State Pensions and the missing £144,625.81

Pension Insight magazine (http://www.pensions-insight.co.uk ) editor Bob Campion recently wrote that the gradual reduction in maximum state pension benefits could end up costing some people £144,625.81.
He calculated this is the amount you’d need to buy an annuity to replace the lost £6,326.84 a year if the maximum state pension reduced from £13,606.84 to £7,280

The £13,606.84 is the theoretical maximum for someone with full basic state pension (BSP, currently £102.15pw in 2011/12 available to those with more than 30 years NI contributions) and maximum second state pensions (SERPS and S2P). This contrasts with the maximum £7,280 payable if we move to the proposed £140 per week flat rate system. It would affect most higher earners and those who do not qualify for any kind of pension credits or means tested pension top ups. At present almost 1 in 2 pensioners are eligible for top ups of some kind but for those who do not qualify for state assistance over and above the basic state pension the changes to state pension rules looks likely to mean a significant reduction in available benefits over the coming decades, with less effect on those retiring sooner, especially in the next 10 years.

As a point of interest if the new rules all come in when proposed (but it looks likely they will be brought forwards) it will be into the 2080’s before everyone is on the same rate. Until then there will be a mixture of different regimes and people will have multiple pensions (private and state) with different rules and retirement ages applying depending on age and pension structure.

This makes it nigh on impossible to accurately calculate one’s own state pension benefits until the point you reach them. Indeed even the DWP are not really sure what income a pensioner will get until they reach state pension age (65 and rising). As an IFA it makes it financially impractical to charge a client to work this out. The time and cost involved outweigh the benefit!

Contracting out (called SERPS up until April 2002 and S2P afterwards) will soon no longer be available from money purchase schemes, which includes personal pensions and SIPPs – see also http://greenfinancial.blogspot.com/2011/12/contracting-out-serps-s2p-all-that.html

It used to be the case, that as an IFA, I could estimate whether it was ‘worth’ contracting out or not. There were a multitude of individual factors but the biggest was often if aged under or over 45. So the ending of contracting out from money purchase schemes is a welcome simplification but as indicated above the change to the new regime will bring complification [ED: not a real word but should be] well into the 2080s. Again, on the plus side, the new rules should benefit lower earners.

But what is the detriment to higher earners?

The loss of the income as stated at outset in this article is one but there is another. The impact on attaining qualification for the new ‘flexible drawdown’
- download Green Financial guide here:  http://www.iangreen.com/downloads/Flexible.pdf
or view on facebook here:
http://www.facebook.com/media/set/?set=a.279726955386751.88831.136170059742442&type=1&l=b96248bd07

This requires a lifetime pension income provision of at least £20,000. So having state benefits of £13,000+ goes much further towards this than £7,280! If you had the £13,606 to buy a comparable annuity to top up to £20,000 would mean you’d need a personal pension of about £93,000 to buy the annuity. At the lower state pension income you’d need more like £200,000 to top up.

To repeat a fact I tweeted last year, to purchase an annuity (so income for life) on the same terms as the state pension a 65 year old male would need a private pension fund of £310,343.19

So in summary, pension and state pension simplification is of course welcomed by all, especially me as I will be far better placed to assist clients in calculating what there state pension entitlement might be. But the journey to a simple state pension regime is far from defined and will be a long journey whatever direction it takes.
Under current proposals I’ll be aged 109 when all pensioners are on a flat rate pension income!

For those retiring in the next ten years, there is not so much to worry about as the status quo all but applies, with changes to retirement age (upwards, see link to calculator below to work out yours) being the main factor coming slowly in.

But for those retiring 10 years out, especially those who aspire to or consider they will have taxable income at the higher rate of tax it is well worth making sure your pension – and most importantly forecast pension income - is reviewed to ensure it is on track to meet your aims.

If you are a pension or retirement income client of Green Financial or would be interested in becoming one, please do contact us. We’d love to help if possible.

Further Reading and Resources

28 page Green Financial Retirement Planning Guide - http://www.iangreen.com/downloads/Retirement.pdf

Government Money Advice Service - http://www.moneyadviceservice.org.uk/yourmoney/pensions_and_retirement/default.aspx

State Pension Age Calculator -
http://pensions-service.direct.gov.uk/en/state-pension-age-calculator/home.asp

Getting a State Pension Forecast - http://www.direct.gov.uk/en/Pensionsandretirementplanning/StatePension/StatePensionforecast/DG_10014008

Green PEAs – The Green financial Pension Evaluation and Analysis Service for personal pensions -
http://www.iangreen.com/pensionperformance.php

Annuities, are they all bad?

Henry Allingham – Probably not a name you have heard of previously. Henry was a World War One veteran who lived to be 113. He owned an annuity.

Henry purchased his annuity (income for life) in 1962 and it paid out, year after year, until Henry passed away in 2010
– 48 years of income.

Annuities generally get a bad press, mostly based around the fact you lose control of a lump sum and if you die you lose the lot with nothing passing to your family.


They are the perceived bad points and whilst true in part do not tell the whole story.

The perception of losing control of a lump sum is not always true, especially if the annuity is purchased from a pension. Perhaps this is the fault of the pension providers who always give us an annual statement with a lump sum figure, yet we should understand from the day we start paying into a private pension it is only ever (under today’s rules) a quarter of the accrued amount that will be payable as a tax free lump sum. The remainder has to be paid as taxable income.

This blog post is not meant to be pro-annuity – As with all my work I remain neutral, preferring not to let personal perspectives get in the way of doing whatever is best and most suitable for any given client at any given time. The aim of this article is just to point out a few positive aspects of annuities I have found in the course of my work, the first being for those that live longer, and we are told life expectancy is increasing all the time, an annuity can represent fantastic value for money.

Living too long or Running out of money

In many ways an annuity could be likened to buying insurance. One is insuring oneself against ‘living too long’, or to put it another way, running out of money.

When financial planning for clients, aiming to generate and provide income for life, one of the greater challenges I face on their behalf is to balance the risk and reward profile, keeping enough money in reserve to fall back on whilst investing in assets that will outpace inflation, thus retaining standard of living and purchasing power as time goes by.

An index linked annuity can address this, providing a definite source of income, for the remainder of life, increasing in line with inflation.

That said, annuity rates today are much lower than in the last 20 or 30 years or so, their rates being closely allied to interest rates and inflation. At the same time life expectancy has increased. In 1970 a man retiring at 65 could expect to receive a pension for 14 years. Today that is expected to be nearer 24 years of payment.

Without going into the maths and actuarial reasons (but for the more technically minded it is known, rather brutally, as ‘mortality drag’) there is a form of cross subsidy at work with annuities whereby, in simple terms, those that die soon after purchasing an annuity subsidise those that live a long time. The approximate cost of this for someone entering Pension Income Drawdown (see other blog posts for more info on this product) is around 0.5% at age 60 – a small price to pay? It rises to around 1% by age 70. However by age 85 the cost is around 5%. So the decade between age 70 and 80 is sometimes referred to as the ‘Annuity Age’ when it may well be sensible to convert pensions to annuities (but always take individual, professional, fee based advice on this)

Another positive for annuities is the simplicity they bring in financial planning, alongside the certainty. A regular, trackable, easy to understand level of income without any concerns over investment performance or otherwise to sustain that income.

But is there an optimum amount, what with the income being taxable? Arguably if you could keep your annuity income under the higher rate tax threshold and create other income that was non taxable elsewhere it may prove tax advantageous for you, especially if you received higher rate tax relief on the way in (in simple term, under current rules, tax relief of 40% on the way in, and only paying tax at 20% on the way out). Again, another area perhaps to take individual, professional, fee based advice on.

Another reason to not have ‘too much’ (crazy idea I know) in your pension when buying an annuity is a recent development by annuity providers based on demographics. Amazingly the size of the purchase price now goes against the policyholder! They now reason the size of the fund buying the annuity reflects social status, arguing a large purchase price means a wealthy client, and wealthy people live longer than poor ones.

The astute client will ensure their financial adviser knows this and will investigate whether to help them to purchase annuities in tranches to maximise income from various providers rather than use the full fund at once with one annuity company.



There are many factors to consider when purchasing an annuity. My other blog post today consists of my helpsheet on this matter with areas and variables to consider before purchase.

Watch out when doing a ‘DIY’ job on annuity purchase. ‘best buy’ tables in newspapers and online are often manipulated to show best rates (ie for a man of exactly 65) and if you do not fit the exact criteria you’ll find yourself worse off. It is also unusual to find your pension provider is also the best annuity income provider so don’t just buy from them, especially if a bank product. Shop around (see other blog post today).
Consider engaging a financial adviser with specialist annuity research software who can pinpoint the annuity provider who will give you the most money (known as exercising your ‘open market option’) for your unique, personal position. Make sure they charge a fee for this service so you can be sure they are not being swayed by a later commission on an annuity purchase. If you wish the adviser to subsequently help with the annuity purchase transaction and implementation, again look for a fee charging adviser so all your money is at work generating you income, not paying a commission.

In summary, conventional annuities are an excellent way of securing a fixed income for life, with or without things such as inflation linking or benefits for dependents. A series of annuities may work well too, especially for those leaving Income Drawdown pensions as time goes on.
Annuities are certainly not the right answer for all of the people, all of the time,
but they definitely are the right answer for some of the people, some of the time.

Ask yourself, when should you buy an annuity?
Just in case, like Henry Allington, you live to be 113 or older.

Shopping around for lifetime annuities

The Open Market Option
Annuity rates vary from one life company to another, so you should make sure you shop around to get the best deal for you. There are a few things to think about first.

• If you're getting a pension from a personal pension arrangement, your pension provider should send you information between four and six months before you are due to retire, setting out what they will offer you based on the value of your fund. They will also tell you that you can shop around for a higher annuity. About six weeks before you retire your pension provider should give you an estimate of the value of your fund. You can use this to compare products from other providers. This is known as your open market option.



• Don’t assume the same company with which you built up your fund will automatically offer you the best rate. You may do better to shop around and check whether another company could offer you more. The annuity rate you get can affect your income by hundreds of pounds a year for the rest of your life.



• If you're getting a pension from an occupational defined contribution pension scheme, the trustees may buy your annuity for you, but you can also shop around on the open market and find the insurance company with the best annuity rate for you, or your scheme trustees can do this for you if you ask.

It can be difficult or impossible to change your lifetime annuity provider after you've bought your lifetime annuity, so take some time to choose the one that’s right for you.

 

Check what your existing provider offers

Before shopping around, make sure you understand what your existing provider is offering you. Check:

• whether your provider offers a guaranteed annuity rate. This is not the same as a guarantee period. A guaranteed annuity rate means that the provider has to offer a minimum annuity rate for your pension fund. Now that annuity rates are a lot lower than in the past, a guaranteed annuity rate can be very valuable and could give a higher retirement income than can currently be bought on the open market;

• whether your provider will charge your fund if you buy your annuity from another company.

Your existing provider will usually give you a quote for a specific type of annuity. Make sure you get a quote for the type of annuity you want, not just the one the provider offers you.

How long have you got?

Annuity quotes are usually valid for between 7 and 28 days.

If you change your mind – you may have the right to withdraw or cancel. If so, the provider will tell you and also tell you how quickly you must act.

Shopping around for your annuity

1. Get an estimate of the value of your pension fund, taking account of any charges, from your provider.

2. Decide whether you want to take a tax-free lump sum, and if so, how much (usually up to a quarter of your fund). If you decide to take a tax-free lump sum, deduct it from the pension fund value your pension provider gives you.

3. Decide whether you want:

o a single or joint-life annuity. If joint life, whether the pension paid to your partner is paid in full or reduced (say by a third) – or

o a level or escalating annuity

4. Think about whether you want your annuity to continue to be paid for a specific number of years (5 or 10), should you die shortly after you buy it.

5. Does your fund need to be a certain size to qualify for the better rates offered by another company? Some firms may not be interested in providing an annuity for small sums.

6. Are you a smoker? If you are, you may get a better rate from some annuity providers.

7. Do you have a medical condition that could reduce your life expectancy? If you do, you may get a better rate from some annuity providers. Some providers of impaired life annuities will also accept pension funds of less than £5,000.

You should now have the facts you need to get quotes from a range of providers.


Or we can do it for you – contact us to discuss our fees for this service