90 Seconds on the pension changes, by Rosie Murray-West
UNTIL recently, purchasing an annuity was the default option for those who needed to make an income from their pension pot on retirement. These annuities, which are essentially insurance products, provided an annual income for life in return for pensioners’ hard-won savings.
However, the annuity rates that pensioners receive have tumbled in recent years, meaning that many people have been reluctant to swap their pension savings for what seems to be a paltry sum.
Annuity rates are linked both to the life expectancy of the retiree and to interest rates as a whole. With interest rates at record lows and life expectancy rising all the time, the annuity has become an unpopular product for many. Research from experts at PricewaterhouseCoopers suggested that 75% of people don’t want to buy an annuity any more. Thanks to Chancellor George Osborne’s decision, many won’t have to.
Landmark changes in the 2014 Budget mean that those approaching retirement will be able to take their pension in cash instead. They can leave it invested until they need it, without the punitive tax regime that made annuity purchase all but compulsory for most retirees.
Withdrawing your pension in cash, in its entirety, used to mean that you would be charged a tax rate of 55% – making a serious dent in your retirement income. From April 2015, those choosing to do this will only be charged their marginal rate of income tax, which could be as low as 0% or as high as 45%, depending on other income.
Essentially, under the changed pension system, from the age of 55 anyone with a defined-contribution pension pot will be able to take it in any way they want, subject to their marginal rate of income tax in that year. As with the current system, retirees will be able to withdraw a quarter of their pension as a tax-free lump sum.
These changes have caused shockwaves across the pension industry, with shares in life insurance companies – which sell annuity products- tumbling on the news. Many experts, such as Ros Altmann, who is now the government’s champion for older workers, welcomed the changes. “Forcing people to buy annuities should have stopped long ago,” she said. “These new freedoms should make pensions more popular, ensure more people save for retirement and encourage them to seek expert financial advice to help them decide what is best for them.”
However, the changes leave retirees with more decisions to make than ever. Should they stick to their plans to buy an annuity, or should they consider taking their pension as cash? And, for those who are due to retire before April 2015, what should they do until the new rules come in?
Is an annuity still for me?
Despite their current unpopularity, it is worth pointing out that annuities are not always the wrong product for retirees. A recent report from the International Longevity Centre (ILC) found that many of these lifetime income products offer “fair value for money”. New research for the ILC from the Open University’s Centre for Public Finance found that rates had fallen due to people living longer and low interest rates, but that most people – particularly women – received good value from their lifetime income.
The report also warned that many people were discounting the products because of a perception that they are poor value, even though they protect against pensioners running out of money because they live for longer than they expect. Jonquil Lowe, lecturer in Personal Finance at the Open University, who carried out the study, said: This much maligned financial product should ideally still play a key role in most people’s retirement planning and in the free, impartial guidance for every retiree promised as part of the government’s pension liberalisation package.”
However, the report showed a wide gap between the best value annuities and the worst, with men in particular losing out if they do not shop around for the best rates. Those in poor health, as well as smokers and those who are overweight, can get better value from impaired life annuities, so should make sure that they do not just take an ordinary default product.
For some people, particularly those with small pots of money, an annuity may not be the right product. However, it is important to have a plan to ensure that your pension will last throughout your lifetime if you do not buy an annuity with it. Your decision will depend on many factors, including your health, your pension pot, and your attitude to risk.
In July 2014, the government announced changes to the tax rules surrounding annuities, leaving scope for providers to provide more flexible products. Experts believe that this could result in more personalised annuities, or guaranteed income products, that may be better suited to new ways of retiring and may make annuities more popular. The new rules mean that you could vary the amount of income you take from your annuity at different stages of your life, perhaps taking less when you start to receive the state pension, or more later in life to pay for care. You will also be able to take a lump sum from an annuity.
Ms Altmann said that she expects these changes to lead to more personalised annuities, as well as many people buying them later in life. “Age 60 or 65 may be too young to buy annuities, but waiting till later allows time for the annuity to reflect future health or market circumstances,” she said.
Other changes you should know about
There are a slew of other changes that you should take into account when deciding whether an annuity is still for you. From 2028, the government has announced that you will be able to take your pension from the age of 57, rather than 55 which is currently the case. You should bear this in mind when planning for retirement. The government has also announced various changes to taxes applied on the death of the pension holder – the 55% so-called death tax on funds held in a pension will be gone as of April 2015 although different rules look likely to apply for withdrawals and lump sums depending on whether the fund holder was older or younger than 75 years at death. Once you start drawing your pension, you will only be able to put £10,000 a year into it, to prevent those who are still earning as using it as a way to recycle their earnings tax free.
Making retirement decisions now
When deciding what to do with your pension pot, it is worth making sure that you completely understand the scope of the changes. The government has promised that everyone will receive free guidance on what to do with their pensions. However, this guidance will not be available until April 2015, when the bulk of the pension changes come in. Those who are approaching retirement now must make their own decisions, while some fear that, even when the new advice is available, it will not be sufficiently in depth for many pensioners.
Philip Smith, the pensions director at consultancy PricewaterhouseCoopers, said that recent news that the guidance would be delivered online as well as face-to-face “makes sense for efficiency”. However, he added that “whether online channels can be as probing, impactful and ultimately effective is up for debate.” Those who require more in-depth help may be better off seeking advice from a financial adviser who specialises in pensions, or from a wealth manager.