A week has passed since George Osborne’s first budget speech but it would seem as though the dust is settling.
Hardly a day has gone by without new announcements, clarification or further details of a particular policy.
This is certainly true of the pensions, and in particular Annuities, where some pretty fundamental changes have been announced.
We thought we would take a look at what the Chancellor said about Annuities in his budget speech, the possible changes that may be brought in over the next year and how the proposed changes might affect your planning over the months to come.
What has been announced?
The Chancellor confirmed in the budget that the requirement to purchase an annuity at age 75 would be abolished.
The change is planned to be introduced from April 2011 and in the meantime, the age at which an annuity must be purchased has been increased from 75 to 77 with immediate effect. This ensures that those people turning 75 before April 2011 are not disadvantaged.
If you are already in an Income Drawdown contract (also known as Unsecured Pension or USP) and reach 75 on or after 22 June this year, you will be able to continue on the same basis, and not be forced to purchase an Annuity.
However, for those with unvested money in a pension, if you turn 75 during this interim period you will still have to take your tax free lump sum, this decision cannot be delayed, although you will not be forced to purchase an Annuity.
Additionally changes to Inheritance Tax (IHT) charges on pension funds in Income Drawdown were also proposed. The change to the age 75 rule will also apply for the purposes of Inheritance Tax (IHT) charges that specifically apply to pension scheme members over 75.
In the interim period before the total abolition of the age 75 rule in 2011-12 tax year, there will be a 35% charge on lump sum death benefits paid to the scheme if they die on after 22 June 2010 and are aged 75 or over.
Previously there could have been a maximum 82% charge on the value of the fund.
Are these changes to be welcomed?
Assuming that the government delivers on its promise many will certainly welcome the end of the requirement and compulsion to purchase an Annuity. Although it should be noted that there are some who believe that in the end the government will simply just extend the age at which an Annuity has to be purchased to 80 or 85.
The spectre of lower IHT on death is also attractive.
However, despite the obvious headline grabbing nature of these announcements the question needs to be posed will they actually make much practical difference?
The average pension fund in the UK is around £30,000, what are the alternatives for the owner of such a fund to the humble Annuity? Income Drawdown (USP) is deemed to be unsuitable by the FSA and the vast majority of advisers, due to the associated risks of such a plan and potentially high charges. Other than Income Drawdown there are no alternatives to the Annuity, the rate of return from which, plus its guaranteed nature, will probably still be highly attractive to those with an ‘average’ fund.
Therefore, unless we see innovation and new products launched for the average size pension fund, an Annuity will probably still be the only practical option.
For pension funds larger than the average other alternatives to a Lifetime Annuity already exist. For example, Fixed Term Annuities are becoming more and more popular (click here for more information on Fixed Term Annuities) and they certainly have a place in delaying the decision to buy a Lifetime Annuity, possibly because an individual thinks they may qualify for an Enhanced Annuity in the future or they prefer the benefits available on death from a Fixed term Annuity. For funds in excess of £100,000 Income Drawdown (USP) is a possibility if the individual is prepared to accept the inherit investment risk associated with such a contract.
It is these types of plans will probably be best positioned to take advantage of the reduction in IHT payable on death post 75.
Should I delay buying an Annuity?
This really is the $64,000 question; it certainly cannot be answered here in full as each individual’s circumstances are unique to themselves.
The proposed changes, whilst welcome, will leave many in limbo until April 2011, unless of course the new rules are confirmed before then.
Taking advice and speaking to a suitably qualified Independent Financial Adviser is a must now.
When considering how to draw an income from your pension and whether to delay the decision to purchase an Annuity you will now need to consider other factors, in addition to those you would normally think about, for example:
- Whether income is needed now and if you have other sources to tide you over until you make a decision about your pension
- Is your pension fund of a sufficient size to be able to consider other options such as Income Drawdown or a Fixed Term Annuity
- Are you likely to purchase an Annuity anyway? If so the cost of delay, your pension will be paid to you for a few months less if you delay, could be an important factor.
- Are you likely to take advantage of the new post 75 IHT rules? How important are lump sum death benefits to you?
One problem with delaying is a piece of European legislation known as Solvency II due to be introduced in 2012.
Solvency II is designed to reduce the risk that an insurer cannot meet its claims and provide regulators with early warnings if solvency does become deplete. However as a result of the legislation financial institutions who provide Annuities to retain more cash in their reserves and invest the money that they receive to purchase Annuities in a more conservative way. Many in the industry believe it will lead to a reduction in Annuity rates due to the constraints it will place on the companies who offer Annuities.
It is perfectly possible to see a situation where a person wanting to retire delays the purchase of an Annuity until after April 2011 only to find that purchasing an Annuity is still the right thing to do but that rates have dropped in the meantime as firms prepare for Solvency II. To compound the bad news they will also have lost out on a few months worth of income which they would have had if a decision had been made sooner.
Confused? We don’t blame you.
The wrong thing to do is to wait, take no action and make decisions based on headlines and newspaper articles.
Think over what you want, plan a cash flow showing your income and expenditure, think over what you want to happen on your death; it is only once you have done this can you start to think about how you achieve these goals with the pension you have worked so hard to build up.
Of course we can help you with all this planning, from an initial discussion; through to planning a cash flow and helping you make decisions that are right for you. There are options you can take now that will provide you with an immediate income, yet will allow you to benefit from future rule changes.
If you are coming up to retirement you have our sympathy, at no time in the history of UK pensions has the decision how to take an income from your pension been more complex, however call us, we are here to help.