The best of all worlds for your pension?
A revolution starts in 2015 and new, one-year annuities will allow retirees to bridge the gap. Chiara Cavaglieri asks if it's the right option
Saturday 26 April 2014
Only a month after radical reforms were unveiled in the biggest shake-up of British pensions for a generation, one-year versions of fixed-term annuities have hit the market for the first time ever. The stop-gap products will enable retirees to take an income and tax-free cash now, while still being able to rethink their options when the new pension rules come into force next year. But are they worth while?
By far the most dramatic news revealed by Chancellor George Osborne in the Budget was that, with effect from April 2015, savers over 55 will have unlimited access to their pension pots. First LV= and now Just Retirement have been quick to react by offering the first- ever fixed-term annuities that last for just one year.
Stephen Lowe of Just Retirement says: "We are in a time of transition when the retirement income landscape is facing a massive upheaval. We shouldn't forget that many tens of thousands of people will want to retire and most will need to switch on a regular income. Fixed-term annuities are one way of making the transition into retirement while waiting for the dust to settle."
Under the current pension system, retirees typically exchange their entire pension savings for a lifetime annuity that pays out a guaranteed income every year for the rest of their life. This removes all the risk in that they know exactly what they will get year, in, year out. But with annuity rates halving in 15 years, pensioners have been getting a raw deal.
Instead of locking into a fixed income for life, the Just Retirement and LV= products last for 12 months and give you a guaranteed sum back at maturity. You use that sum to invest in a different retirement income product such as a lifetime annuity, income drawdown or even another fixed-term annuity.
Both providers have previously sold fixed-term annuities lasting for three and five years, but the new one-year plan has a clear purpose as an interim measure for retirees who want to wait for the new rules to kick in. With such major changes on the way, a short-term solution could work well if you need a reliable income now, or if you want to bridge the gap between semi and full retirement, without committing to a lifetime annuity or exposing your pension to investment risk.
Kusal Ariyawansa of the adviser Appleton Gerrard says: "As opposed to being locked into a low annuity rate for life when in good health, [people] might chose to work for a few extra years in the hope of securing a better income later, as you tend to get more the older you are. In the meantime, if they can access the tax-free cash to pay down debts, or, enjoy a once-in-a-lifetime event, all the better".
However, drawdown rules can make this more complicated, not least because if you don't take the 25 per cent tax-free lump sum to which you are entitled at the start of the contract, you lose it. Comprehensive financial planning and advice is crucial - the costs of which may be prohibitive on a product that lasts for only one year.
Another drawback is that the timescale leaves no opportunity for a return on your investment, so you may be better off leaving your pension as it is until next April. If you will be getting a lifetime annuity in a year's time anyway, there is also a risk that annuity rates will be even less attractive by then. David Gibson of the adviser Gibson Financial Planning warns: "By the time a client signs up ... and the funds get transferred to the new provider and benefits commence, it could be six weeks - and by then you've only about 10 months until the new rules come into play."
Some people have predicted that the pension revolution will sound the death knell for annuities, but Mr Gibson expects that over the next year or two, new and more flexible products will come on to the market.
In the meantime, parking your pension in an income drawdown plan is another option. Here, you can take a quarter of your pension tax-free, leave the rest invested in the stock market and take an income from investments such as dividend-paying shares, equity income funds, bond funds and property funds.
However, you must be comfortable putting your savings at risk. The big danger is that you run down your pension too early or the stock market performs badly. Lifetime annuities still make a lot of sense if you're cautious and can't stomach any losses, although it's a big move to lock all of your pension money away now if you can take as much as you want, subject to income tax, next year.
If you have a number of small pension pots, some important adjustments have already come into play making it much easier to release money from your pension. If you are over 60 and have less than £30,000 in total, or three individual pots of up to £10,000, you can take the whole lot as cash. The first 25 per cent is tax-free. Previously, you had to have less than £18,000 in total and you could only take up to two small pots worth no more than £2,000 each.
Alternatively, you may actually want to top up your pension if you don't need the money now. Pensions are much more attractive without the restrictions on access: you get tax relief on your contributions and, once you're 55, you only pay income tax on three quarters of your pension money - with no limits as to how and when you take it. If you are reviewing your retirement plans, compare what income an annuity will give you with the growth you need each year in your pension fund to maintain your standard of living.
New rules in place now
As of 27 March, over-60s can cash in their entire pension if it is worth £30,000 or less, and up to three individual pots worth £10,000 or less. The first 25 per cent is tax-free.
The minimum income requirement for flexible drawdown has fallen from £20,000 to just £12,000, giving many more pensioners access to unlimited withdrawals within a drawdown plan.
Big changes next year
From April 2015, you will have unlimited access to your pension from the age of 55. You can take a quarter of this as tax-free cash and the remainder is taxed as income at a rate of 20, 40 or 45 per cent.
There is no longer any requirement to buy an annuity.
The Government is providing £20m over the next two years to fund 15 minutes of free "at retirement" advice.
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