Middle Britain’s retirement plans
Flexibility around pensions and retirement income will require regular review and robust and accurate planning tools, says Nigel Chambers, managing director CTC Software
Now that we have had time to get used to the revolutionary changes introduced in this year’s budget, and received some much needed clarification, we can set out more clearly the way in which middle Britain is most likely to plan for retirement income.
More than ever before we can explain to people that what they need to do during their working lifetime is to build up the largest possible pot of money to live off in retirement. There are many ways in which this can be done but saving within a government approved pensions tax wrapper remains the most efficient because tax relief is granted on all contributions paid in, but tax is only levied on 75% of the monies paid out.
Leaving money in pensions
For the future, we believe that the guidance should first suggest that money is best left invested in a pension plan until it actually needs to be spent. Drawing money from the pension plan at the earliest opportunity and putting it in a building society until it is needed is unlikely to be the best option both because historically investment returns from building societies are lower than other investments and, as importantly, interest on such savings and building societies can be taxed. The new rules allow a person to take money from their pension pot whenever they want (be that once a month, once a year or just as it needs to be spent on a holiday or a new car for example). Each time money is taken 25% can be paid tax free and the rest will be taxed along with any other income. This is what the government now term taking an Uncrystallised Fund Pension Lump Sum” (UFPLS). Money can be drawn in such a way throughout a person’s lifetime but crucially any balance that is remaining on death can be paid as a lump sum (with George Osborne’s ending of the 55% tax on defined contribution pension pots meaning beneficiaries will only have to pay their marginal rate of tax on the inherited pension).
Of course, the problem with taking money whenever you need it is that it may run out before death and anyone following this route will need to regularly review how much they are drawing and how much is left. Increasingly planning tools will be able to build in statistics on a person’s expectation of life and present these to help in future planning (see below).
Annuities v drawdown
The best method of guaranteeing that money will not run out is to purchase an annuity and because increasingly annuities are underwritten so that, for example, smokers or those in poor health can get a larger regular payment to reflect the fact they may not live so long this will remain attractive to many. However, if an annuity is purchased it will almost always be sensible to draw the 25% of the total pot that can be taken tax free at the time the annuity is set up.
One of the main advantages of the new rules is that buying an annuity is no longer a one-off decision that needs to be made at the point of retirement. A person could start by drawing money using the UFPLS rules outlined above and then buy an annuity later, perhaps when better rates are available (because of ill health or changes in market conditions). Some people will also be attracted by the idea of a blended approach where some of the money is committed to an annuity and some remains to be taken when needed.
Where a person has a need for some of the money as an immediate tax free lump sum – and it makes sense looking at current and future tax positions – up to 25% of the remaining pension pot can be taken at any time tax free and the balance either used to purchase an annuity, or if some flexibility is still required, it can be transferred into a Flexi Access Drawdown Fund. This operates in exactly the same way as for UFPLS’s but because the tax free cash sum has already been drawn all the income taken (which can again be regularly or on an ad hoc basis) will be taxable as income.
A final alternative for those who wish to draw tax free cash immediately, want some guarantees but do not want to commit to a lifetime annuity purchase, is for the drawdown fund to be used to purchase a short term annuity (one for up to 5 years) where at the end of that time the capital will still be available and all the different choices described above will become available anew.
‘In retirement’ options
So what about those who are already retired? Regrettably for those who have already purchased annuities no change is possible. However, for those who have already set up drawdown facilities, the majority of these currently operate as what is termed “Capped Drawdown”, this puts a maximum limit each year on the amount that can be drawn. Some, more wealthy people, will already have flexible drawdown accounts which operate in exactly the same way as the new Flexi Access Drawdown Funds. Those with Capped Drawdown funds can transfer them to the new Flexi Access arrangements from April 2015. Indeed, most people with such accounts should follow this more flexible route, the only exception being those who wish to continue to make further contributions into a pension arrangement. Ironically, much of the documentation issued by the Treasury in regard to the new rules relates to the small proportion of people who have sufficient money available to be able to continue contributions at the same time as they are drawing income from a pension plan.
What has not changed with the new rules is that pension planning while you are working will remain a matter of contributing as much as you can and finding the best places to invest the funds. Once in retirement both investment returns and tax will be important and, as ever in a flexible world, regular review will be vital.
CTC Retirement Hub planning tool
The CTC Retirement Hub is a planning tool that can help support people ‘at retirement’ who are self-selecting their retirement income or those that are being advised. The Retirement Hub compares in real numbers an annuity purchase against drawdown with an amount of cash built in as required. There are three steps in the CTC Retirement Hub.
1. Client priorities: key information used to create an income in retirement scenario
2. Scenario modeling: exploration of different options – eg, drawdown and annuity –creating a mix of income and remaining fund invested scenarios.
3. Scenario comparison: a visual comparison to explore the different options.