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  • FIRST POST
    • TennisFan
    • By TennisFan 17th Sep 16, 7:36 PM
    • 24Posts
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    TennisFan
    25% tax free lump sum and 10 year annuity
    • #1
    • 17th Sep 16, 7:36 PM
    25% tax free lump sum and 10 year annuity 17th Sep 16 at 7:36 PM
    As part of my retirement planning I'm considering a mixture of state pension, income drawdown and annuities. (I'm also fortunate in that my partner has a reasonable Final Salary pension).

    I'm currently looking at a 10 year fixed term annuity with a decent GMA. I don't have a need to take the available 25% lump sum but my financial advisor suggests I take it anyway as it's more tax efficient to take the lump sum (tax free) with smaller annuity payments, then get higher annuity payments but pay tax on everything. (It looks like it's not possible to take the 25% tax free amount as part of the the twice yearly annuity payments).

    Some articles I've read have said if you don't need the 25% lump sum to leave it invested as it'll generate more income that way.

    So I'm a bit confused!! Am I missing something?

    Thanks for any advice.
Page 1
  • jamesd
    • #2
    • 17th Sep 16, 8:32 PM
    • #2
    • 17th Sep 16, 8:32 PM
    Take the 25% tax free lump sum and invest it within a S&S ISA as the annual allowance or that allows. Tax fee on the way out of the pension and still tax free from then on via the ISA.

    Forget annuities unless you are so averse to investment or even savings risk that you are willing to throw away half of your money to get someone to say that they guarantee income. Unless you are of such poor health that an enhanced annuity makes sense due to your low life expectancy.

    Is our financial adviser a financial adiser or an independent financial adviser? the former not required to consider all products, the later required to include all within the typical categories.

    Has your financial advisor explained the benefit of state pension deferral in providing a 5.8% increase in state pension per year of deferral, so roughly equivalent initially to a 5.8% of capital inflation-linked annuity? That's more than twice the inflation-protected income available from an annuity if in normal good health.

    And that explains the likely value of a decent GMA: negative, because it might fool you into buying an annuity at some point.

    But annuities aren't all bad. Eventually, when you get to around 80-85 years old they can offer good value for money, as they can if your life expectancy is so much lower than normal that they pay more than the state pension deferral option. And if you are extremely risk averse and/or so rich that efficiency doesn't matter to you, you just might be willing to throw away half of your capital to get the guarantee claimed for an annuity.

    Your FA probably hasn''t explained any of the research about safe withdrawal rates to you. So to get started on learning about tuat, please have a read of Drawdown: safe withdrawal rates.

    At present you're likely to find that you can take about twice the inflation-linked income available from an inflation-linked annuity, but with the caveat that you must be willing to accept some reduction if you are unfortunate to experience uncommonly bad investment results. In exchange you get a higher starting income, so you are still likely to end up worth more than the annuity alternative would pay. And if you get even average performance you'd do much better. In fact, historically, even the now out of date 4% rule would have left more than 90% of all people using it with the same nominal amount of money in their investments (so not inflation adjusted) as when they started drawdown. With no running out of money even in the worst investment performance periods in history. You'll find that you can pick floor income levels - at say the annuity income level - as well. those may reduce the initial income level but they provide good assurance that you wont be worse off than if you'd bought an annuity.
    Last edited by jamesd; 23-09-2016 at 5:38 PM. Reason: added a missing -
    • dunstonh
    • By dunstonh 18th Sep 16, 12:02 AM
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    dunstonh
    • #3
    • 18th Sep 16, 12:02 AM
    • #3
    • 18th Sep 16, 12:02 AM
    I'm currently looking at a 10 year fixed term annuity with a decent GMA. I don't have a need to take the available 25% lump sum but my financial advisor suggests I take it anyway as it's more tax efficient to take the lump sum (tax free) with smaller annuity payments, then get higher annuity payments but pay tax on everything. (It looks like it's not possible to take the 25% tax free amount as part of the the twice yearly annuity payments).
    That is correct for an annuity.

    Some articles I've read have said if you don't need the 25% lump sum to leave it invested as it'll generate more income that way.
    That is correct for phased flexi-access drawdown.

    So I'm a bit confused!! Am I missing something?
    Basically, you are not comparing like for like but reading bits that cover different options.
    I am an Independent Financial Adviser (IFA). Comments are for discussion purposes only. They are not financial advice. Different people have different needs and what is right for one person may not be for another. If you feel an area discussed may be relevant to you, then please seek advice from a Financial Adviser local to you.
    • TennisFan
    • By TennisFan 18th Sep 16, 3:11 PM
    • 24 Posts
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    TennisFan
    • #4
    • 18th Sep 16, 3:11 PM
    • #4
    • 18th Sep 16, 3:11 PM
    Thank you dunstonh - I had a feeling I was probably comparing apples with pears!!!
    • TennisFan
    • By TennisFan 18th Sep 16, 3:28 PM
    • 24 Posts
    • 9 Thanks
    TennisFan
    • #5
    • 18th Sep 16, 3:28 PM
    • #5
    • 18th Sep 16, 3:28 PM
    Thank you Jamesd - I didn't want to write chapter and verse on what I'm doing but yes - I'm taking a deferred state pension, I have invested in S & S ISAs and draw down SIPP, the Annuity is for a small proportion of my pension pot .... basically I'm trying to get a mixed balance of safe/predictable and somewhat riskier approaches.
    It's going to take me a few days to absorb all you detailed advice (many thanks for taking the time to explain it all), but my understanding Vis a Vis the annuity is that if I am already in a tax paying situation due to other income (State + Drawn down SIPP) at say 20% any further income from an Annuity (Fixed term 10yrs with GMA) will be taxed also at 20%.
    Hence the advice to take the tax free lump – and use this as income as required and take a lower annual annuity income.
    In the this case the GMA is lower as the Annuity provider has less capital than if I had not taken the 25% tax free portion.
    But the reduction in GMA is more than offset by the tax saving over the 10 years.
    This assumes the tax rate and thresholds do not vary too much and I do use the tax free sum as income over the 10 years.
    Now I'm off to read the links provided in your comprehensive reply !
    • FatherAbraham
    • By FatherAbraham 18th Sep 16, 5:24 PM
    • 654 Posts
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    FatherAbraham
    • #6
    • 18th Sep 16, 5:24 PM
    • #6
    • 18th Sep 16, 5:24 PM
    Forget annuities unless you are so averse to investment or even savings risk that you are willing to throw away half of your money to get someone to say that they guarantee income. Unless you are of such poor health that an enhanced annuity makes sense due to your low life expectancy.
    Originally posted by jamesd
    Do you know what "begging the question" means?

    How can someone who has so much understanding of annuities fail to mention longevity risk in his or her out-of-hand dismissal of this indisputably evil, outrageous, and deficient excuse for an insurance product?

    Oh wait, did you say "Insurance product"? :-)

    Warmest regards,
    FA
  • jamesd
    • #7
    • 18th Sep 16, 6:08 PM
    • #7
    • 18th Sep 16, 6:08 PM
    basically I'm trying to get a mixed balance of safe/predictable and somewhat riskier approaches.
    Originally posted by TennisFan
    That's useful. It's just a value for money issue on getting guaranteed income, since more deferral probably offers you more guaranteed income for your money than the annuity. But that does depend on how much deferring you're already planning, if you're already looking at ten years of it then something else might be a better move.

    One useful property of guaranteed lifetime income is that it increases the safe withdrawal percentage rate for the investment portion. That's part of why I suggest always doing some deferring of the state pension even for those happy to take investment risk.

    my understanding Vis a Vis the annuity is that if I am already in a tax paying situation due to other income (State + Drawn down SIPP) at say 20% any further income from an Annuity (Fixed term 10yrs with GMA) will be taxed also at 20%.
    Hence the advice to take the tax free lump and use this as income as required and take a lower annual annuity income.
    Originally posted by TennisFan
    Right.
  • jamesd
    • #8
    • 18th Sep 16, 6:43 PM
    • #8
    • 18th Sep 16, 6:43 PM
    Do you know what "begging the question" means?
    Originally posted by FatherAbraham
    When you get half of the guaranteed the income for your money you are effectively throwing away half of your money. That's what is typically being done around state pension age if buying an annuity is done instead of deferring the state pension by a person in normal good health. Both are guaranteed income for life but one is a smarter buy than the other.

    How can someone who has so much understanding of annuities fail to mention longevity risk in his or her out-of-hand dismissal of this indisputably evil, outrageous, and deficient excuse for an insurance product?
    Originally posted by FatherAbraham
    Annuities are not an evil, outrageous product. It's very likely that I will buy at least one myself if there is a time when they are offering me good value for money, which seems likely, eventually.

    Nor are they typically deficient, except sometimes in value for money- see for example PPI, extended warranties and mobile phone insurance. I don't buy those three types because I can self-insure at that cost level and know they offer poor value for money.

    Longevity risk is important. Buying an annuity is not initially the best way to reduce it in the UK, deferring the state pension is, because you get around twice the protection for your money if in normal good health at around state pension age. Protect against longevity risk, just do it with the best value for money choices.

    For amounts beyond the practical limit for deferral, insurance may well be a good choice, though that does posit abnormally bad investment results, compared to history, since it'd take something like loss of half the money with no recovery to get down to the annuity level of sustainable income. Even so, that's not impossible, so someone might prefer to speculate that an annuity provider and/or government paying on its bonds could survive that and continue paying out. I'm not so confident that the government and annuity provider could, given what it'd take to produce a thirty year long 50% loss in a mixed portfolio including equities and bonds diversified globally when much of the annuity backing is likely to have high single country concentration.

    But annuities definitely offer less work and understanding as an income product than investments and that's one reason why many might prefer them. But that group can still probably get a better deal on the first part of their money with state pension deferral, so that's the fist buy to make.

    You'll find extensive coverage of risk including longevity risk linked from the thread I linked to in the post, Drawdown: safe withdrawal rates, where among other things you'll find me writing "Defer your state pension if you have normal life expectancy and no special case for not doing it. Up to five years has a good chance of breaking even, up to ten years can be good for longevity insurance". Both parts in bold relate to longevity risk since they posit the case of living longer than normal life expectancy.

    If someone is in a position where the annuity offers higher income than the state pension deferral option then they should go with the annuity, all other things being equal.

    Similarly, there's nothing wrong with insurance in general and I'm paying more than a couple of thousand pounds a year for extensive permanent health insurance, medical insurance, property insurance and more than ample life insurance myself. Insurance is fine, just be a smart buyer.

    There's nothing fundamentally wrong with annuities or insurance, it's just about getting the best value for money. Sometimes that'll be insurance but in retirement income around state pension age it happens that it's state pension deferral that's offering the best deal at the moment.
    Last edited by jamesd; 18-09-2016 at 6:46 PM.
    • dunstonh
    • By dunstonh 18th Sep 16, 8:50 PM
    • 84,097 Posts
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    dunstonh
    • #9
    • 18th Sep 16, 8:50 PM
    • #9
    • 18th Sep 16, 8:50 PM
    It is worth noting that the mix of annuity and drawdown is exceedingly popular at the moment. Annuities can pay more income than drawdown. So, by using the annuity to secure a guaranteed income for life, perhaps to a level that covers committed expenditure, then using drawdown for the rest, you would not have to draw as much from the drawdown pot. So, the value will not go down as much.

    It should also be noted that the individual has to sleep at night not worrying about what they have done. Annuity provides guaranteed income for life. It certainly has negatives (as do all options) but some people cannot handle investment risk and some people cannot afford to take investment risk and some people who say they can handle investment risk then go and do the complete opposite when the risk event occurs (behaviour risk). So, its not right to demonise annuities. They are not as valuable as they once were but they still serve a purpose.
    I am an Independent Financial Adviser (IFA). Comments are for discussion purposes only. They are not financial advice. Different people have different needs and what is right for one person may not be for another. If you feel an area discussed may be relevant to you, then please seek advice from a Financial Adviser local to you.
  • jamesd
    Annuities can pay more income than drawdown.
    Originally posted by dunstonh
    What circumstances did you have in mind? Some that come to mind include:

    1. Substantially reduced life expectancy so that an inflation-linked income guaranteed for life of greater than that obtainable from the state pension can be bought.
    2. Guaranteed annuity rate above state pension deferral rate.
    3. Guaranteed minimum pension above state pension deferral rate.
    4. Unwillingness to take volatility risk, say an intention to use cash, with a long enough life expectancy such that that would pay less than an annuity.

    4 is particularly common and state pension deferral then annuity for amounts above the practical deferral level can be an excellent solution.

    its not right to demonise annuities. They are not as valuable as they once were but they still serve a purpose.
    Originally posted by dunstonh
    Definitely! That's why I eventually expect to buy at least one myself, in appropriate circumstances.
    • choccydigestive
    • By choccydigestive 22nd Sep 16, 4:37 PM
    • 2 Posts
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    choccydigestive
    Good value for money
    Annuities are not an evil, outrageous product. It's very likely that I will buy at least one myself if there is a time when they are offering me good value for money, which seems likely, eventually.
    Originally posted by jamesd
    Hi jamesd, would love your thoughts and approach on how to assess good value for money in the context of annuities.
  • jamesd
    Simply compare to the alternatives then do whatever offers the best deal. That's likely to be:

    1. state pension deferral for up to ten years if you're close to state pension age and in normal good health. Because it offers about twice the inflation-linked income for the money spent initially, gradually declining as you defer for more years and get older.
    2. income drawdown with the Guyton-Klinger method and Guyton's sequence of return risk taming.
    3. maybe annuity on top of the state pension deferral.
    4. at younger ages perhaps consider mixing two drawdown policies. One at say 95% historic success rate and another for the most critical spending at 100% success rate. If well below state and work defined benefit pension ages you might use a 100% success rate over ten or twenty years approach for 100% of the income during that time followed by 95% after that planning horizon has ended.
    5. at older ages or if not in good health annuities are definitely worth considering to see how good the value for money they offer is for the specific health and age.
    • xylophone
    • By xylophone 23rd Sep 16, 11:01 AM
    • 18,439 Posts
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    xylophone
    Eventually, when you get to around 8085 years old
    I knew life expectancy was increasing but that seems to be erring on the optimistic side.....
  • jamesd
    I knew life expectancy was increasing but that seems to be erring on the optimistic side.....
    Originally posted by xylophone
    A perfect case for buying an annuity to deal with longevity risk!
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