Retirement Planning

Guaranteed Annuities

Despite a long-term trend of reducing annuity rates, these are still by far the most popular method of deriving retirement income, as they do so without risk. Developments in the annuity market include offering investment linked annuities, be they with profits or equity linked, and impaired life annuities, which provide higher incomes to those who medically cannot expect a normal life expectancy due to their health. This similarly applies to smokers, who can also receive higher than normal income levels.

The key benefit of annuities is the guaranteed income stream and lack of investment risk. The downside, however, is that, unless relatively expensive death benefits are purchased at outset, the initial investment capital is lost upon death. Death provision can be provided for by building in a minimum number of payments, known as a ‘guaranteed period’ and additionally a widow’s/widower’s pension. This would mean that an income would continue to be paid for the duration of the annuitants’ lifetimes at the same level although, usually upon the first to die, this would be at a reduced level, typically at 50% or 2/3rds the initial pension. It must be noted, however, that provision of this benefit will reduce the level of pension that would otherwise be available at outset.

A further downside is that income for the duration is calculated based upon the age of the annuitant(s) at inception and their expected mortality. Therefore, relatively young retirees would be securing income at a relatively low level.

Investment & With Profit Linked Annuities

These are a hybrid of a guaranteed annuity and the investment linked income options.  In regards to investment linked annuities, the initial income level is based upon your expectation of return. If the actual return each year is above the benchmark set, the income level may rise. Equally if it is lower, then of course the income may reduce.

In regards to With Profits, because of the lower risk and inherent guarantees, a clear upside would be that the income fluctuations would be less volatile. Conversely, due to the reduced level of equity participation of such funds, which reduce volatility, the level of prospective increases will be restricted.

A downside of such plans is that you may not change provider once the plan is purchased. Thus if the provider performs poorly, you will essentially have to ‘grin and bear it’.

Be it guaranteed or investment linked, a disadvantage of an annuity is that generally you may not change the structure of the annuity once purchased. For example, if at outset a widow’s/widower’s pension were purchased and in due course the spouse were to predecease the annuitant, the provision made would be no longer needed and effectively become redundant. As stated above, at outset the income level is reduced to accommodate such a benefit.

One take on this type of plan is where a temporary annuity is provided, thus ensuring a guaranteed income for a period of 5 years. The remainder of the fund is then invested for that period. Providing a certain rate of return is achieved the original investment may be returned. At the 5th anniversary, the annuity may be repurchased based upon an age 5 years older and based upon a structure appropriate for the next 5 years. In the above example, should the annuitant be predeceased by their spouse, the next time round, no such benefit need be bought.

Capital Protected Annuities

Following the introduction of the new pension regulations, post 6th April 2006, capital protected annuities were introduced providing the option of money back on death. This will equate to the purchase price of annuity less pension instalments paid out, less 35% tax, although the protection ceases at age 75.

These may appeal where there is a desire for lump sum death benefits, although such benefits will be at the expense of a reduced available initial income.

Phased Retirement / Unsecured Pension (USP – formerly known as Income Drawdown)

Whilst very different products, essentially both are investment linked income plans.

Phased retirement plans provide an income stream at outset formed partly out of annuity purchase and partly of tax-free lump sum benefits.

These plans are suitable for clients where a tax free cash lump sum is not necessary or desired at the outset of retirement.

Unsecured Pension (USP) differs in that full tax-free cash may be taken at the outset. From the fund that continues to be invested, clients may increase or decrease their income stream between 0% and 120% of agreed parameters known as Government Actuary Department (GAD) limits. The limits are reviewed every 5 years or earlier if requested.

Via USP, monies may remain invested until age 75 without the enforced purchase of an annuity. Beyond this age, if clients still do not wish to purchase an annuity, then they may explore the option of Alternatively Secured Pension (ASP).

Please note that whilst USP provides the benefit of retaining the fund, upon death, if paid as a lump sum, this would be passed on less a 35% tax charge. The full value of the remaining fund may, however, be utilised to provide a continuing pension income to a widow / widower or dependant, either directly via USP or by way of annuity purchase.

Alternatively Secured Pension (ASP)

USP is not available after age 75 but the ability to avoid purchasing an annuity at that point is offered by Alternatively Secured Pension (ASP).  This is similar to USP whereby the fund remains invested.  However, since ‘A Day’, further legislative changes have occurred, resulting in the imposition of penal tax charges for this type of arrangement thus, as a consequence, it is unlikely to be attractive to a majority of clients.