The new dawn of pension freedoms finally emerged from the shadows earlier this month, bringing with it the ability for people aged 55 and over to cash in their pension savings. However, new products have not yet appeared, meaning the options available are largely the same as before – other than the additional ability to cash-in savings with the tax consequences that action brings.
Meanwhile, the humble, much-maligned annuity has had a facelift. They can now provide a money back guarantee on death, removing a key downside and providing people value from their annuity whether they live or die.
This month’s new rules remove the old one that restricted annuity guarantee periods to 10 years. And while value protection was available it was seldom used as lump sum payments were subject to an onerous 55 per cent tax charge.
Now an annuity can pay an ongoing income for 20 or 30 years, irrespective of when death occurs, or pay a lump sum equal to the initial purchase price less income taken, giving families peace of mind the money invested in providing a secure income will not be lost. This removes the understandable sense of financial injustice that was sometimes felt when an annuitant died early.
Meanwhile, the tax changes introduced mean beneficiaries will pay less on that annuity death benefit than previously – and no tax at all if death occurs before age 75. Even on death after age 75, advisers can help mitigate the tax impact. For example, rather than leave all benefits to a partner who may pay income tax, some could be left to a grandchild who can receive some income or lump sum tax-free.
These changes give much more flexibility and control to annuity customers and are likely to prove popular with people previously concerned about providers retaining the balance of the fund on death. This key change can reinvigorate the annuity market. Despite the freedom and choice being introduced, many are still looking for some level of guaranteed regular income in retirement.
There has been enormous media focus on people cashing in their pension to go on a cruise, invest in property or buy the much-advertised Lamborghini, but for many the aim will be to use the majority of the savings to ensure they have an income through their later life. While drawdown will be used more as a result of these freedoms, many will be uncomfortable with investment risk later in life as well as dealing with the uncertainty over how long they will live. A guaranteed income – sourced through the competitive open market – together with the certainty their family will benefit should they die, means “money back” annuities are well placed to help customers and their families.
Andrew Tully is pensions technical director at MGM Advantage
David is a 65-year-old smoker with a £100,000 pot who wishes to provide death in retirement benefits for his wife Sarah.
If he chooses a single life annuity with no death benefits, he can get an income of £6,100 a year. If he opts for an annuity with 100 per cent value protection his starting income is £5,570. David dies nine years later aged 74.
If he had chosen the basic annuity he would have received £54,900 (9 x £6,100) income in total. No further benefits would be payable after he dies.
If he had chosen the value protected annuity, he would have received income of £50,130 (9 x £5,570). On his death, a further payment would be made to his nominated beneficiaries of £49,870 (£100,000 initial purchase price less £50,130 paid to date). As he died before age 75 the £49,870 is paid free of tax.
A 20-year guarantee period would achieve a similar outcome but with the death benefit being paid as an ongoing income following David’s death, rather than a lump sum. Similar to above, ongoing income instalments are paid tax-free if death is before age 75. If death is age 75 or later, income is taxed in the hands of the recipient. Longer guarantee periods of, say, 30 years may appeal to those who want to prioritise an ongoing income to their family.