Income drawdown vs annuity purchase at retirement

Paul_Herring

champys wrote: »

Interesting, I didn't know that - can you explain why an annuity bought with non-pension cash is more tax efficient? Or should I take that to another thread.

With a normal pension annuity, all the money received is treated as income and thus 100% of it is liable for income tax (subject to personal allowances and income from other sources, e.g. state pension.)

With a purchased life annuity, some of the money received is treated as return of capital so is 'tax free' (since it was taxed when you first got it) and the rest is treated as income, and it is only this latter proportion that is liable for income tax

dunstonh

Whilst a purchased life annuity is more tax efficient. It may not provide the best "bottom line". A lifetime annuity can be rated more on price than a purchase life annuity. So, the gross annuity rate can be higher and maybe enough to beat the purchased life annuity.

There is also the potential to feed the tax free cash back into the pension again as long as its not in breach of HMRC rules. That can be a good option for someone retired to put in £3600 a year for a few years and then take that chunk of pension later. It gives boost in income later whilst still getting tax relief when you are not working. The net effective rate of income can come out to around 9% (more if older and ignoring growth potential).

jamesd

twentyfour11 wrote: »

Is it possible to take an Income Draw Down and invest the money in property? I am thinking of some Freehold Ground Rents (residential).

Within a SIPP you can purchase commercial property, including borrowing to buy it. You can't purchase residential property. I don't know the position of residential freeholds but expect that they would be treated as residential property and prohibited. You could probably hold them in a unit trust that invests in them.

Except for the 25% lump sum you can't currently withdraw more than that from the pension pot to do anything you wish with. There's talk of this changing, in which case, subject to sufficient guaranteed income, you might be able to draw most of the pension money and invest it freely. However, the money you withdraw would be taxed as normal income, including at 40% or 50% rates if you draw out enough to take you into those tax brackets.

twentyfour11

thank you for the info on SIPPS.

champys

Paul_Herring wrote: »

With a purchased life annuity, some of the money received is treated as return of capital so is 'tax free' (since it was taxed when you first got it) and the rest is treated as income, and it is only this latter proportion that is liable for income tax

Thank you, I can see that makes sense. But if I would purchase a life annuity with money that was previously invested, I guess I would first be liable for capital gains tax, if I sell the shares in order to buy an annuity?

Paul_Herring

champys wrote: »

Thank you, I can see that makes sense. But if I would purchase a life annuity with money that was previously invested, I guess I would first be liable for capital gains tax, if I sell the shares in order to buy an annuity?

Outside of a tax efficient wrapper (an equity ISA for example,) you'd be taxed only on the gains (subject to allowances again,) but in a similar manner to the purchased annuity, the original capital won't be taxed, since it came from taxed income.

jayship

Si have a retirement fund with Zurich of £100,000. Not very savvy with investing (although am in the market) but likely to get a better return via SIPP under drawdown compared to annuity rates that are low at the moment. As i am 64 they suggested that i should switch to a fund with low risk where the money is invested in banks and building society short term products.The product fact sheet showed a nil return in the last 2 years but no loss. To do this there is a charge of £55 which is insignificant. However what concerns me is the buying and selling spread of 5% which will cost £5000 that will be incurred when i request a trasfer to HL Sipp which is my preferred option at this stage. The managed fund has recovered the losses incurred since May 2010. Hence the urgency before the markets go loopy again. Any advice will be appreciated. Come on Dunstoch and other savvy investors.

middlepuss

When comparing an annuity with income drawdown people often point out that income drawdown from a stock market investment is riskier than an annuity because the value of your fund will fall if stock markets go down.

But does this matter? Suppose you have an income drawdown SIPP invested in a unit trust and only take as income the dividends the unit trust pays.

OK, the capital value of the units may fall, but so what? The income from your (we'll assume well spread) unit trust may not fall at all, probably won't fall very much and may even rise despite the capital value going down.

So, is the risk of income drawdown somewhat overstated?

dunstonh

When comparing an annuity with income drawdown people often point out that income drawdown from a stock market investment is riskier than an annuity because the value of your fund will fall if stock markets go down.

Its not really stockmarket as anyone with 100% equities in drawdown clearly isnt investing sensibly. Its investment risk vs no investment risk.

OK, the capital value of the units may fall, but so what? The income from your (we'll assume well spread) unit trust may not fall at all, probably won't fall very much and may even rise despite the capital value going down.

What if you have had a 45% stockmarket crash and you have taken out more than the natural income so your value is say 60% lower than the value at the last review? What would happen to the income then? (working on your basis of 100% equities).

So, is the risk of income drawdown somewhat overstated?

No. Although sometimes it is viewed too simply as risk vs no risk when in reality its a combination of risks vs a combination of different risks. However, it is a riskier option than annuity.

Lee_Martin_2

There's no doubt this is an important issue and one that needs further investigation. I will be speaking with my clients about the matter and taking them through how it effects them and their pension provisions. If you have an IFA you should consult them about your individual circumstances.