Open Market Option

Mistral001

I am self-employed and over 55 and I am thinking of taking my small private pension now and getting a tax free lump sum.

A short while ago I contacted an independent financial advisor, with whom I was dealt before, and he said that I should consider "the Open Market Option". He was actually the person who set up my pension scheme years ago and is listed as my advisor by that pension company.

However, I know the financial advisor has to make his money and I am worried that his fees and the transfer fees by the pension companies might make it not worthwhile or even more expensive in the long run.

I have actually two small private pensions: one with a value of about £50k and the other of a value of £15k. The £15k one has performed fairly badly over the years and I have always thought this was due to the administration cost associated with the very small monthly payments.

Maybe this is the time to amalgamate the two pensions together and also consider other companies who might perform better than the companies I am with at present. However, as I mentioned above I am worried about the admin. and IFA commission costs involved in the transfer. There is also the aspect of putting all my eggs in one basket so to speak.

Any experience or advice would be appreciated.

dunstonh

However, I know the financial advisor has to make his money and I am worried that his fees and the transfer fees by the pension companies might make it not worthwhile or even more expensive in the long run.

Are their transfer fees? The adviser is paid if you use the same company to provide the annuity. So, why not use the adviser? Especially if he can get more.

The £15k one has performed fairly badly over the years and I have always thought this was due to the administration cost associated with the very small monthly payments.

More likely to do with the poor investment returns over the last decade.

However, as I mentioned above I am worried about the admin. and IFA commission costs involved in the transfer.

What would be your alternative to using the IFA and how much would that cost you and would you benefit more from it?

Mistral001

Thanks Dunstonh.

Looks like I need to do a little research into how different pension funds are performing. I do not want to gamble with this money and I am a bit cautious about transferring based on today's trends as trends can quickly change.

I have been told that many people transfer because they are a heavy smoker or are in poor health and some pension funds treat those people more advantageously as they reckon that they will have shorter lives than the average. I am in reasonably good health so that is not an advantageous for me as far as I can see.

jamesd

You might also consider using income drawdown instead of an annuity. Annuity rates now aren't great and at a young age like 55 they are particularly unpromising.

Mistral001

jamesd wrote: »

You might also consider using income drawdown instead of an annuity. Annuity rates now aren't great and at a young age like 55 they are particularly unpromising.

Thanks for the suggestion. I have heard of "drawdown" but I am not sure what it is. I will look into it

Loughton_Monkey

Mistral001 wrote: »

Thanks for the suggestion. I have heard of "drawdown" but I am not sure what it is. I will look into it

Although you talk about possibly amalgamating them, your first post implies you are considering 'taking' the £15K pension.

Drawdown is usually highly inappropriate for such a small sum.

Drawdown, put very simply, is an alternative to the usual 'safe' annuity option. Always shop around for the best annuity rate if going that route. The annuity provider will 'invest' in safe (but lowish interest) bonds in order to pay you the agreed amount each month. Your income is then safe, secure, and guaranteed.

With drawdown, you sort of 'do it yourself'. You keep the money invested in funds of your choosing, which may (or may not) grow enough for you to take an income larger than the annuity. But performance of these funds could be very volatile. They could drop substantially almost overnight. OK, they would likely recover the following year, but (unlike paying into the pension) if you need the income and draw some of it out, you have less money to benefit from the upturn.

In short - much more risk. Would need a 'careful' investing mind and frequent attention. With respect, your story doesn't seem to indicate that you're that sort of person.

As for the amalgamation idea, you need, I think, to look at it in a different way. You have two pensions. Each pension is a 'wrapper' that merely provides administration to allow your investment into funds. Imaging that between the two pensions, your contributions have gone into 6 funds, then I could have six pensions - each in one of those funds. Joe Bloggs could have one pension but also invested across the 6 funds in similar proportions. They will all perform just about exactly the same.

If you are in the wrong funds, in either pension, almalgamation will not help you at all unless you switch to more appropriate funds. And swithcing to more appropriate funds would be possible anyway without amalgamation.

Having said that, sometimes the 'same' funds are available under different wrappers (pensions) in slightly different 'flavours' - or perhaps charges - in which case amalgamation to the 'better' wrapper may provide a small improvement.

Most of us start with defining the funds within which we wish to invest our pension money. Then we shop around for which pension providers give access to those funds [or very similar ones] with lower charges. In the (unlikely) event that I wanted to be in 20 funds and found them at the lowest charge with 20 different providers, then I would take out 20 different pensions.

Same as cash savings, really. If I want £5K instant access, £25K in a 2 year fixed rate ISA, and £15K in a 5 year high interest fix, then I'd buy each seperately and (almost certainly) end up with three different banks, because it's unlikely that one bank gives the best rate on all three types....

Mistral001

Thanks Loughton Monkey. I am now seeing drawdown in a different light.

Loughton_Monkey wrote: »

Although you talk about possibly amalgamating them, your first post implies you are considering 'taking' the £15K pension.

Actually the "small" here refers to the size of my pension fund compared with most pensions fund amounts that people mention here and on money programs on the radio. I was considering getting a lump sum from the bigger (£55k) pension and would also consider doing the same with the smaller (£15k) one as well.

Loughton_Monkey wrote: »

In short - much more risk. Would need a 'careful' investing mind and frequent attention. With respect, your story doesn't seem to indicate that you're that sort of person.

At the minute I am not willing to take many risks with regard to money. I have done fairly well in the past investing in shares etc, but that was when I had money and could take risks with it. Maybe in the future if business and income picks up I could take more risks.

jamesd

Drawdown is not usually inappropriate for a sum of £65,000. It is inappropriate if the costs are excessive or the investments don't match the risk profile of the investor. Costs are as little as £25 a year from some providers and that's easily cheap enough for the amount considered here. Using a provider that charges a few hundred or a few thousand a year could well be inappropriate and that's the sort of level that was normal back when the old guidance on sizes was written. It might be inappropriate with some financial advisors, depending on cost level for the adviser and some advisors might choose not to do it if the amount is below say £100,000 for that reason. Appropriateness also depends on other income sources and ability to handle losses.

Drawdown does not necessarily have more risk than an annuity. Depending on the investments chosen it can have less risk or more risk. You can pick any level of risk you like, from 100% FSCS protected cash deposits through UK government bonds payout out a guaranteed annual income at maturity each year through owning a commercial property with a mortgage or buying emerging markets funds. Or any combination of those and many other options.

As well as the tailoring of risk level and income level to the individual drawdown offers these advantages compared to an annuity:

1. No reduction in investment proceeds at any age, though the GAD limit may restrict how much can be taken out of the pension pot at younger ages.
2. 100% spouses pension with no tax charge and no reduction of current income level to get this. The spouse just inherits the pension pot.
3. Option for the spouse to take the money as a lump sum if that is preferred, but after a 55% tax charge.
4. Inheritable by anyone with a 55% tax charge, instead of losing it all with an annuity.
5. Option to buy one or more annuities gradually as you get older and annuities might start to look more attractive for income sometimes.
6. You aren't restricted to only the low income option of an annuity, you can choose to have more risk to have more income if you want to. Or less risk and less income than an annuity if you prefer that.
7. No need to take the income if you don't need it. You can take the lump sum, go into drawdown and just leave the rest of the money invested and growing as it has been until you do want an income from it.

I'd normally suggest a mixture of investments that would have higher volatility than an annuity payment and use smoothing via a savings account containing one to five years of income. Then the stable regular income income comes from the savings account while the investments pay into it. If the income level from the investments was to drop by 20% and not go up again a 5 year savings pot would keep the income constant for 25 years, a good deal longer than any likely real drop of that magnitude is likely to last. The amount in the savings can be adjusted depending on how cautious you want to be.

But that's normal. If someone does want very low volatility investments then savings accounts are fine and can be used in a drawdown pension pot.

If you're not familiar with choosing investments then it would definitely be good to get advice from a financial advisor about which ones to use to hit any particular volatility target.

Loughton_Monkey wrote: »

But performance of these funds could be very volatile. They could drop substantially almost overnight. OK, they would likely recover the following year, but (unlike paying into the pension) if you need the income and draw some of it out, you have less money to benefit from the upturn.

That is misleading. First, drawdown at age 55 is likely to be taking income from the investments, not capital, so it is not true that taking income will prevent the capital value from recovering, because the income isn't coming from the capital. If there was a desire to take income from the capital then that would be coming from investments with low volatility chosen for that purpose, not those with high volatility. An almost overnight substantial drop is not something that can be expected for funds typically used in drawdown. Anyone concerned about this can simply choose funds that do not have a level of volatility that they consider unacceptable to them, and should.

Mistral001

jamesd wrote: »

That is misleading. First, drawdown at age 55 is likely to be taking income from the investments, not capital, so it is not true that taking income will prevent the capital value from recovering, because the income isn't coming from the capital. If there was a desire to take income from the capital then that would be coming from investments with low volatility chosen for that purpose, not those with high volatility. An almost overnight substantial drop is not something that can be expected for funds typically used in drawdown. Anyone concerned about this can simply choose funds that do not have a level of volatility that they consider unacceptable to them, and should.

I am a bit confused now. Surely drawdown is dependent on the size of the pot (or value) for income. I assume with drawdown if the pot reduces as a result of poor performance, income goes down. With an annunity if the pot goes down the income does not change (I assume). Also the word "drawdown" suggests, to me, that some of the income is "drawn" from the pot. Does that mean that the pot does not grow? Or grow as much as with the annuity case.

jamesd

The amount of income that can be available depends on the size of the pot and the GAD limit on how much can be taken out. A bigger pot means more potentially available income.

The pot size concern can be the potential impact of varying income levels on the individual. If someone has lots of other income compared to their spending needs then a drop in the long term income from drawdown might have minimal effect. This can happen at low income and pot size where most of the income can be the state pensions but it can also happen at higher levels of other income and higher levels of drawdown income. If 90% of your income would come from drawdown then trouble with drawdown could hurt a lot more than if it was just 20%. In such a case it'd be prudent to have much higher cash reserves and some greater lower risk components than someone with a lower dependence on the drawdown income. It's very much a case of considering your own specific situation and picking a suitable combination.

One approach that can be used is to take a mixture of state pensions and annuities for the minimal required living expenses. Then you have the level of income regardless of what happens to the drawdown portion. For someone like you who's probably well away from state pension age a level annuity can be good for this because later the state pensions will kick in to cover some of the inflation-linked drp in value of the level income.

The income doesn't necessarily go down if the capital value goes down. If the investments are paying fixed interest rates there may be no change. If it's dividends, there can also be no change. The two can move independently. The change in income is usually less than the change in capital value. You still should use a savings account to smooth things.

If part of your income is coming from the sale of the investments then the income doesn't necessarily have to go down but if you were to sell investments that have dropped a lot, there would be less to recover so the cost of taking the money out would be higher. You deal with this by having a significant amount of low volatility investments and planning to do any selling from those, not the more volatile ones. At younger ages this aspect can be fairly moot because at the moment the GAD limit may make it impossible to even take out all of the normal income generated, so there may be no point in selling anyway.

Later in life when the GAD limit goes up, or when the 15 year gilt yield that GAD is also linked to goes back up to more normal levels the amount of income that can be taken will increase. Then you would have to decide which investments to sell if you wanted to take more income by selling some of the investments.

Whether the pot grows or not depends on the investments chosen and the amount of income. At younger ages it can be sensible to take less than the maximum possible income to increase the growth potential. I tend to suggest something between 4% and 6% if there's a desire not to hav the pot vale decrease and to have some reasonable chance of keeping up with inflation.

When it comes to annuities the inflation-linked annuities tend to be very unpopular with most of the market being level annuities - I think more than 90%. This is because of the substantial reduction in initial income level, in part due to the less competitive market for these annuities. One approach that can be taken is to use a level annuity but invest half of the difference between level and index-linked annuity income. that'll provide some combination of higher income and inflation protection. No rule saying you can't use more than one annuity of different types either, some of each perhaps.