Annuites and Income Drawdown

Retirement Income
Good advice is so important to achieve the best out of the savings that you have made over a lifetime.

Annuities
The term ‘annuity’ is not a word familiar to many people. An annuity is a regular income stream paid to an individual from a lump sum investment for a specific period. In the case of retirement annuities, these are arranged with an insurance company, where an income is paid for life and the lump sum is forfeited. The amount paid out depends on how long a person lives.

This is the most common way for people moving into retirement to start to receive their pension income, but it is by no means the only way.

People wishing to retire now have to be offered ‘Open Market Option’ by their pension provider. This is where an independent financial adviser goes to the insurance market to find the best annuity deal for the person retiring, based upon their stated objectives and the current pension legislation.

Before making a decision on the provider, there is a need to decide whether to take the Pension Commencement Lump Sum (PCLS) of up to 25% tax free cash, which will reduce the income by a similar amount, whether a spousal pension will be required, if guarantees are needed, or if escalated rates are a safer option. These should be discussed in full with the adviser.  Protected Rights will be handled differently from other personal pensions.

Protected Rights accrue as a result of deciding to be contracted out of the state additional pension scheme.  In return for ‘contracting out’ the government pay a rebate payment into your personal pension plan.  These benefits are treated differently from normal contributions in that they must provide a 50% spouses pension at retirement and on death, if married / in a civil partnership.  The government intends to remove the ability to ‘contract out’ from April 2012 when you will then simply accrue benefits in the state scheme.

Consider inflation when deciding on the type of Annuity Purchasing Power of level of income of £1000
Annual inflation	5 years	10 years	15years	25years
2.25%	£894	£800	£716	£573
4.00%	£821	£675	£555	£375
6.00%	£747	£558	£417	£233
8.00%	£680	£463	£315	£146
(Source: Prudential - October 2008)

Unsecured Income (previously known as Income Drawdown)
In recent years, a small but growing group of people reaching retirement age prefer not to give up their pension funds for an annuity. For those between age 50 (55 from 6th April 2010) and age 75 the Unsecured Income is available. This allows people to take their  Pension Commencement Lump Sum and vary their income between nothing and 120% of a government rate similar to the annuity rate. They retain their pension fund.

The Unsecured Income is only suitable for people with the right risk profile, as the value of the pension funds may go down as well as up, and charges are higher than an annuity. The pension rules change at age 75, and an Annuity or an Alternatively Secured Pension can be taken. 

The Third Way
This is a recent development in the United Kingdom, where a small number of providers try to match the aspirations of those retiring to keep control of their pension funds for longer, but without the risks associated with the Unsecured Income. These providers now offer an Unsecured Income with a guarantee, either of the income or of the capital investment. However, these guarantees come with a cost which needs to be considered carefully. Alternatively, a temporary annuity can be purchased for a limited period of 3 or 5 years until the age of 75.

 

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