Royal London GAR

Robert_McGeddon

I have a pension pot at Royal London that is subject to a Guaranteed Annuity Rate (GAR). They are proposing a scheme whereby the GAR is removed in exchange for an uplift in the pension pot value of 53%. It is possible to opt out of the scheme and thereby retain the benefit of the GAR.

I have two questions:
1 Is the GAR valuable and worth retaining?
2 Would a stocks and shares ISA be preferable to either form of annuity?

So, a bit more detail.

As regards annuities.
Assuming the pension pot is £100,000 the uplifted transfer value would be £153,000. Royal London say the annuity they would pay under GAR would be £7,863 per annum paid monthly in advance and for a guaranteed period of five years and thereafter until death. By comparison, they say that for a pot of £153,000 without a GAR the annuity would be £7,401 per annum. I got a couple of quotes online for a simple lifetime annuity paid monthly in advance and these were around £8,000/£8,100 per annum. So not exactly comparable, but not far off the Royal London GAR figure.

On the face of it, the GAR does not seem particularly valuable. On retirement in a couple of years time I may or may not want to cash in the pension pot as an annuity but it seems to me that taking the uplift and buying a annuity away from Royal London is a very workable option.

As regards a stocks and shares ISA.
25% of the £153,000 would be tax-free. To restrict tax to 20% on the balance I would probably need to take it out in tranches over a few years, but this shouldn't be a problem as I would also need to keep under the annual ISA investment limits. The net value for investment would be around £130,000 and if the ISA performed at 3.5% pa the annual tax-free income would be around £4,500. This is not too far away from the post-tax annuity numbers and has the great advantages of both allowing me drawdown in the future and leaving a residual pot for my children.

Thoughts and observations very welcome!

dunstonh

1 Is the GAR valuable and worth retaining?

Yes. potentially. RL have GARs in double digits. They have some that are in low single digits. The value will be relative.

2 Would a stocks and shares ISA be preferable to either form of annuity?

It would be a strange choice but it is theoretically possible it could be most suitable in certain circumstances. It is not the logical option as it would mean taking it out of the pension and paying tax. Whereas leaving it in the pension, it remains tax free. Pensions and ISAs share the same investment options and have the same charges. So, paying tax for no reason seems pointless. However, it could work in some scenarios depending on income and personal allowance use.

A GAR of 7.863% is not that high but that could be because of age. GARs tend to get better at 65+. They may not even exist until 60.

I got a couple of quotes online for a simple lifetime annuity paid monthly in advance and these were around £8,000/£8,100 per annum. So not exactly comparable, but not far off the Royal London GAR figure.

An IFA usually beats the online quotes. So, you can consider those comparisons to be a bit under reality.

As regards a stocks and shares ISA.
25% of the £153,000 would be tax-free. To restrict tax to 20% on the balance I would probably need to take it out in tranches over a few years, but this shouldn't be a problem as I would also need to keep under the annual ISA investment limits.

Why would you want to do that? The Treasury will be quite happy and you would have thanks from the taxpayers but it doesn't seem a logical thing to do.

The net value for investment would be around £130,000 and if the ISA performed at 3.5% pa the annual tax-free income would be around £4,500.

Forget returns when comparing pensions and ISAs as they would be identical.

Robert_McGeddon

Thank you, dunstonh, for your prompt and informative response.

I am a couple of years away from retirement and have not particularly researched my options to date. There is certainly a steep learning curve! I expect I will take professional advice in due course but my short-term focus is on the Royal London GAR – the decision needs to be made within two weeks.

A GAR of 7.863% is not that high but that could be because of age. GARs tend to get better at 65+. They may not even exist until 60

.
That was from age 65. You say an IFA can get better rates than the online ones I got. That pretty much sways me to forego the GAR and take the uplift. I can still take the annuity route in a couple of years but also have the option of investing separately with a larger pension pot.

Why would you want to do that? The Treasury will be quite happy and you would have thanks from the taxpayers but it doesn't seem a logical thing to do.

Well, it seems to all get taxed somewhere! ISAs get taxed at point of investment (unless part of the 25% tax-free lump sum) and pension returns at point of paying out. so one scenario might be to take the lump some and invest in higher return equities inside an ISA whilst leaving most of the pension pot as-is and investing in lower risk/return investments. As I understand it, pension pots are largely tax-free to my descendants if I died before age 75 – this is a definite plus point.

Forget returns when comparing pensions and ISAs as they would be identical.

Got it! A different mindset to what I'm used to.

Thanks again.

dunstonh

Well, it seems to all get taxed somewhere! ISAs get taxed at point of investment (unless part of the 25% tax-free lump sum) and pension returns at point of paying out. so one scenario might be to take the lump some and invest in higher return equities inside an ISA whilst leaving most of the pension pot as-is and investing in lower risk/return investments. As I understand it, pension pots are largely tax-free to my descendants if I died before age 75 – this is a definite plus point.

Why take it out of the pension to move into an ISA though?
Why not leave it in the pension where it is more tax free than an ISA (same on income tax and capital gains tax as an ISA whilst invested but the pension is outside of your estate for IHT. ISA is not).

The general rule of thumb is to not draw money from the pension unless there is a justification for doing so. Paying tax on the pension just to put it in the ISA is not a justification as you have created tax for no reason.

The pension you are currently in is a product of yesteryear. Modern pensions have identical charges and investment funds as the ISA. So, there is no difference in returns or costs. Just the tax handling. You can always move the RL pension to a modern pension once the GAR issue is sorted and you can run it like the ISA internally.

So, choice of investment is not a valid justification as you can do that in the pension if you want.

Terron

If the GAR were not valuable they wouldn't be offering you so much to get rid off it. Whether you should exchange it depends on how good a deal you think the scheme is.


It seems that what they are offering is reasonable at current rates. The benefit to them is that they would be transferring risk to you. If the annuity rate fell between making the exchange and taking the pension you would lose out. Conversely you would gain if they went up.


An advantage to you might be the greater flexibility you would have. I have a couple of small pensions with GARs of 10.6% but the guarantee only applies if it is taken as a fixed single life annuity at age 60+.payable annually in arrears.



So it depends on your attutude to risk and how much you value the flexibility.

kidmugsy

If you're past 55 you've reached the age where it make sense to draw money out of your ISAs and contribute it to a pension. The main exception would be if that led you to be a higher rate taxpayer in retirement. (Or, indeed, to contribute it to your wife's pension if she's past 55.)

Robert_McGeddon

Thanks again, dunstonh.

Why take it out of the pension to move into an ISA though?
Why not leave it in the pension where it is more tax free than an ISA (same on income tax and capital gains tax as an ISA whilst invested but the pension is outside of your estate for IHT. ISA is not).

The general rule of thumb is to not draw money from the pension unless there is a justification for doing so. Paying tax on the pension just to put it in the ISA is not a justification as you have created tax for no reason.

I'm not understanding something fundamental here. I need the pension fund to provide income in retirement. Putting 25% in an ISA is tax free at point of investment and on income withdrawn over the years. If I leave it in the pension pot aren't I subject to income tax on withdrawals? And if the ISA investments were the higher return investments, so much the better......

Thanks also to kidmugsy. The concept of transferring existing ISA funds into a pension pot had escaped me. Not sure I'll do it, but at least I know about it now!

Robert_McGeddon

Thanks Terron.

Pretty much echoes my thoughts.

kidmugsy

Robert_McGeddon wrote: »

The concept of transferring existing ISA funds into a pension pot had escaped me. Not sure I'll do it, but at least I know about it now!

If the TFLS remains at 25%, if you currently pay tax at the basic rate, and if the basic rate stays at 20% when you draw money out of the pension, the money in the pension is worth 6.25% more than in the ISA. (Less costs.)

It's worth much more, of course, if it thereby avoids Inheritance Tax. And it's worth much more if it saves you 40% income tax on the way into the pension. If it saves you both, yippee!

dunstonh

Putting 25% in an ISA is tax free at point of investment

That assumes you draw it at the start. We find the most popular method is to draw the 25% as part of the income. You will get more out tax free that way.

If I leave it in the pension pot aren't I subject to income tax on withdrawals?

I was reading it that you were also going to draw the 75% over time to fund the ISA too. If not, then you can disregard that bit.

And if the ISA investments were the higher return investments, so much the better......

And why cant the pension use those investments?

Robert_McGeddon

I was reading it that you were also going to draw the 75% over time to fund the ISA too. If not, then you can disregard that bit.

You read it correctly - that was my original intent. However, with the help/advice already provided I'm changing my mind!

And why cant the pension use those investments?

My thinking has been that income generated from the ISA investments will be tax free. This is what I would use (in part) fro day-to-day living. I thought income taken from the pension pot would be taxed at my marginal rate, almost certainly BR.

So I may not be understanding the tax implications of leaving monies in a pension pot. I gather there's no tax on capital growth. I'm less clear (i.e. not clear at all!) about monies taken out. Is income taken out taxed at marginal rate or treated as a capital distribution and taxed at 25%? What's the distinction for tax between a continuing pension pot and an income drawdown product? Perhaps someone could point me to a simple online guide? I've seen the moneysavingexpert 23 page pdf about taking pensions and it didn't help me in this area.

Anyhow, the investment side of things is longer term. I'm minded to take the uplift on the Royal London pension pot. I've seen that they will contribute towards financial advice on the matter so I think I will consult a local IFA.

Thanks to all for the quality input to date.