in the first place. In some circumstances you may vary your level of income and convert to a conventional lifetime annuity.
Disadvantages of an Asset Back Annuity
Investment returns may not be favourable during the period you hold your annuity meaning that your income levels achieved may be lower than that provided by a conventional annuity. Your income will fluctuate on occasions from year to year since the income payable in any one year is dependent on the rate of investment return achieved and the initial assumptions made. It is possible that you may not get back the amount of money you use to buy the Annuity if you die early. Options selected at outset which are a cost may not be used in practice, e.g. if you choose a spouse‟s or partner‟s Pension option and your spouse/partner predeceases you, then the cost of this benefit has been wasted. They are more complex plans and usually require some ongoing advice with regard to any changes that you may require
Buying a Fixed Term Annuity Since the introduction of Pensions Simplification in 2006 it is now possible to purchase a new style of annuity – one that provides a guaranteed level of income for the term of the annuity (which is typically either until age 75 or for a fixed term of 3 years or more). This approach enables people retiring to enjoy the same amount of certainty with regard to their income as they would enjoy in a conventional annuity, but this time for the term selected, rather than throughout life. At the end of the term a guaranteed maturity value is provided from which a further fixed term annuity can be purchased (up to the age of 72 which is the latest age to establish such a plan), a conventional annuity, or any of the other forms of retirement income plan covered in this document and allowable at this point by the pension legislation in force. The Fixed term annuity thus provides considerable flexibility by offering the ability to change the amount and shape of income on a regular basis throughout retirement. The simplest approach is to establish the plan to age 75. The amount of income received from the point of retirement until age 75 is likely to be comparable to that of a conventional life time annuity but the income will cease at age 75. At this point, the guaranteed maturity value will be available for you to reinvest in another type of annuity (Fixed term annuities are not available beyond age 75 currently). The amount of the guaranteed maturity value is free of any investment risk and is known at the point of commencing the fixed term annuity. It is set at the level that aims to provide you with a comparable level of income for the rest of your life, beyond age 75, provided that underlying annuity rates do not change. As such it provides both certainty of income in your prime time retirement years until age 75 and the flexibility to control how you provide yourself with a future income during your senior retirement years beyond age 75. If you are in good health at present there may be a benefit in seeking to delay the purchase of a conventional lifetime annuity until age 75 in order to seek to capture the benefits of fading health. You are more likely to contract a medical condition that results in your health fading (whether this be to a very limited or significant extent) between age 65 and age 75 than in the years leading up to this point. If you experience declining health you may well then be able to secure an enhanced annuity rate through an underwritten annuity (also known as an impaired life annuity). Such annuities can provide an increase in annuity income of more than 70%. Nevertheless please bear in mind that the availability of such an annuity is dependent on your health at the time and underlying annuity rates may be higher or lower than at present. This plan also provides an additional death benefit (if selected) known as value protection that ensures you and your family can benefit from the full value of the starting retirement fund since the death benefit payable is the purchase price less the income received. The introduction of Income Drawdown (please further details below) was seen by many as a way of ensuring people maintained control over their retirement fund and the death benefits available. A fixed term annuity is a clear alternative to Income Drawdown. It is not so dependent on investment performance but does not offer as much control and flexibility. For many people it may be an interesting alternative or complementary strategy to that of an Income Drawdown plan. Further flexibility can be provided by establishing the plan for a shorter term (a minimum of 3 years).
Advantages of a Fixed term annuity
Buying a fixed term annuity is straightforward, with minimum paperwork, and you will continue to receive ongoing advice from us at the maturity date of the annuity You receive a fixed income for the duration of the term of the plan, which cannot fall. You have no exposure to investment risk as your payments are guaranteed for the term of the annuity. At the end of the term you can use the guaranteed maturity value available to purchase the amount and shape of income that is appropriate to you at this point, subject to the prescribed limits and depending on the underlying annuity rates available to you. You may be eligible for an enhanced annuity through an impaired life annuity if your health has faded in the period between establishing the fixed term annuity and the maturity date of the plan This style of annuity enables you to reinvest the guaranteed maturity value in any form of allowable pension product (i.e. a conventional annuity, another fixed term annuity – if under aged 72, an asset backed annuity, or an Income Drawdown plan written under unsecured pension or alternatively secured pension rules). As such it provides considerable flexibility. The value protection facility enables you to ensure that you or your spouse and/or dependents receive the full value of the purchase price of the annuity, either through the income payable and guaranteed maturity value or the payment that will be made upon your death during the term (which is the purchase price less the income payments received to date) You can receive all of your tax-free cash lump sum at outset.
Disadvantages:
Your pension options are fixed for the term of the annuity at outset and cannot be altered to take account of changes in personal circumstances, during the term. Your pension cannot be altered in value during the term (except for any contractually agreed increases in payment) to take account of fluctuations in supplementary sources of income or to take account of the effect of inflation. The pension you receive is dependent upon annuity rates at the time of purchase - which are currently low. Whilst the maturity value of the plan is guaranteed the actual amount of income payable from this maturity value in the future is dependent on the prevailing annuity rates available at the time.
Phased Retirement Purchasing Annuities With these, you have a number of pension plans, some of which will be divided into a number of segments or arrangements which will allow you to „phase‟ your retirement. Instead of cashing in your entire Pension Fund to get your tax-free cash and buy one large Annuity at the outset, you only cash in some of the segments or Policies over a number of years. The phased retirement option allows you to make the most tax-efficient use of your pension income. It also allows you to build up the value of your pension when it suits you. Your pension fund is split up into a number of equal segments or established in a way that enables you to withdraw (or crystallise) any amount from £1 upwards. The amount crystallised can be phased in over a number of years until age 75. Every time you phase in some of the pension plan value you can choose to receive a tax-free cash lump sum of up to 25% of the value of these segments, and the remainder of the fund will be used to buy you an annuity. If the transfer payment or part of it, has come from an occupational pension scheme the tax-free cash lump sum may be further restricted due to transfer regulations. The pension bought will be guaranteed to be paid to you for life, and you can choose whether to buy a pension to continue for your spouse when you die, or one that increases in value each year. The remaining uncrystallised value of your pension plan will continue to be invested in a tax-efficient environment, thus providing you with the possibility of a higher future income. This is however entirely dependent on the level of investment returns achieved and future annuity rates.
You can decide when you wish to phase in the value of your pension plan. Each element of phasing will provide the option of another tax-free cash lump sum, and will increase your pension income by the value of the annuity purchased. This will continue until your entire pension fund has been crystallised. If you are still working you may continue to make contributions to your plan to build up future pension income.
Advantages of Phased Retirement
You can draw benefits from your Pensions gradually with just some of the Fund buying an Annuity in the earlier years. As part of the ‘income’ is provided by tax-free cash, the level of income tax paid is minimised. The balance of your Pension Fund continues to be invested in a favourable tax environment. This allows you to take advantage of investment opportunities as they arise with the possibility of a higher future income. The older you become, the better the underlying Annuity rates are likely to be. However, the actual amount of annuity income payable to you will depend upon the rates available at the time and may be higher or lower than the rates currently available. The balance of your Pension Fund can be returned to your beneficiaries free of inheritance tax on your death. You can vary the level of income each year according to your needs and tax position, although once you have bought an Annuity this income will continue for the rest of your life. You can choose to buy a type of Annuity which suits your personal circumstance on each occasion that you crystallise your pension fund. The lump sum death benefits are usually higher with phased retirement than with Annuities or Income Withdrawal/Unsecured Pension (described later). You have the option to continue to contribute to your pension fund (from any earned income).
Disadvantages of Phased Retirement
The whole of the tax-free cash lump sum entitlement cannot be taken at outset but must be phased as part of your income. Future investment returns are unknown and the value of units remaining invested in your remaining Pension Plans will fluctuate over time, and this may not be to your advantage. Annuity rates are not guaranteed and may decrease in future in line with yields on Gilts and changing life expectancy. You will have to buy an Annuity at age 75 regardless of the level of Annuity rates at the time, unless you convert to ASP (Alternatively Secured Pension – see later). The value of your remaining Pension Fund when added to the Annuities you have already bought may not finally give you the same income as an Annuity would have given you at the outset. They are relatively complicated arrangements usually involving annual decisions on what income is required.
Income Withdrawals/Unsecured Pension or Drawdown If you phase your retirement as outlined above, whenever you cash in any of your arrangements, we suggest you use your tax-free lump sum to provide part of the income needed. This could be by investing the capital in a tax wrapper that will provide income and access to the capital to suit your circumstances at this time. You can of course use the tax-free cash for any purpose you may wish. Income withdrawals/Unsecured Pension, however, allows you to take all of your taxfree cash entitlement at the outset with an income drawn directly from the Fund. You can vary the income you take from the Fund between certain limits and how often the payments are made and you do not have to purchase an Annuity until age 75. When the time does eventually come when you do wish to draw an income from the balance of the Fund, the maximum limits will equate to 120% of a Government Actuary‟s Department limit, which roughly equates to a single life Annuity (reviewable every five years) to age 75. There is no requirement to take any income so the annual variation can be between zero and 120%. At age 75 the requirements to buy an Annuity goes (although it may be sensible to do this depending on your circumstances) and an income can continue to be drawn from the Fund (ASP – Alternatively Secured Pension) between 55% and 90% of the equivalent Annuity for a 75 year old. This income level will be reviewed annually but still based on age 75.
Advantages of Income Withdrawals/Unsecured Pension
Immediate access to all of your tax-free cash. Income may be taken from your Pension Fund without buying an Annuity between a maximum and minimum figure each year. These limits equate to the equivalent of what could have been purchased as an ordinary single life Annuity at the maximum end down to nil. Income within these limits can be taken each year, and is reassessed by the Government Actuary’s Department every five years based on the then value of the Fund and the yield on 15 year Gilts. You can plan in advance the level of income you wish to take each year and influence the level of tax you pay on that income. You do not Have to receive a fixed income and are able to vary it to suit your personal circumstances between prescribed limits to supplement other sources of income. Your Pension Fund (less the plan charges and income taken from it) remains fully invested, allowing you to make the most of new investment opportunities and the potential for capital growth in a tax efficient environment. The potential death benefits are generally better than under an Annuity (but usually not as good as phased retirement). Difficult decisions on the type of Annuity you need can be deferred until your personal circumstances are clearer. Your spouse could use the remaining fund for his/her income.
Disadvantages of Income Withdrawals/Unsecured Pension
There is no guarantee that your income will be as high as that provided by an Annuity. Future investment returns are unknown and the value of Funds remaining invested in your plans will fluctuate over time. A combination of poor investment returns and high income withdrawals can reduce the value of your remaining Pension Fund. Withdrawing too much income in the early years may have an adverse effect on preserving the pension purchasing power or preserving the capital value of your fund. The value of the remaining Pension Fund may not be enough to maintain income at the same level to that from an Annuity bought at the outset. You will have to buy an Annuity at the age of 75 regardless of rates at the time and these may be lower than anticipated unless you convert to ASP. Death benefits payable as a lump sum will be subject to tax at 35%. However, the Inland Revenue have advised that in most circumstances no IHT (In heritance Tax) will be payable. Reductions in Government Actuary’s Department rates in future could reduce the maximum income you are allowed to take. In this respect the allowable maximum and minimum income levels are recalculated every five years. The level of income that you get from an Annuity is based on the average life expectancy of someone of your age and health. A Life Company, when fixing an Annuity rate, will take into account that the Funds of those people who die early will remain in a pool to effectively subsidise those who live longer. This is known as ‘mortality gain’. Income withdrawals do not benefit from any subsidy. When you invest in one of these pension plans the income you take is not subsidised by anyone else. If you are not to lose out in comparison to the annuity you could have bought, your plan must earn extra returns to make up for not benefiting from mortality gains.
They are relatively complicated arrangements requiring annual decisions to be made on desired income levels. They are certainly regarded as higher risk than Annuities.
Phased Income Withdrawals / Unsecured Pension It is also possible to combine phased retirement and income drawdown. This option allows you to phase in part of your pension fund to an income drawdown plan, with the option to take some tax-free cash from the crystallised part of the plan and, instead of purchasing an annuity, draw down an income from this invested fund. The pension fund remaining in your phased retirement plan will continue to be invested in a taxefficient environment. This way you are able to combine the best of both worlds. By only phasing in the part of your pension fund you need, and not being restricted to buying a conventional fixed lifetime annuity, you can defer buying all annuities until the age of 75. You can build up your income as and when you want to, with the added flexibility of varying the income between certain limits. With continued investment in a tax-efficient environment and the ability to take a series of tax-free cash lump sums as part of your annual income, this option offers you the maximum flexibility for tax planning purposes.
Advantages of Phased Withdrawal Plans / Unsecured Pension
Retain the option of switching some of your entire Pension Fund into Unsecured Pension at a later stage. This can maximise the potential lump sum death benefits for as long as possible as the lump sum death benefits under Unsecured Pension are subject to tax at 35%. The lump sum death benefits may be significantly higher than those available from an Annuity. Up to 100% of the lump sum death benefits from the uncrystallised Fund still invested in existing arrangements, and not used at the date of death to provide income, will be payable free of IHT. Maximises ability to vary income levels in a tax efficient way. You have the potential to benefit from future investment performance in a taxefficient environment and to exercise control over your investment portfolio. It gives you the flexibility to defer purchasing part of your annuity and to phase gradually into retirement. You can take a lower income in the earlier years and increase it later to suit personal circumstances.
Disadvantages of Phased Income Withdrawal / Unsecured Pension In the case of the monies held in the phased plan, the disadvantages detailed under the „Phased Retirement Purchasing Annuities‟ section above apply. In respect of the Unsecured Pension part of the plan, then the same disadvantages as those listed in the Unsecured Pension section apply.
Combining Conventional, Asset Backed and / or Fixed Term Annuity with Income Drawdown All of the options we have considered in this report may be used either individually or as part of a combined “cocktail solution” whereby you select the combination that you believe is most suitable for your needs. It is important to consider this combination option as part of your retirement strategy.
Other Matters to Consider It is important to understand the importance of investment performance in phased retirement or Unsecured Pension, as there is no guarantee that the Pension Fund investments will outperform inflation or that you will receive as good an income in the future as the Annuity route would provide. Whilst one of the main reasons for selecting phased retirement or Unsecured Pension, instead of buying an Annuity, is often that the balance of the Pension Fund remains invested to benefit from potential capital growth, these plans also provide for income levels to be varied (within limits) to meet changing needs, and provide more generous benefits on early death. It may transpire that the use of deferring the Annuity could improve your personal position both from a taxation point of view and your intended beneficiaries on your death.
Death Benefits on Options
Conventional Annuity – will cease on death or at the end of a guaranteed period or on the death of the last survivor if a spouse’s Pension is included.
Fixed Term Annuity - A fixed term annuity offers all of the death benefits associated with conventional annuities (i.e. a guaranteed period and spouse’s pensions) but two further important benefits. First value protection and second, (for joint life cases) a guaranteed maturity value that your joint life beneficiary may use to decide the future shape of their income. This is much more flexible and provides you with considerably more control than a conventional annuity. Value protection provides you and your family with the certainty that you will benefit from the full value of the starting retirement fund since the death benefit payable is the purchase price less the income received. A fixed term annuity is a clear alternative to Income Drawdown in view of the strong death benefits and control it offers. The death benefits differ to that available from Drawdown which is based on the current fund value (which may be more or less than the death benefit offered through value protection). Since, a fixed term annuity provides you with the flexibility to change the shape and amount of your income at the maturity date (i.e. at age 75 or a pre selected term of 3 years or more) this same decision can be taken by your joint life beneficiary at
the maturity date of the plan if you establish the plan on a joint life basis. Such flexibility is not available through a conventional lifetime annuity. You should however note that the underlying annuity rates that may be available in the future may be higher or lower than they are currently. Whilst the amount of your maturity value available for purchasing a future income is guaranteed, the annuity rate that will be used to turn this into a regular income is not guaranteed and will be dependent on the rates available at the time. To offset against this risk there are the potential benefits of health fade that may be available as covered earlier in this report. 
Unsecured Pension (up to age 75) – the remaining Fund would be paid to your spouse less 35% tax or he/she could continue to keep the fund in place and continue to draw an income up to his/her age 75. Other beneficiaries can be appointed other than dependants.
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