Annuity or Drawdown

jayship

A family member aged 63 has a pension pot of £65,000. He wants to take the 25% and leave the balance £48750 invested for another 5/7 years. His company Aegon suggested an annuity or a drawdown option where the minimum amount should be £50000 which for a drawdown seems small due to its high risk and other charges which may eat away the long term benefits. He is quite happy to draw a smaller amount and leave the rest invested for another 5/7 years.
What do forum readers think from their experience and the alternatives available. Naturally we will shop around for an annuity if it comes to that. He already invests in funds and is aware of the markets and the risks. Readers thoughts will be appreciated.

dunstonh

What do forum readers think from their experience and the alternatives available.

50k is low for drawdown typically. Over £100k after TFC is more the normal minimum. However, it is certainly possible. Probably not worth it via Aegon though.

CannySaver_2

Hi

A few thoughts for you:

1. If he wants to take no income he has two options (1.) Income Drawdown and (2.) Fixed Term Annuity. Any other option means that he will have to take an income

2. Does he really have to access the pension? Is it the only way of him raising funds? If there are alternatives he should explore them. One of the major drawbacks of the proposed course of action is the tax on lump sum death benefits. If he dies before vesting (taking the tax free lump sum) the non protected rights portion of the fund will pay out in full with no tax deducted, if he dies in drawdown then tax at the rate of 55% would be payable on any lump sum death benefits

3. I don't buy this £100,000 'rule' on Income Drawdown plans it is too black and white, individual circumstances are more important and these days the charges are no significantly greater, if at all, on most Income Drawdown plans compared to most Personal Pensions

4. Income Drawdown does not have to be high risk, this is a misconception. A SIPP in Income Drawdown invested in a series of deposit accounts carries zero capital risk (providing the accounts are spread and the £85k compensation limit considered). You do of course introduce inflation and oppportunity risk, but there is zero investment risk

In summary:

1. Think of other options to raise the capital
2. Consider Fixed Term Annuities as well as Income Drawdown
3. Remember Income Drawdown does not have to be high risk

I hope this helps.

The Canny Saver

jayship

Thanks 4 the response. No he does not need the cash at the moment. The only reason to take the 25% was to ensure that all is not lost should he decide to go into drawdown and invest in medium to high risk funds. He may be 70 by the time he decides to exercise his options and the market may not be bouyant at the time.
We had a look at the drawdown being offered by HL which has reasonable charges. Are there others?

What r other options available than those already mentioned. Thanks to both respondents and your thoughts are appreciated.

CannySaver_2

Hi

If he doesn't need the cash then it makes absolutely no sense taking it and going into drawdown, it's terrible advice.

If he is worried about risk then simply allocate 25% to low risk funds, even cash, within either a Personal Pension or a SIPP and invest the balance in riskier assets.

Income Drawdown contracts will have very similar if not the same investment options to a Personal Pension, you can therefore achieve the same thing.

I'd also see another adviser, I'd be very supicious of motives of an adviser who is suggesting Income Drawdown when it is clearly not needed.

The Canny Saver

jayship

Thanks Cannysaver.
The annuity and the income drawdown were the options available from Aegon when we rang them. We r now trying to find out other options available to ensure that we get it right from the start and avoid an expensive mistake. What would u do? I am aware that everyone's situation is different and cannot draw a parallel. Should we decide to see a IFA we will be well prepared with the Q & A that have been put forward by our fellow readers. Hence all input will be appreciated.

jem16

jayship wrote: »

Thanks Cannysaver.
The annuity and the income drawdown were the options available from Aegon when we rang them.

Aegon are not able to offer advice - they will only have told you what was available.

If he doesn't need the cash now then don't take it - no point in bringing it into a taxable environment and changing the death benefits by taking the pension.

An IFA might be the best course of action now.

CannySaver_2

jayship wrote: »

Thanks Cannysaver.
The annuity and the income drawdown were the options available from Aegon when we rang them. We r now trying to find out other options available to ensure that we get it right from the start and avoid an expensive mistake. What would u do? I am aware that everyone's situation is different and cannot draw a parallel. Should we decide to see a IFA we will be well prepared with the Q & A that have been put forward by our fellow readers. Hence all input will be appreciated.

I'm not sure you have even identified a problem yet, what is the issue you are concerned about?

Loughton_Monkey

There are a lot of unknowns here. Like his tax status. What other assets he has and how he will 'live' for the next 6/7 years. And most of all what he's really trying to achieve.

Drawdown seems to me a 'red herring'. If the objective is simply to get another 6/7 years' growth before taking it, then simply leave it invested and buy an annuity at age 70. If he desperately needs 25% now, then simply take it, leave the rest invested, and, again, buy an annuity at age 70 [but it seems he doesn't].

If he is in the 'annuities are a rip-off' camp [a common, but possibly ill-conceived view) then, OK, consider drawdown, but not until age 70.

There are many of us (presumably) like me who have 'outstanding' pension pots. Despite being retired since age 56 (6 years ago) I even pay into a small pension (£3,600) a year gross). Here, my objectives are quite simply that it meets fully my need to maintain a certain proportion of my wealth in equities - in as tax efficient manner as I can. I project that I don't need to touch them for another 6/7 years either. So I will simply let them 'ride'. Simple. I will decide upon when exactly to crystallise them, and how to crystalise them nearer the time.

jamesd

There are at least two good options that income drawdown lets him use:

1. Taking the income and investing it in a S&S ISA or elsewhere, just as it's invested in the pension. The amount of income that can be taken is capped by the GAD limit and taking it as soon as possible lets you save it to top up the income in earlier retirement when the income can be most needed.

2. Taking the income and paying it into another pension. This gets the tax relief and 25% tax free lump sum again, so it can be a nice way to boost income. Unlike 1 it does lose access to some of the cash that could otherwise be accumulated but it does avoid paying a possible high rate of tax on the money. This is of articular value to those who are able to make pension contributions with salary sacrifice of higher rate tax.

If he's going to use tracker funds like the HSBC range then Hargeraves Lansdown can be quite inexpensive.

If he'll use managed funds then he'd pay about 0.5% of his pension pot in avoidable commission to Hargreaves Lansdown. About £250 a year. With a possible seven years it's worth considering using a low cost IFA to buy something else on fee basis with no ongoing advice and no 0.5% trail commission. The best way to pay the fee would be to have the IFA take an initial commission payment on the transfer because that way the cost will come out of money on which he's received tax relief - effectively tax relief on the IFA's charge.

Because drawdown is seen as a fairly high risk transaction it's possible that an IFA might refuse to do it on execution only basis and the fee could be too high to make it worth doing compared to doing it yourself with Hargreaves Lansdown. But assuming he lives a good long time and uses drawdown for that time it may well be worth paying.

It's not really a good time to be transferring at the moment. The FSA is soon to release a new set of rules for investment platforms that may ban certain types of scheme and may produce some significant changes in offerings. Waiting a few months is probably a good idea - say until November.

We should also consider your own pension situation. If you won't get pension income, including the state pension, of at least £10,000 a year then it's worth making more pension contribution in your name to get tax relief on the way in but pay no tax on the way out.

For your protection it's often a very good idea for the spouse to use income drawdown because 100% of the pension pot, no tax, can be paid into a pension pot in your name. That gets you a 100% survivor's pension, something that would be quite costly for him to buy in an annuity. So you get the benefit, without extra cost.

Drawdown is also better than an annuity for inheritance to others if that is of interest. With no tax charge the capital can be paid into pensions or with a 55% tax charge outside a pension. If there's a desire to have a 100% payout outside a pension life assurance can make up the difference. This compares very well to the typical zero payout from an annuity after death and any payment guarantee period.

Since drawdown can use just about any level of risk/volatility there's often little reason for those who know how to manage risk to buy an annuity for many years, if ever.

Eventually, sometime after age 75, likely many years later than that, the extra income available from an annuity may be enough to make it better to buy an annuity. That's because there's a cross-subsidy form those who die early to those who live a long time that boosts annuity payouts if one is purchased to cover the period when many people are dying. With male life expectancy at age 65 now going to around 87 or so that makes the early to mid 80s the time when insurance companies will have the highest death rate with the lowest number of years to pay out before then, so it's th period when the cross-subsidy may start to be most valuable - but do check the actual payouts and compare to drawdown income.

CannySaver_2

jamesd wrote: »

There are at least two good options that income drawdown lets him use:

1. Taking the income and investing it in a S&S ISA or elsewhere, just as it's invested in the pension. The amount of income that can be taken is capped by the GAD limit and taking it as soon as possible lets you save it to top up the income in earlier retirement when the income can be most needed.

2. Taking the income and paying it into another pension. This gets the tax relief and 25% tax free lump sum again, so it can be a nice way to boost income. Unlike 1 it does lose access to some of the cash that could otherwise be accumulated but it does avoid paying a possible high rate of tax on the money. This is of articular value to those who are able to make pension contributions with salary sacrifice of higher rate tax.

If he's going to use tracker funds like the HSBC range then Hargeraves Lansdown can be quite inexpensive.

If he'll use managed funds then he'd pay about 0.5% of his pension pot in avoidable commission to Hargreaves Lansdown. About £250 a year. With a possible seven years it's worth considering using a low cost IFA to buy something else on fee basis with no ongoing advice and no 0.5% trail commission. The best way to pay the fee would be to have the IFA take an initial commission payment on the transfer because that way the cost will come out of money on which he's received tax relief - effectively tax relief on the IFA's charge.

Because drawdown is seen as a fairly high risk transaction it's possible that an IFA might refuse to do it on execution only basis and the fee could be too high to make it worth doing compared to doing it yourself with Hargreaves Lansdown. But assuming he lives a good long time and uses drawdown for that time it may well be worth paying.

It's not really a good time to be transferring at the moment. The FSA is soon to release a new set of rules for investment platforms that may ban certain types of scheme and may produce some significant changes in offerings. Waiting a few months is probably a good idea - say until November.

We should also consider your own pension situation. If you won't get pension income, including the state pension, of at least £10,000 a year then it's worth making more pension contribution in your name to get tax relief on the way in but pay no tax on the way out.

For your protection it's often a very good idea for the spouse to use income drawdown because 100% of the pension pot, no tax, can be paid into a pension pot in your name. That gets you a 100% survivor's pension, something that would be quite costly for him to buy in an annuity. So you get the benefit, without extra cost.

Drawdown is also better than an annuity for inheritance to others if that is of interest. With no tax charge the capital can be paid into pensions or with a 55% tax charge outside a pension. If there's a desire to have a 100% payout outside a pension life assurance can make up the difference. This compares very well to the typical zero payout from an annuity after death and any payment guarantee period.

Since drawdown can use just about any level of risk/volatility there's often little reason for those who know how to manage risk to buy an annuity for many years, if ever.

Eventually, sometime after age 75, likely many years later than that, the extra income available from an annuity may be enough to make it better to buy an annuity. That's because there's a cross-subsidy form those who die early to those who live a long time that boosts annuity payouts if one is purchased to cover the period when many people are dying. With male life expectancy at age 65 now going to around 87 or so that makes the early to mid 80s the time when insurance companies will have the highest death rate with the lowest number of years to pay out before then, so it's th period when the cross-subsidy may start to be most valuable - but do check the actual payouts and compare to drawdown income.

Hi

A few thoughts on your post:

1. Re taking income drawodwn early to make ISA contributions. Unless I am misunderstanding you this makes no sense, why incur an income tax charge of 20%. 40% or even 50% just to make an ISA contribution?

2. Assuming the OP is a tax payer his doesn't achieve anything, you are simply taking money from pot A and moving it to pot B with tax paid when money is taken from pot A and then tax relief claimed with it is paid into pot B. If the OP is a non taxpayer (including the pension income), which is unlikely but I guess possible then this coud have some benefit up to the maximum contribution level of £3,600 gross pa

3. Re RDR (Retail Distribution Review) and waiting until November, I'm not sure of the merit in this, really can't see what product development is going to happen in four short months. Besides RDR will affect how advisers charge not necessarily the charges on products. Many IFAs have already adopted a post RDR charging structure, it shouldn't be too difficult to find one of these and I don't see a whole new range of drawdown products hitting the market before November, from what I understand drawdown providers are still wrestling with the last set of government charges, e.g. flexible drawdown

I stick by my point, if you don't need the income or lump sum there is no reason to move into income drawdown. You may well incur advice charges and the lump sum death benefits are taxable at 55%, compared to zero tax on no protected rights prior to retirement.

The Canny Saver