Derek is a new client who has come to me with a grievance. He is someone who has been gravely disappointed by the Chancellor’s back-tracking on alternatively secured pensions. Now that they have been rendered virtually unusable, Derek’s long-term plans for his quite substantial pension funds have been shredded. What should he do?
Annuities can be a pretty tedious subject to deal with. They can also be difficult to advise on because they are so important for retirees but perceptions of them are generally negative.
Derek had been holding off on his pensions because he did not believe annuities offered good value and he had other assets to support his fairly minimal drawdown. He had been using a drawdown policy on part of his funds for a few years and had been looking forward to the idea of family pensions.
His options are now limited because he reaches 75 in a couple of years and so wants to know how best to move forward.
It seems that I am of a different opinion to his previous adviser in that I believe that conventional annuities offer considerable benefits and so we have lengthy discussions about them. They offer a degree of certainty that one cannot get anywhere else.
I illustrate to Derek the difficulty in generating a reliable stream of income from a portfolio of assets, whereas annuities can provide a stable core income for life with very little risk.
He has also told me that he is looking for simplicity, clarity and reasonably low risk in his financial affairs as he get older. Coupled with the fact that his wife is some 10 years younger than he is, good old-fashioned non-profit annuities have a lot to be said for them.
We can start by reducing the annuity options down to two – non-profit annuities and ones with some sort of investment linking. Derek has said he does not want much in the way of risk, so this basically precludes any sort of unit-linked options.
He is too old for capital-protected annuities and other options such as the annuity growth account, flexible lifetime annuity or open annuity are mostly too complicated and/or risky.
So we are left with non-profit annuities but he will be happy to accept some level of risk through a with-profits annuity.
Having had many with-profits investments over the years, Derek understands the concept and is content to include a with-profits annuity for a portion of his fund. We have agreed on guarantees for 10 years, with a two-thirds widow’s pension. The question of index-linking is tricky because of his wife’s age but in the end we decide to opt for level annuities because of the other assets that are available to them both in the future to provide inflation backing for the annuities.
I show Derek that it can take over 25 years before the accumulated purchasing value of an index-linked annuity catches up with the level one. He accepts also that it is in he early years of retirement when cash needs are likely to be highest.
So he opts for 75 per cent level annuities with 25 per cent in with-profits. He can start off with a with-profits annuity on a 3 per cent assumed bonus rate that is only a little lower than the level one, with some potential for growth.
With-profits annuities also offer some protection so that, if the worst comes to the worst with investments, there is a floor below which his annuity will not go.
After looking at some fairly basic financial planning projections, I show Derek that by locking in his annuities now, thereby giving him some certainly of income in the future, backed by sufficient assets for inflation protection, he actually has a great deal more scope for inheritance tax planning than he would have done had he simply stuck to the notion of Asps.
Asps might have enabled him to pass on his pension funds to his children but by switching the emphasis to annuities, he can now make some provision for minimising the amount that he passes to the Exchequer. So his children will still benefit – and sooner rather than later because he can help them with IHT-effective gifts during his lifetime rather than only on his death.
He is very happy with the strategy of using annuities and particularly so now that he can contemplate some asset protection for his family.
Mark Bolland is a director at Chamberlain de Broe.