How can pensions be made to work?

Pal

Editor wrote:

I know someone who has his drawdown invested entirely in gilts -that's safer than an annuity.:)

Depends on your definition of risk. Annuity rates are based on Gilt yields, so this person is not going to profit from their investment in any way. They are subject to possible capital loss if inflation or interest rates rise (assuming fixed Gilts).

The only possible benefit to what they are doing is that they might retain some money if they die relatively young, but that could be countered by buying an annuity with a 10 year guarantee. The only other benefit is that there is no risk that the insurance company they purchase the annuity with collapses - a very small risk in my opinion.

In the end this person is still going to have to buy an annuity at some point, so I can't really see how they are benefiting from drawdown if they are investing in Gilts.

But the Government is not happy about this arrangment because they don't want to have to pay out 2 state pensions later: they want the private sector to provide one of them.They want people to contract out of Serps/S2P.Which the private sector refuses to do at a cheap rate.And the Govt doesn't want to pay more. So there's a conflict.

As someone who works in the industry I have never heard of this argument. I have also never heard about compulsion leading to tax benefits being removed. Finally the new simplification proposals have reaffirmed that the tax free cash sum is going to stay a feature of pensions for the forseeable future, despite media scare-mongering to the contrary (an easy scare story that is rolled out by lazy journalists every year just before the budget).

I think I had better challenge you to post a suitably authoratitive link to the article or paper where you read these interesting theories, otherwise I might just conclude you made it all up.

EdInvestor

Hi Pal, on the gilts issue, as of next year you won't have to buy an annuity any longer, as I'm sure you're aware.

Re the connection between compulsion and tax relief, these two articles from
pensions commentator Steve Bee of Scottish Life explain the concerns.

Adair Turner of the Pensions Commission has an interesting interview in the Independent today, worth a read. I wonder what he means by "large Government-sponsored schemes with very low charges"?

Pal

When you say that you do not need to buy an annuity under the Alernatively Secured Income proposals, I think you are mistaken. It is a system of drawdown where you can take an income of up to 70% of the amount you would get annually from an annuity while leaving the capital invested.

I hate to disappoint you but these proposals do not mean that money is returned to anyone on death. See http://www.capitahartshead.co.uk/themes/CHP/PDF/CI/CI_SIMPLIFICATION.pdf

quote: "there is no return of funds on death".

I have not researched this in depth yet (no point until it the regulations come out) but it appears to me that the only "advantage" of ASI is that the individual can draw a lower income and leave more money behind to buy a spouse's annuity when they die. However their adult children or estate gets nothing, so it no different from purchasing an annuity. It is only any use for those who think they will not live long after age 75.

So your friend is investing in bonds in order to give himself a secure income using ASI that is lower than the amount that he would get by buying an annuity? I don't see the point of that unless his life expectancy is short. Neither route gives the family an inheritance. The only way it makes sense is if your friend is going to switch to other asset classes at some point and try and earn himself more money, in which case your argument that there is "nothing high risk about income drawdown" doesn't work, does it?

EdInvestor

Hi Pal,

Did I say there was a return on capital after death when taking an ASI? I think I said there was a return on capital to heirs after a 35% tax charge if a person dies while taking drawdown.

With the ASI, you have this money in a SIPP.You will then be able to bequeath the SIPP to your dependants/heirs etc, so they have a ready made big pension fund which can continue to grow until they retire.This ought to mean that the next generation will have to save less in pensions - and they will thus get their "inheritance" early, rather than having to wait for their parents to die and sell the house. If the parents need extra money, they can top up by trading down/ releasing equity from the home knowing that they will still be able to leave their children the pension capital to be used in their own old age.

Doesn't this sound like a better idea than giving all the capital to the insurance company ?

Pal

Can you post a link to where this 35% tax charge/inheriting pension proposal was published because it is not something I have ever seen.

I somehow doubt that the IR would accept 35% tax. More likely they would insist on 55% tax in line with taxation for amounts in excess of the new lifetime allowance.

I await your response with interest. If you are correct then it opens up a whole new area of tax planning, as it will not just be SIPPS that are subject to the new rules. All pension schemes will be in the same position, especially those occupational schemes that do not purchase annuities.

EdInvestor

It's just the drawdown rule, been around for years.If you die before 75, the fund can either be passed on as an annuity to spouse/dependant or as a lump sum, after a 35% tax deduction.

At the moment, at 75 you have to buy an annuity. But from next year you can go the ASI route and hand on the drawdown fund inside a SIPP to your dependants.Personally I think there's no need for that - they should just continue with the existing drawdown rule beyond 75.

But it's a start At least compulsory annuitisation has now gone.

Money purchase pensions under the new rules should be able to avail themselves of drawdown AFAIK, so yes you're right, there should be a big drawdown boom.

Protected rights pensions can already be drawn down BUT they are not allowed in SIPPS and most insurers won't offer PR drawdown because the funds are too small.

This is an area where the DWP needs to wake up and smell the coffee IMHO as it's intention is not in the spirit of the A-day changes. You can imagine what a problem this will cause for money purchase pensions which are mixed contracted in and out

EdInvestor

Pal

The only reference I can find in a quick look is this one buried in the Trustnet report about SIPPS.

Nothing about post A day rules. Would there be any point in an occ scheme running a kind of "internal drawdown"?

EdInvestor

Pal

Here's a link explaining the return of fund death benefit in income drawdown.One of it's big attractions to many I imagine

I assume that people with money purchase pensions have had access to this all along , but would need to transfer to a SIPP first? Mind you I imagine people with maturing money purchase schemes are still a bit thin on the ground.

http://www.barnett-waddingham.co.uk/cms/services/small/news02091/viewDocument

EdInvestor

Hi Peter

peterbaker wrote:

So who are these "well pensioned up people" you meet exactly? I believe that generally, the only well pensioned up people out there are some of those already drawing their pensions and those directors officers and trustees who are in a position to directly influence employer's funds into their own pensions. Perhaps those are the ones you are thinking of?

This impression was gained from various speeches and comments made recently by Adair Turner of the Pesnions Commission, who says there is a kind of two tier structure. I am not sure exactly what income levels we're talking about here, but my impression is that the dividing line isn't very high.

I agree with you that people who retired in the 90s have had the best of it - with final salary pensions still heavily suppported by companies at that time and funds inflated with many good stockmarket years,not to mention high annuity rates.

It's a different story these days.

Pal

Editor wrote:

Pal

Here's a link explaining the return of fund death benefit in income drawdown.One of it's big attractions to many I imagine

I assume that people with money purchase pensions have had access to this all along , but would need to transfer to a SIPP first? Mind you I imagine people with maturing money purchase schemes are still a bit thin on the ground.

http://www.barnett-waddingham.co.uk/cms/services/small/news02091/viewDocument

It is something of a relief that this is an existing rule and not a feature of the simplification proposals, as at least I haven't missed anything! Personal pensions are not really my area of expertise.

All personal pensions (not just SIPPS) have this feature as long as the provider is able and willing to provide the facility. Occupational schemes do not offer the feature because most companies are not able or willing to offer the facility because of the advice requirements: few company employees are willing to pay for advice on their company schemes - believing instead that the company should pay for everything. As a result they do not receive advice. In the end it is easier to insist that people transfer out to a personal pension instead, and that is likely to be the way it stays.

I would not surprise me at all if this feature was removed from April next year, and replaced with ASI.

Your assertion that the requirement to buy an annuity has gone is a bit odd. The individual can only take a lower income from ASI than an annuity would buy and there is no return of capital on death, unlike current drawdown rules which continue to only apply to age 75.