Your role in the pension revolution

10th November 2014

Jonathan Watts-Lay, Director, WEALTH at work comments in The Times on what individuals might want to do after the pension changes come into force in April 2015.

Please see below for our ‘Pension People’ examples.

1)          Individual with Average Pension Pot

James is 65, single and doesn’t have any children. He is retiring in April 2015 with a pension pot of £30,000 and no other assets. He lives in Liverpool, is a smoker and is in poor health. He will be in receipt of his state pension of £5,881.20 p.a. and qualifies for pension credit which will increase his income to £7,714.20 p.a.

Two options James might want to consider for his pension pot are……

Firstly, James could take 25% tax free cash from his pension fund which is £7,500 and leave the remaining £22,500 to access as and when he wants. If he does this he can withdraw c£2,750 each year, running his fund down to zero over about 8 years (if he remains in cash) without paying any tax as it would be within his personal allowance of £10,500 for 2015/16, or take larger lump sums as and when he needs with the possibility of some income tax being payable at 20%.

However if James has health issues such as diabetes he could get an enhanced annuity rate, in this case as a smoker and with type 2 diabetes we estimated around 7%. He can take his 25% tax free cash of £7,500 and receive a secure income for life of around £1,600 per year on the balance of £22,500. This is based on taking a level income to maximise the amount he receives when he first retires. As this keeps James within his personal allowance, the income from his annuity will in effect be tax free. As he can expect to live on average until his early 80’s, he will have received his full pension fund back by the age of 79 (14 years) so this might be a reasonable option.

2)          Couple with Average Pension Pot

Jim (65) and Jennie (62) are retiring in April 2015. They both have pension pots of £30,000 each and will both receive the state pension of £113.10 per week/£5,881 p.a. (2014/15 figures).

Two options Jim and Jennie might want to consider for their pension pots are…

They could choose to withdraw their cash in tranches as outlined in the example above, or use the new rules which allow complete flexibility to cash in the whole funds in one go. They would receive £7,500 as tax free cash and the remaining amount, £22,500 will be added to their annual income and taxed at their marginal rate. If we assume they do this in a year when the state pension is their only other income then they will be liable for c£3,576 in tax, effectively releasing £26,424 from each scheme (£5,881 + £22,500 – £10,500 x 20% (being their marginal tax rate)).

If they want to purchase an annuity either because of ill health or their risk profile; depending on their health they will receive annuity rates of approximately 5-5.5% for level term single life annuities. Once they had taken their £7,500 tax free cash, the annuity would pay around £1,125 p.a.  These incomes are secure and given their individual tax allowances of £10,500 each they will be able to receive their state pension and annuity income free of tax.

3)          Couple with defined benefit pension paying £18,000 p.a. and a defined contribution pot worth £100,000.

Gerry and Mary are both 65 and have two grown up children. Gerry has two pensions; a defined benefit (DB) scheme which will pay him a pension of £18,000 p.a. plus a tax free lump sum of £27,000 and a defined contribution (DC) scheme which has £100,000 in it. He will also receive his state pension of £113.10 per week (£5,881 p.a.) plus a further £67.80 per week (£3,526 pa) as he is married.  In total Gerry will have secure and index linked pensions of nearly £27,500 p.a. They own 100% of their home.

Mary has no pension or NI contribution record of her own, however if anything were to happen to Gerry, she will receive a spouses pension of 50% of his company DB scheme and she will be able to claim some of his state pension.

Gerry and Mary have a number of options to consider and should take financial advice…..

As Gerry wants to make sure Mary is looked after, he could take 25% tax free cash from his DC pension and use the balance of £75,000 to buy a level annuity with a 10 year guarantee and 100% spousal pension which will give them c£3,866 p.a.

Gerry could go into drawdown, either crystallising fully or using a more tax efficient phased approach, drawing any income needed. A benefit of this approach is that if Gerry pre-deceases Mary, she will have the ability to continue to draw a pension directly from the pension fund or purchase an annuity in her own name.

As Gerry and Mary do not need additional income or a capital sum, they could leave his pension invested in a cautious portfolio (a mix of bonds, cash and equities) whilst always having the opportunity to dis-invest or purchase an annuity in the future, for example were he to see his health deteriorate. Although they would lose the annuity income for each year deferred, if Gerry can earn an investment return of around 5% net of charges to match the annuity rate, there is no ‘deferral’ loss. In addition, by not taking anything from his defined contribution pension, his fund will remain exempt from death taxes until he is 75. After 75 it can be managed so that only marginal rates of tax apply to a beneficiary. As Gerry and Mary have a property which could trigger an inheritance tax liability, this is a useful way of mitigating some of that risk.

4)      Couple with defined benefit pension paying £28,000 a year and a defined contribution pot worth £300,000.

John and Helen are in their early 60’s, in good health, and plan to retire in April 2015.  John’s generous defined benefit (DB) scheme will provide a pension of £28,000 a year and a tax free lump sum of £42,000. Helen has a defined contribution (DC) scheme worth £300,000; they both have other savings and investments, and no mortgage.

John and Helen have a number of options to consider and should take financial advice….

If John’s pension income is enough to cater for their day to day needs, Helen could leave her fund untouched and she could leave it invested in appropriate assets which match her risk profile.  At the same time, if she has other assets to draw on such as deposit account or ISAs, she could take an ‘income’ in the form of capital from them without touching her pension which will remain in a tax favourable investment situation.

If Helen would like to secure her own income for life she may want to consider purchasing an annuity. After taking a £75,000 tax free lump sum she could use the remainder of her fund, £225,000 to purchase a single life annuity (John is self-sufficient).  Given she is in good health an annuity is likely to pay around £12,240 p.a. (a rate of 5.4%) and she will have received her initial pot back after 18 years.  However, this offers no flexibility to Helen and cannot be changed to account for any changes in her health or lifestyle in future and although there is talk of new types of annuity coming to the market we haven’t seen any yet.

From April 2015 Helen could decide to access her pension fund in any way she wants. She will be able to access 25% of her fund tax free i.e. £75,000 and the remainder can be taken as lump sums or income, both which are taxed according to her marginal tax rate. If Helen passes away before the age of 75 then her remaining fund can be paid out to any beneficiaries free of tax.  Should she pass away after the age of 75 then her pension fund could be managed in such a way that a beneficiary would only pay marginal rates of tax on receipt of money from the fund. Although John is self -sufficient there seems little need to fully crystallise Helen’s pension pot when she could use phased drawdown to create a more tax efficient income stream.

Jonathan Watts-Lay, Director, WEALTH at work, comments, “What  is hopefully clear from these examples, is that in all cases there are options to consider and it’s up to the customer whether they feel knowledgeable enough to make their own decisions or want to take advice. Which decision to take really is down to each individual’s unique circumstances; everything from their health, to where they live, what other assets they have, and whether they want to leave anything for their children, all need to be considered when planning for retirement.”

Please see The Times for further information.