Income drawdown vs annuity purchase at retirement

jamesd

It's easy enough to do but before you opt for flexible drawdown, are you still working and able to make more pension contributions? If you are, you'd probably benefit from doing that before starting flexible drawdown, since you'd make a tax gain on the 25% tax free lump sum, even if not the rest. If you don't actually need the income from the existing pensions, recyling their income into more pension contributions can be a nicely profitable idea.

Offgrid

Inspired partly by Spakkaman above... Ours must be a fairly common situation so apologies if it's already been addressed here and I missed it. Also, I'm a pensions novice (e.g. I haven't considered SIPPs yet - I'm no longer in employment but my wife is) and some of my assumptions may be wrong.

Starting March 2015 my wife and I (aged 60 & 61) will retire having combined £13k per annum index-linked DB pension, £200k DC pension fund, £390k in cash (half in ISAs), and £55k in equities. Then in 2019-2020 we each get £7.5k pa State Pension (fingers crossed).
Mortgage paid off, no debts or dependents, we can live comfortably on £32k pa before tax now.
I'm trying to decide whether Flexible Drawdown could be useful for us, e.g. perhaps to minimise the income tax we pay, especially after our SPs kick in.
Route 1: Going the flat annuity route with our DC fund would yield say £9k pa + £50k tax-free which would leave a £10k pa gap to fill from savings for 5 years but then mean income of around £40k pa when the SPs start, implying income tax on around £17k pa (assuming the personal tax allowance has risen to £11.5k by then).
Route 2: If we use £150k of our cash in March 2015 to buy a flat annuity, we'd meet the £24k pa secure pension income threshold (and income tax on £4k) necessary for Flexible Drawdown. Our DC fund in FD could then very likely take us sustainably to the £32k pa (say £36k by 2020, but we could pad out to this from savings if necessary) we need (after taking £50k tax free lump sum) and then be reduced when the SPs start, meaning income tax on around £13k pa.

So, it seems to me it would cost us £150k to be able to use FD, to let us reduce taxable income by £4k (although our remaining FD fund may grow, and would be bequeathable).

Have I missed some other benefit to using FD? Or does it really only work for those whose DB pension meets the £12k threshold?

jem16

Offgrid wrote: »

So, it seems to me it would cost us £150k to be able to use FD, to let us reduce taxable income by £4k (although our remaining FD fund may grow, and would be bequeathable).

Have I missed some other benefit to using FD? Or does it really only work for those whose DB pension meets the £12k threshold?

You would be best to try and wait one month till the new pension regulations kick in from April 2015. At that point you don't need any £12k income requirement to draw down your DC pot.

atush

I agree.

But I have to say, holding 390K in cash and only 200K in pension is amazingly bad. While you still have an income, whack as much of that cash into a/the DC pension as you can, and open 2x 15K S&S isas. If you wife doesn't have a DC pension open one for her and max it (taking into acct her DB pension)

Offgrid

Jem16 thanks, I didn't know that. It changes everything.

Atush, thanks as well, but 200k is in DC pension, we also have the £13k pa in DB. We believed we were maxing out DC contribs but may not have been. My wife has AVCs - are you suggesting we put more into those (I don't know if this is possible)? I am not employed.
We are pretty much theoretically maxed out in cash ISAs already (including this year). Is the Pensions vs ISAs argument (as discussed in another thread in this forum) settled in favour of Pension?

Sorry for the naive questions. I find this all quite complex.

jem16

Offgrid wrote: »

Atush, thanks as well, but 200k is in DC pension, we also have the £13k pa in DB. We believed we were maxing out DC contribs but may not have been. My wife has AVCs - are you suggesting we put more into those (I don't know if this is possible)?

AVCs are not the only route as you can use a personal pension. Is the £200k in AVCs or is your wife's AVC separate to that?

As to whether or not more pension is needed, I'm not so sure unless your wife is a higher rate taxpayer? All pension income is taxable apart from the 25% tax free lump sum. The idea would be to use up your personal tax free allowance in retirement. With £13k DB pension, you have another £7k to utilise. That can be drawn from your DC pension. Anything above this would be taxed so you lose the tax advantage unless your wife is currently paying higher rate tax.

kidmugsy

The way to do your drawdown next tax year is by "phased drawdown". Each year you crystallise (i.e. take benefits from) just part of your DC pension. That means that the remainder is uncrystallised, so that if you die that bit can pass to your widow tax-free. If your DC provider doesn't offer that option, transfer to one that does. (I enjoy the excellent service from Hargreaves Lansdown, but they are probably too expensive for a sum as large as £200k - unless they will let you haggle.)

An obvious alternative is to leave all your money in the pension pro tem and instead spend down that huge pile of cash. Be sure that you both use up your annual allowance against income tax though (£10,500 p.a. from April).

atush

You if you are not employed, can still put 2880 into a DC pension, and this gets grossed up to 3600. And you can not 'retire' if you want and keep paying in if you like- but hard to say as the 13K DB pension you mention we have no idea how that and the 200K is split between you. Basically you want to use the person who has less DB income to be able to use the DC pension as income up to your PA so as to not pay tax.

AS for the cash, I said to put more into pension if you can for the tax relief if you are about to be pensioners. Esp for your wife is she is earning. This is better than AVCs as it isn't tied to the main pension scheme and can be taken at any time (or left for the spouse to inherit tax free).

That is a whole lotta cash, losing ground to inflation each year (ie shrinking and not growing). This is big a risk as investment risk over long periods (like retirement).

So even if you didnt' use pension (and I would) you should really have at least some of it invested so as to be able to beat inflation.

Offgrid

Thanks again guys, helpful comments...

Jem16: The way the £200k is split: £55k is in my wife's AVCs, which are linked to her £6.5k pa DB workplace pension (she is not a higher rate taxpayer and she will cease work at the end of September i.e. in 2 months). £145k is in my deferred DC pension from previous employment, closed to further contributions. So, as you say, our DBs plus what the £200k would purchase, pretty much takes us up to £21k pa pension income i.e. same as the tax threshold next year. This was the point of my original question although I should have made it clearer.

Annuitising the £200k DC we could have £21k pa DB +DC pension income next FY. But we need £32k pa. In 2020 we'll have the SP taking our DB + DC + SP pension income to £21k+£7.5k+£7.5k=£36k pa, plus some indexation so say £38k - well above the income tax threshold in 2020. So my question re-phrased is: how do I best bridge the £21k (income) to £32k (required) gap now to minimise our exposure to income tax when our SPs kick in? This is why I started thinking about an alternative to a plain old annuity for my £145k DC fund.

Kidmugsy: Thanks for this tip - it sounds like I should learn all about phased drawdown. Perhaps it will be useful.

Atush: The £13k DB is split roughly 50:50 between us. And cash... this is a separate discussion, maybe for another thread... but I know we have a lot of cash, however we have £55k in various equities and I have kept track of this versus our cash over the last 16 years and the cash growth was ahead until very recently. We have chased the best rates for cash and moved it frequently to keep ahead. In equities there somehow often seems to be a gap between the return I actually receive and the published fund performance; several times I've found the "Total" in TER is not what it seems and that extra charges have been applied. It feels as though you need to be a full-time detective to make sure you are not being ripped off. Effective inflation for us is pretty low: paid off energy efficient house, no dependents, small car, don't want to go on world cruises. Anyway you've made me think about it, maybe there is still time to do something.

I have a retirement advisor visiting next week. Really you guys have helped me understand a bit more. I think the deeper one's understanding the better the conversation you can have with a professional. Thanks all.

kidmugsy

Offgrid wrote: »

£55k is in my wife's AVCs, which are linked to her £6.5k pa DB workplace pension ... she will cease work at the end of September i.e. in 2 months).

Then there's time to check whether your wife's is one of those DB schemes which will let her take all her tax-free lump sum from the AVCs, with the whole of the DB "pot" directed to pension.

Offgrid wrote: »

Annuitising the £200k DC we could have £21k pa DB +DC pension income next FY. But we need £32k pa. ... So my question re-phrased is: how do I best bridge the £21k (income) to £32k (required) gap now to minimise our exposure to income tax when our SPs kick in? This is why I started thinking about an alternative to a plain old annuity for my £145k DC fund.

i) You are far too young to annuitise.

ii) You could reserve your ISAs for tax-free income-generators such as cash or bonds, and hold equities exposed to tax, on the grounds that as long as you are both well under the 40% tax band, there's no extra tax to pay on the dividends. You would be exposed to CGT but you can usually avoid that by buying and selling adroitly. Additionally note that there are stunts for avoiding income tax such as VCTs and EISs. They are seen as high risk, but you could argue that they'd balance your cash pile. I'm considering them for us, but holding fire until (if?) Wall St collapses.

There is, however, no avoiding the fact that asset prices are high, and current and prospective returns low.

AFTERTHOUGHT. What is the date for your wife's State Retirement Pension starting?