Special Focus: Pensions Freedom

Special Focus: Pensions Freedom

Pension freedoms are causing big changes to the annuities market as people, understandably, assess whether to buy an annuity or to explore the alternative options came into force in April 2015.

Clive Barwell, an Independent Financial Adviser with Wren Sterling and Accredited Member of the Society of Later Life Advisers, talks about how the new freedoms will impact the annuities market over time and why the role of the adviser has arguably never been more important in pre and post-retirement financial planning.

The impact on the annuities market

Annuities have had a tough time of late. They’ve been bashed in the press for allegedly providing poor value for retirees, so there is understandably a hesitancy to commit to them at the point of retirement. New options have appeared allowing individuals to access their pension pots in ways that were not previously possible. This makes it all the more important to shop around for the best deal.

Changes to pension inheritance laws complicate matters still further. A scheme member will be able to nominate any beneficiary and payments to that individual will be made free of tax, if the pensioner is aged 75 or below at death, whether it is taken as a lump sum or accessed through drawdown.

Unfortunately, this will not apply to dependant's annuities and scheme pensions, already in payment as of 6 April 2015, as these will continue to be taxed at the beneficiary's marginal rate. However, the new rules do apply to protected annuity lump sum payments.

Where a member dies aged 75 and over, the member will be able to nominate any beneficiary to receive the death benefit. Payments to the chosen beneficiary will be subject to income tax at the beneficiary's marginal rate from 6 April 2016 (45% in 2015/16), but there are no restrictions on the level of withdrawals that can be taken.

This has manifested into a 49 per cent drop in annuity sales for Prudential in 2014, while Legal & General expects sales to drop by 50 per cent in 2015.

Similarly, final salary or Defined Benefit (DB) schemes may also prove less attractive as generally they don’t have such generous terms when passing on to spouses or beneficiaries. People can accept a cash lump sum in exchange, but this really does need expert advice to avoid a potentially expensive mistake.

Lump Sum
  • You can take up to 25% of your entire pension fund tax free, as long as the entire pension fund is below the threshold of the Lifetime Pension Allowance (LTA) (£1.25m as of April 2015).

  • Anything between 25% of your fund and the LTA is charged at your marginal rate. Any lump sum(s) is counted as taxable income and may well push you into the higher or additional tax bracket.

  • If your fund is in excess of the LTA then you will be charged 55% tax if taken as a lump sum.

  • With greater freedom, some retirees may choose to take much or all of their pension as a lump sum to invest elsewhere, although this is unlikely to be good advice.

Handing over the keys to the sweet shop?

But with freedom comes risk and the risk of poor decision making in preretirement is now extremely high. As in any walk of life, there will be people attracted to having cash in their pocket who will pay little attention to the long-term consequences. In some cases there will be nothing wrong with this approach if depending on their individual circumstances, they can afford it.

Trading your annuity?

One additional feature of the new freedoms is a the development of a secondary market where annuities can be bought and sold. However, when this comes in – due April 2017 - and if you’re thinking about selling your annuity on this basis, consider the following. If you were considering selling your car and you visit a second hand dealership, the dealer would try to buy your car from you, not tell you whether it’s the best price you can achieve. If you’re contemplating selling your annuity back, it is critical that you speak to someone that isn’t incentivised to buy it from you, or you could end up with a poor deal.

There’s a chance it could be a good deal, but you’re unlikely to know this unless you engage an expert.

Flexible-access Drawdown (FAD)
  • This means taking an income directly from your pension pot.

  • There’s no limit on how much you can withdraw from your pension pot each year.

  • All income is counted as taxable income and assessed accordingly for income tax at the appropriate rate.

  • If any tax-free element remains, this can be withdrawn up to 25% of the fund as a Pension Commencement Lump Sum (PCLS). The remaining 75% will be designated to provide drawdown, which may be taken as a regular income or on an ad hoc basis as required. The amount that can be withdrawn is not subject to income limits; however any amounts withdrawn will be added to taxable income in that year.

  • The reforms mean you can put money back into your pension pot as well, but only up to an annual limit, which is reduced to £10,000 if you are in FAD.

So is the annuity dead?

Reading this article and some of the press coverage, you might be forgiven for thinking so, but the certainty that comes with annuities — particularly when interest rates finally rise — means it will remain a very attractive product for many.

Some of the major providers are reporting dramatic drops in individual annuity sales and in the short term we could see this trend continue. Ultimately, an annuity can be suitable as part of a carefully considered portfolio of different products for many people who want to provide a guaranteed level of income in later life.

Providers will need to work harder to make it a more attractive product in light of the new freedoms, but encouragingly for our clients, disruption in a market usually means those that don’t adapt and compete will leave the space, so pretty soon only the best value products will remain.

The trick of course is making sure you get the right product for you at the right time. The sort of decision best made with the help of an expert, to avoid a short-term binge at the sweet shop that you might regret for a long time.
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