MSE News: Compulsory annuities scrapped for all in pension shake-up

jamesd

It's very disappointing that the government has chosen to increase the incentive to save for retirement outside a pension instead of in a pension.

The increased incentives not to use a pension for retirement income are a result of:

1. A large reduction in the amount of income that can be taken in drawdown, from 120% of the poor annuity rates to just 100% of the annuity rate. This makes it impractical to use a pension to keep a level income from before and after the state pensions start, which requires drawing income at a higher than annuity rate.
2. More frequent checks of income against capital, making it harder to keep a steady income during times of market turbulence.
3. Increased tax on lump sum payments in case of death before age 75 after taking an income.
4. Completely ignoring all of the other income a person has when working out whether capital can be taken out of a pension, made even worse because of the increased incentive not to use a pension for retirement income. Only lifetime annuity, work defined benefit pension and state pensions count, regardless of how high your drawdown or non-pension income levels are. So even if you have plenty of money, you're forced to throw some away by buying an annuity if you want to qualify.
5. No more pension tax relief after you've started taking pension income in flexible drawdown form (presumably including taking the lump sum and leaving the money invested). A big blow to those with pension mortgages and a term that ends before state pension age, or to those who retire sick and then get better or have to work if they find that they have an income that's not sufficient and are forced back to work anyway. But at least this seems to affect only wealthier pensioners who have £20k in annuity/state/work pension income plus their other income and hence meet the very high flexible drawdown income requirement.

This seems substantially worse than the existing USP/ASP combination.

For the reasons above, this has greatly increased my incentive not to use a pension to accumulate retirement income.

The reduced income level is particularly painful, since that was a major attraction of drawdown, letting you take a more sensible income level, from higher return investments, than provided by an annuity.

It looks like a gift to wealthy pensioners, at the expense of those on a little over average pension income down to benefit level income. Exceptionally generous to those with large inheritances, who will be able to make increased use of a pension as an inheritance tax planning tool. Also a gift to annuity providers, making drawdown less attractive compared to annuities than it was. Shame it makes use of pension at all unattractive for the same reason, so they may not reap the benefit because the money may never arrive in the pension.

Here's a link to the budget proposals page and directly to the pension income reduction proposal itself. And the consultation responses and replies.

Stargazer57

jamesd wrote: »

4. Completely ignoring all of the other income a person has when working out whether capital can be taken out of a pension, made even worse because of the increased incentive not to use a pension for retirement income. Only lifetime annuity, work defined benefit pension and state pensions count, regardless of how high your drawdown or non-pension income levels are. So even if you have plenty of money, you're forced to throw some away by buying an annuity if you want to qualify.

The difficulty here is ensuring that those who have plenty of money when flexible drawdown starts still have enough throughout their life to avoid becoming dependant on means-tested benefits. I can see that flexible drawdown would fall into disrepute if this didn't happen and assume that none of the 180 or so respondents came up with a workable plan in this area. What's your solution?

jamesd wrote: »

5. No more pension tax relief after you've started taking pension income in drawdown form (presumably including taking the lump sum and leaving the money invested). A big blow to those with pension mortgages and a term that ends before state pension age, or to those who retire sick and then get better or have to work if they find that they have an income that's not sufficient and are forced back to work anyway.

The way I read the consultation response suggested it is only those in flexible drawdown who can't make further pension contributions. (Para 3.30) If you use capped drawdown (the current version) I can't see where further contributions are prohibited.

Overall though I see your point that pensions have become less attractive for some people. I think the challenge has been the gap between state pensions and means-tested benefits. The coalition are making some moves in the right direction with the restoration of the earnings link but I suspect the bigger strides will come with the green paper expected in the next month or so.

jamesd

Those who are using drawdown are already presumed to be competent enough to have made investment and contribution decisions, perhaps with professional help, to get them to the point where drawdown is viable. That also implies that they should be competent to monitor and adjust income and possible future income, perhaps assisted by planning tools that advice sites could provide, to keep them on track with an appropriate level of income being drawn.

At the moment the planned 100% GAD income limit so badly hurts the contingency or planned early retirement cases that I think it makes use of pensions before age 55, except to get employer matching, imprudent for many whose planning considers those situations. While a 150% GAD limit until state pensions start, then 120%, might favour pension use. (150% is very ballpark, haven't analysed what it would take yet)

There's a trade off here between prudent individual planning for adverse life events and early retirement and the need to protect the exchequer. This plan seems to have gone much too far in the protect the exchequer direction and severely handicapped the use of pensions, making them substantially less flexible and useful than under the USP/ASP combination. Whch in turn backfires and eliminates the protections the exchequer was seeking, because pensions would be used less, to enable the required drawdown rates.

Yes, it's only flexible drawdown, I corrected my post while you were writing.

SallyG

" A large reduction in the amount of income that can be taken in drawdown, from 120% of the poor annuity rates to just 100% of the annuity rate"
Thanks for confirmation jamesd.

Gatser

jamesd wrote: »

It's very disappointing that the government has chosen to increase the incentive
to save for retirement outside a pension instead of in a pension.

1. A large reduction in the amount of income that can be taken in drawdown,
from 120% of the poor annuity rates to just 100% of the annuity rate.
This makes it impractical to use a pension to keep a level income from before and
after the state pensions start, which requires drawing income at a higher than annuity rate.

Yes...I am shocked by the changes... I thought the new legislation would recognise
the serious limitations of Annuities for those that want to save for retirement.
Instead, those over 75 are not forced to buy an annuity but (wait for it!)
those under 75 ARE forced to buy an annuity if only PP funds are available.
If we refuse to buy an annuity to hit the MIR of £20k, then we are forced
to accept a punitive drawdown based .....on Annuities! Durrr......

Has someone got a personal interest in Annuities??

If the Govt want to allow flexible drawdown and avoid us "blowing our pension savings",
why can't they have a rule that allows flexible drawdown provided retained pension fund
value is no lower than (say) £350k? Below £350k, drawdown could be at annuity rates.

middlepuss

Stargazer57 wrote: »

The way I read the consultation response suggested it is only those in flexible drawdown who can't make further pension contributions. (Para 3.30) If you use capped drawdown (the current version) I can't see where further contributions are prohibited.

Please could you explain the difference between flexible and capped drawdown?

As I understand it you can currently be drawing as many pensions as you like but still get tax relief on (the higher of) £3,600 or earned income when you contribute to a Stakeholder/SIPP.

In future, if you have one (perhaps tiny) pension in "flexible drawdown" does that put the kybosh on any further pension contributions tax relief?

lvader

I think overall I like the changes, I'll take a small annuity at the state pension age to bump up my final salary and state pension to 20k (or what ever the figure is then) then use flixuble drawdown on the rest. Before then I'll use the capped drawdown and use other savings as income.

JamesU

Cautious_Investor wrote: »

They are not just helping the rich, exactly what do you think is wrong with these proposals? What would you have done instead?

Exactly what do you think is wrong with these proposals?

As in link below, the Government's MIR calculation is quite amusing really:

http://www.hm-treasury.gov.uk/d/consult_age_75_annuity_responses.pdf

The level of MIR considered appropriate is based on the Government's convenient assumption that everybody aged 65 will live to be 100 yrs old "on the basis that there is the chance that 8% of the population may achieve this (A5, p17)".

The Government's assumptions and calculations (A1-A10, pages 17-18) summarised:

Income level required where pension credit does not need to be paid: £9620
Basic state pension: £5078

(i) Target additional income required by pensioner is 9620-5078 = £4542

(ii) Assume 65yr old lives to 100, therefore compound the target income of a 65yr old for an additional 35 years of retirement.

(iii) Include a variation in "earnings growth rate" of 3.75-4.75% (e.g. CPI target=2% + productivity growth=2% + differential between RPI/CPI "wedge" =0.75%; added total = 4.75%):

Therefore for a 65 year old:

£4542 compounded over 35 years at 4.75% = £23048
£4542 compounded over 35 years at 3.75% = £16475

Average of the two possibilities is approx £20K, so MIR is set to £20K by the Government.

The problem I have with the above calculations is that ONS data for the average UK life expectancy of 65 yr olds is 17.8 yrs for men (to age 83) and 20.4 yrs for women (to age 85), (page 1, Table 1 in first link below). More correctly though one should really use cohort life expectancy (second link below) which leads to an additional 2-3 yrs +/- 1yr. Hence a value of 23yrs for calculating MIR would seem to be more realistic:

http://www.statistics.gov.uk/pdfdir/liex1010.pdf
http://www.statistics.gov.uk/downloads/theme_population/Interim_Life/period_cohort_tables_index08.pdf

Assume 65yr old lives to average UK life expectancy of aged 88, therefore compound the target income of a 65yr old for an additional 23 years of retirement.

Then, the MIR calculation looks very different:

£4542 compounded over 23 years at 4.75% = approx £13200
£4542 compounded over 23 years at 3.75% = approx £10590

And the average of the two possibilities is approx £12K, so MIR would then be set at £12K.

What would you have done instead?

(i) I would have set the MIR at a lower and more reasonable level based on ONS data for UK average cohort life expectancy (average age = 88yrs, 23 years compounding from age 65 for MIR calculations) rather than the 8% chance of living to age 100 "so that individuals have the flexibility to decide when and how best to turn their pension savings into retirement income" (box 1A, point 3, p.3).

(ii) I would not include a 0.75% RPI/CPI "wedge" (A7, p.17). The government believes CPI is a better measure of inflation for uprating pensions as it is closer to a pensioner's inflationary experience, and if this really is the case, presumably it should not be necessary to calculate the MIR using RPI by the inclusion of a 0.75% RPI/CPI wedge.

JamesU

Stargazer57

JamesU wrote: »

What would you have done instead?

(i) I would have set the MIR at a lower and more reasonable level on the basis of realistic life expectancy "so that individuals have the flexibility to decide when and how best to turn their pension savings into retirement income" (box 1A, point 3, p.3).

At that level, assuming all other things are equal, half of all those affected could take a lump sum out of their pensions and spend it in the knowledge that if they lived beyond average life expectancy they could claim means-tested benefits. In some countries I believe this is known as double-dipping.

JamesU wrote: »

(ii) I would not have included a 0.75% RPI/CPI "wedge" (A7, p.17). The government believes CPI is a better measure of inflation for uprating pensions as it is closer to a pensioner's inflationary experience, and if this really is the case, presumably it should not be necessary to calculate the MIR using RPI by the inclusion of a 0.75% RPI/CPI wedge.

That wedge is only there to enable a reasonable estimate to be made of the likely long term rate of increase in earnings (which is that rate at which basic state pension and the pension credit threshold increase). The wedge only exists to explain how they got to the answer. It would only be sensible to exclude it if you were actually going to increase bsp and pension credit at a slower rate than at present.

jamesd

JamesU, you used the wrong life expectancy table. You should be using cohort life expectancy - the life expectancy that someone living through the following year's health effects will have - not period life expectancy - the life expectancy if everyone lived with today's health effects. That's around 87 for men and 89 for women.

Gatser wrote: »

Below £350k, drawdown could be at annuity rates.

That's enough at 6% income to provide £21,000 plus around £7,000 from the state pensions, when total average taxable income for a pensioner today is around £18,000.

I prefer not to limit the ability to get a level income before and after state pension payments start to only relatively well off pensioners. £12,000 to £14,000 is sufficient (more than I need) if forced to retire early for some reason but the need at that point is to drain capital to get the £14,000k income level until the £7,000 or so from the state pensions arrives, then drawdown can drop to a steady for life £7,000k that combines with the state pensions to give the same £14,000 income for the rest of life.

If you want a laugh, have a read of how Hargreaves Lansdown made a fool of themselves in describing this, covering anything that might seem positive while ignoring the decrease in allowed income levels and increase in death tax for those who die before age 75.