A Guide to Retirement Options. Contents

Transcription

1 A Guide to Retirement Options Contents 2. Quick Guide 5. Lifetime Annuities (Secured Pension) 6. Single Life and Joint Life Annuities 6. Level and Escalating Lifetime Annuities 6. Impaired Life and Enhanced Annuities 6. Protected Rights Annuity 7. Guaranteeing Lifetime Annuity Payments 7. Investment Linked Annuities 7. With-profits Annuities 8. Unit Linked Annuities 8. Retiring Gradually or Later 9. Unsecured Pensions 9. Unsecured Pensions using Short-term Annuities 9. Unsecured Pensions Using Income Withdrawal 9. Alternatively Secured Pension 9. Hybrid Products 10. General Points To Note 1

2 QUICK GUIDE LIFETIME ANNUITY WITH PROFIT UNIT LINKED VARIABLE SCHEME PHASED RETIREMENT UNSECURED ALTERNATIVELY SECURED Regular and secure income For life. An income that has a minimum level in retirement normally, with the potential to have an enhanced income from with profit bonuses An income that is completely linked to the performance of a managed fund. An income supported by the underlying assets that can rise and fall depending upon health and investment performance. Regular income which can be secured by a promise of an income for life, or is supported by the scheme investments only. Part of your fund and part of your tax free cash are used in segments when required to provide income. Tax free cash lump sum paid at outset and fund remains invested. Income can also be elected if required Available at age 75 for people who do not wish to purchase an annuity. A tax free cash sum may be provided at outset and your remaining capital used to purchase an income paid for life A tax free cash sum may be provided at outset. The remaining capital buys an income in two parts. Firstly a minimum level, usually for life, and then an additional income based on the bonuses provided by the underlying with profit fund. A tax free cash sum may be provided at outset. The remaining capital invests in a managed fund or funds, with the income rising and falling on the performance of the funds. A tax free cash sum may be provided at outset. The remaining capital invests in a range of funds which you may select yourself. It is underwritten on a regular basis to determine what income may be received A tax free cash sum may be paid at outset. The income payable depends upon the scheme paying it. Often this will be an income for life backed up by the pension scheme, but it can be an income that is dependent upon the scheme assets set aside for you personally. This is often called earmarking. The balance of the fund not used for income / tax free cash remains invested with a view to providing higher future benefits. The balance of the fund not used for income remains invested with a view to providing higher future benefits. All funds which are not used to purchase an annuity at age 75 will move into ASP. 2

3 LIFETIME ANNUITY Your annuity income is paid at least annually and can increase or remain level in payment. Additional options can be selected at outset such as annual or one off increases, spouse s benefits or guarantees. Buying some of these options will reduce your own income, or the initial income available. Once you have bought your annuity, you usually cannot change your mind or change the benefits. On death there may also be the option of a lump sum if selected at outset, subject to certain tax charges. WITH PROFIT Your annuity income is paid at least annually with a proportion fluctuating depending on the with profit fund performance. Additional options can be selected at outset such as annual or one off increases, spouse s benefits or guarantees. Buying some of these options will reduce your own income, or the initial income available Once you have bought your annuity, you usually cannot change your mind or change the benefits. On death there may also be the option of a lump sum if selected at outset, subject to certain tax charges. UNIT LINKED Your annuity income is paid at least annually and can potentially rise or fall Additional options can be selected at outset such as annual or one off increases, spouse s benefits or guarantees. Buying some of these options will reduce your own income, or the initial income available Once you have bought your annuity, you usually cannot change your mind or change the benefits. On death there may also be the option of a lump sum if selected at outset, subject to certain tax charges. VARIABLE SCHEME Your annuity income is paid at least annually and can potentially rise or fall. Your income is paid at least annually and can increase or remain level in payment. Where the scheme underwrites the income on you personally, you can obtain a potentially higher income. Additional options can be selected at outset such as spouse s benefits or guarantees. Buying some of these options will reduce your own income Additional options can be selected at outset such as annual increases, spouse s benefits or guarantees which reduce your own income. In practice, unlike other annuities, with a variable annuity, it is possible to transfer it to a lifetime annuity should you wish to do so. On death there may also be the option of a lump sum if selected at outset, subject to tax charges. Once you have selected your scheme pension, you often cannot change your mind or change the benefits. For those few who are able to do so, they can change their arrangements to almost any other retirement option subject to age restrictions. No further tax free cash sum will be available. 3

4 PHASED RETIREMENT Your starting annuity is smaller, but is supplemented by a portion of your tax-free cash sum. Each year you decide how much fund to use for annuity purchase and how much tax free cash is used to supplement your income. Because you don t commit all your funds to buy an annuity immediately, you keep your options open until you reach age 75. UNSECURED You can choose the income you want, and when you want it, between nil and 120% of an equivalent single life annuity. If investments do well, you may benefit from higher future income payments, and vice versa. On death, the remaining fund is available to pay benefits to your family or dependants. ALTERNATIVELY SECURED You can choose the income you want and when you want it between 55% and 90% of an equivalent single life annuity. If investments do well, you may benefit from higher future income payments, and vice versa. On death, the remaining fund is available to purchase a pension for your dependants. It could also be paid to a nominated charity if there are no dependants. Otherwise, it is possible in theory for the funds to be paid to your estate, however there is likely to be an effective tax charge of 82% of the remaining value. 4

5 If saving for retirement in a money purchase pension scheme the options are: a personal pension; a stakeholder pension; an employer s defined contribution occupational pension scheme. a group personal pension plan arranged through an employer; an additional voluntary contribution (AVC) scheme. a free-standing additional voluntary contribution (FSAVC)scheme. a section 32 policy used to transfer out of an employer s pension scheme. retirement annuity contracts, sold pre1988, before personal pensions first became available. How retirement options work The options to consider when taking an income from the pension savings are: Lifetime annuities This is the option most people use. A lifetime annuity pays an income for life. They are purchased from life insurance companies or other financial institutions. When calculating their annuity rates they take account of the fact that some people live longer than others. People who live longer than average will take more from their annuity than, for example, someone who dies three or four years after retirement. People who die early subsidise the annuity rates for those who live longer. Insurance companies adjust rates because average life expectancy is rising. Interest rates also affect annuity rates because insurers base annuity rates on the return they get from investments. Once an annuity is purchased the annuity rates offered at that time are locked in. It won t make any difference if rates increase or fall. The amount of income an annuity pays depends on, among other things: the amount in the pension fund; the amount of tax-free lump sum taken (if any); whether the fund has been used to contract out of the additional State Pension (See separate notes below on contracting out.) age, whether male or female, and general health the benefits chosen, such as whether the annuity is for a single life or includes a partner. Usually the starting income from the same size of pension fund is higher for a man than for a woman of the same age. This is because, on average, a woman is likely to live longer than a man of the same age. The older the age when buying an annuity, the higher the income is at the start. This is because, on average, an older person has fewer years left to live than a younger person. Normally there are options of having income paid every month, every three months, every six months or once a year. Please note - the income from a lifetime annuity is taxable. There are different types of Lifetime Annuities, and it is sensible to start thinking about the choices at least four months before retirement. 5

6 Single-life and joint-life lifetime annuities Basic lifetime annuities can be single life or joint life. Unless there is a guarantee, a single-life annuity will only pay out during the owner s lifetime. A joint-life annuity continues to pay an income to a partner after the owner s death. Joint-life annuities are more expensive than single-life annuities because the insurance company will expect to continue paying the annuity for longer. There is usually a choice between a joint-life annuity that pays a partner the same as was being received, or two thirds, or a half of what was being received. There is also usually the option of a joint life annuity that is level or escalating. If not married, it would be worth checking with the provider that a partner will be eligible to receive the income from a joint-life annuity. Level and escalating lifetime annuities A level lifetime annuity has a higher starting income than escalating annuities and pays the same income year after year until death. The buying power of this type of annuity will reduce however as prices rise. An escalating lifetime annuity pays a lower initial annuity but then increases each year. There are two main choices: fixed-rate escalating annuities income is guaranteed to increase at a fixed rate each year, say, by 3%; RPI-linked annuities income is adjusted each year to reflect changes in the Retail Prices Index (RPI), so will rise and fall. Typically, it would take around 12 years for the escalating annuity to catch up with the income that would have been paid by a level annuity. Impaired life and enhanced annuities Some companies offer annuities that pay a higher-than-normal income if there is a health problem that threatens to reduce a normal lifespan. These are called impaired life annuities. Relevant health problems might include, for example, cancer, chronic asthma, diabetes, heart attack, high blood pressure, kidney failure, multiple sclerosis or stroke. It might be possible to get an enhanced annuity because of being overweight or smoking regularly. Some companies offer higher rates to people who have followed certain occupations and to people living in certain parts of the country It is worth shopping around to compare the income from different providers. Protected rights annuity If an individual has contracted out of the additional State pension, known as the State Second Pension (previously called the State Earnings Related Pension Scheme or SERPS), and put The rebates into a personal pension fund, that part of the pension fund must be used to buy a protected rights annuity. The pension provider will advise if protected rights applies, and what this means. 6

7 A protected rights pension: can be taken at the same time as an occupational or personal pension permits up to one quarter of the protected rights fund to be taken as a tax-free lump sum; will have to buy a joint-life annuity paying a 50% spouse s pension if married or with a civil partner; and can be taken as a level or escalating annuity. Guaranteeing lifetime annuity payments If death occurs soon after buying an annuity, it will not have paid out much. There are two options to ensure that the annuity will continue to be paid in these circumstances. 1) Guarantee periods, usually for five or ten years worth of income, even if death occurs within this period. On death, the income may continue to be paid for the rest of the guarantee period. If there are financial dependents, this should not be seen as a substitute for a joint-life annuity. (If choosing a joint-life annuity, a guarantee period may not be useful.) 2) Annuity protection lump-sum death benefit This ensures that on death before the age of 75 a lump sum equivalent to the pension fund used to buy an annuity, minus income received, will be paid to either the estate or beneficiaries. There will be a tax charge and may also be an inheritance tax charge on this payment. This option will reduce the amount of money available from an annuity because of the cost of paying for the protection. Investment-linked annuities Specialist financial advice should be taken if considering an investment annuity. These put the pension fund into investments, such as stocks and shares. The fund could continue to benefit from stockmarket investments after retirement, but there is also the risk that the value of the investments could fall. With an investment-linked annuity the income in retirement is linked to the ups and downs of the stockmarket instead of receiving a pre-set income, as with a lifetime annuity. Investment linked annuities offer the chance of a higher income in future but only by taking extra risk. They may also have high charges. Investment-linked annuities can be either with profits or unit-linked. With-profits annuities The pension fund is invested in an insurance company s with-profits fund. The income is linked directly to the performance of this fund. It is usually made up of a starting income and bonuses. The starting income is set at a low level, but, unless investment conditions are very bad, usually at least this much income will be paid. Some providers may guarantee a minimum level of income. The insurance company usually announces bonus rates once a year. Bonuses can be both reversionary (usually paid each year for the duration of the annuity) and special (paid for a year or so) until the next bonus announcement. The amount of any bonuses depends on many factors, such as: how well investments are doing for example stockmarket performance; business risk the financial strength of the fund; and 7

8 the insurance company s assessment of what it can afford to pay out in bonuses. Bonuses are not guaranteed. Whether or not a bonus is paid depends on the financial strength of the firm. Unit-linked annuities The pension fund is invested in units in investment funds. Income is linked directly to the funds invested in. The more risky the underlying fund selected, the more the retirement income may vary both up and down. Retiring gradually or retiring later Using annuities to retire gradually Phased retirement uses part of the fund to buy an annuity. The rest of the fund remains invested. Later another portion of the fund can be used to buy another annuity. In this way a flexible income can be provided. Each time part of the fund is converted to an annuity, some tax free cash from this portion of the fund can be taken. Converting portions of the fund regularly for example, once a year effectively means the tax-free cash, as well as the annuity could be used to provide an income. Insurance companies often set a minimum fund size for annuity purchases so enough of the fund would need to be converted each time to enable purchase an annuity. Postponing the annuity and retiring later It could be risky to assume that annuity rates will be much higher if postponing buying an annuity. Rates may fall or rise for various reasons. It is not however compulsory to buy an annuity with the pension fund at retirement. Alternatives could be postponing buying an annuity until a later date or not buying an annuity at all, instead drawing an income directly from the pension fund instead. Phased retirement is usually only suitable for fairly large pension funds (after taking any lump sum), or if there is other assets or income to live on. If, for whatever reason, it is decided not to buy a lifetime annuity, the following options are available: an unsecured pension using short term annuities; an unsecured pension using income withdrawal. However, pension income must be secured by the 75th birthday at the latest, as an annuity or as an alternatively secured pension. 8

9 Other Retirement Options Unsecured pension An unsecured pension means that after taking any tax-free cash, the rest of the pension fund remains invested. Unsecured pensions involve extra costs and extra investment risk when compared with buying a lifetime annuity straight away. They are not usually suitable for small pension funds (after taking any lump sum) or if there are no other assets to fall back on. Unsecured pension using short-term annuities With a short-term annuity, part of the pension fund can be used to buy a fixed-term annuity lasting up to five years. In the meantime, the remainder of the fund continues to be invested. At the end of the term of the annuity another short-term annuity can be purchased. Income from a short-term annuity with income withdrawal can also be combined. Unsecured pension using income withdrawal With income withdrawal a taxable income direct from a pension fund can be taken. This is also known as income drawdown or pension fund withdrawal. Income withdrawal is an option with most personal pensions and some occupational money purchase schemes. If in an employer s scheme, in some cases it would be necessary to first transfer pension rights from the employer s scheme to a personal pension to utilise this option. HM Revenue & Customs (HMRC) sets a limit on the maximum amount of income that can be taken from the fund. Arrangement must be reviewed every five years to make sure it is within this limit. There is no minimum amount of income that must be taken. Phased retirement and income withdrawal can be combined It is possible to draw an income from just part of the pension fund on one date, leaving the rest of the fund intact. If using one of the above unsecured pension options it must be decided how to secure an income from the pension funds before age 75. This generally means buying a lifetime annuity. Alternatively secured pension At the 75th birthday another option is to use an alternatively secured pension. This works in a similar way to unsecured pensions but has different limits and rules. Alternatively secured pensions are not suitable for everybody and it is important that professional advice is taken if thinking of taking this option. Inheritance tax and other significant tax charges may apply to any leftover funds on death. Hybrid products Hybrid products pay a regular income and offer guarantees of either investment growth or the amount of pension fund left to buy an annuity later on. They vary in what they are called, the guarantees they offer and the charges they make to cover the cost of the guarantees. Normally, some investment growth potential has to be given up to pay for the guarantees. 9

10 General points to note For all these schemes investors will have to convert most of the money within the pension fund or funds into an income. The investor can decide when to convert the fund without having to stop work to do this. Pension savings cannot be converted before age 50 (going up to 55 by April 2010) and must be converted by the 75th birthday at the latest. Up to a quarter of the fund can be taken in cash, as a tax-free lump sum. The remaining fund has to provide an income, which is taxable. Occupational schemes may have different rules about when a pension can be taken. This should be checked with the scheme administrators. If the total of all an individual s pension funds is less than a minimum amount, (this changes annually) it may be possible to take a cash lump sum instead of an income. The individual must be at least 60 but not yet 75 and would have to convert all pension funds to cash within a 12-month period. Key points 10