Buy annuity with tax-free lump sum!

FatherAbraham

Given a defined-contribution personal pension fund, which offers a 25% tax-free lump sum, and wishing to buy annuity income in retirement, there are presumably two extremes:

1. Take no lump sum, converting the entire capital to a compulsory-purchase annuity
2. Take the maximum lump sum at 25% of the fund, then use this to buy a purchased life annuity, and the remaining 75% of fund buys a compulsory-purchase annuity.

Presented with that choice, would the first option ever be right? (I suppose there's a pathological case where the difference in annuity rates is enormous, but I don't think we're there yet).

The second seems to have such significant tax advantages (since the purchased life annuity's "yield" is only partially income-taxed) that the first option looks like idiocy.

However, there doesn't seem to be much discussion of this. Is it so obvious that it doesn't need discussion?

There's something about it here: http://www.sharingpensions.co.uk/pension_annuity7.htm

Warmest regards,
FA

dunstonh

Presented with that choice, would the first option ever be right?

Yes. But not often.

However, there doesn't seem to be much discussion of this. Is it so obvious that it doesn't need discussion?

I think there have been several threads already this year that have mentioned it. Although any thread is easy to miss if its not a subject you are looking out for.

jamesd

Taking the entire capital for a compulsory purchase annuity would probably be right if the taxable income including state pensions would still be below the personal allowance for income tax. Also for some range above that because the purchased life annuity tax free part is partial rather than complete. In addition the PLA market is less competitive than the compulsory purchase one so a slightly better annuity rate may compensate for higher tax.

kidmugsy

If you are already old enough for a State Pension, then take the lump sum and use it to compensate you for lost income while you defer your state pension. That deferral earns you extra index-linked pension at 10.4% for each year of deferral. You won't beat that commercially. (In fact it's so absurdly generous that the rate offered will be halved when the new state pension system is introduced.)

https://www.gov.uk/deferring-state-pension/what-you-may-get

mania112

As far as I can see there is no tax benefit to 100% CPA - no matter who your liability is, when you consider that PLA have better rates (normally).

The only case where 100% CPA is preferable is if you are looking at enhanced CPA's (enhanced due to ill-health by the way). There simply aren't enough providers offering enhanced PLA's so the loss of rates will sometimes outweigh the tax benefits.

jamesd

kidmugsy gave one good alternative to a PLA. Taxable income, though, so do allow for that.

kidmugsy

jamesd wrote: »

kidmugsy gave one good alternative to a PLA. Taxable income, though, so do allow for that.

True, but unless the deferrer is very old the net extra pension will currently beat the (nearly) gross PLA paid as a fixed rate annuity. And still the index-linking would come "free".

dunstonh

Ok, three other reasons would be enhanced annuity rates on lifetime annuities beating PLA annuity rates (on net effect). Or guaranteed annuity rates which could be higher (Again on net effect). Or the pension pot size gets a pension annuity rate which is due to the size of fund whereas the 25% fails to get such a high rate as it only has a small value. Plus, there are not many PLA providers nowadays and the cross subsidy pool is low. So market rates on PLAs can often be much lower than on lifetime annuities (assuming net effect again).

On an advice case, you would expect the adviser to get a PLA illustration to compare against the lifetime annuity. In many cases, you would expect the lifetime annuity to be higher than the PLA. Although the text book answer if you were sitting an exam would be that you would use a PLA.

mania112

dunstonh wrote: »

Although the text book answer if you were sitting an exam would be that you would use a PLA.

R01 on Tuesday (and only learnt the differences between PLA/CPA this week!).

R02 - done
R05 - done

R04 - March
R03 - July
R06 - September

dunstonh

mania112 wrote: »

R01 on Tuesday (and only learnt the differences between PLA/CPA this week!).

R02 - done
R05 - done

R04 - March
R03 - July
R06 - September

R04 is a doddle. Its almost an embarrassment. R03 is not difficult in topic but heavy in calculations and time is the big issue on that one. I didnt finish R03. I passed but I was about 10 questions short at the end. I never sat R06 as I didnt need it.

If you get a chance when that bunch are out of the way, look at J05. That is quality qualification to have. Focuses on retirement income options. You would never believe it is the same level of R04 given the depth of subject and it being a conventional written exam. You can actually sit J05 in place of R06 as both have 20 points and R06 doesnt give any gap filling. So, nothing is gained from R06. Having J05 on the other hand would as any consumer looking at retirement income should be looking for advisers with J05.

Another CII quirk is that generically, you would recommend a friendly society plan if you had a question on what someone should do to meet long term savings goals. Yet in real life, you are more likely to find that recommendation ends up as a mis-sale as commercially, those plans are dire.

mania112

^ thanks for the feedback.

I've been working for a chartered firm (who specialise in pensions) for 4 years and only in the last 9 months started to take the job/industry as a career path seriously (I started off building their websites!).

If all goes to plan this year, I'll be looking at becoming a pension transfer specialist and level 5 in a couple of years - which will allow me to be in a position to become chartered in 5 years and take over the business from the Directors who are 55+ and helping me along the way (with my friend and colleague who is in an identical position, I think they've found their exit strategy!).

Long way to go, but enjoying the journey.