Mr Singh, 65, is a self-employed property developer. He and his wife, 64, are in good health and he has no intention to give up work. He has £95,000 in a paid-up retirement annuity contract which does not offer any guaranteed annuity rates. His wife is retired and has adequate pension provision.
He wants to release the full pension commencement lump sum from this pension pot as he requires capital to invest in his properties but only needs a small additional income from his pension of around £1,500 a year in order to top up his current income of £16,000, made up of state pension and rental income.
He is not happy with current annuity rates and does not wish to lock into an income for life at the present moment. He wishes to minimise the investment risk on his pension provision.
Issues to be aware of:
Option of accessing tax-free cash without without committing to a lifetime annuity
The risks associated with fixed term annuities
With the client and his wife being in good health, they are ineligible for an enhanced annuity and with relevant income under £20,000 this tax year, the client is unable to do flexible drawdown. Standard annuity rates, both level and increasing, are not attractive to the client as he does not wish to fix his income for life at the present time.
With the pension pot below £100,000 and Mr Singh wanting the full pension commencement immediately phased retirement is not suitable, as most of the income drawn in the first year would actually be tax-free PCLS.
A fixed-term annuity (capped drawdown) is a possible solution for the client. These contracts are actually written under drawdown rules and therefore subject to GAD limits and 55 per cent tax on any lump-sum death benefits.
The maximum tax-free PCLS can be paid out to the client and subsequent income payments are usually for a fixed term and a guaranteed amount is payable at the end of the term which can vary depending on the amount of income selected.
Typical options include value protection, guaranteed periods and a spouse’s pension. It is also possible to include lump-sum death benefits although these would be subject to 55 per cent tax.
There is a risk of annuity rates being lower at the end of the term and the initial income from these types of plans tend to be lower than that compared with standard annuities. However, in this case, the client does not require the maximum amount of income at the present time.
To reduce the likelihood of income falling after the fixed term ends, a client should not automatically opt for maximum income and should instead consider the provider’s default option which should represent a sustainable income.
If the client’s health has worsened during the subsequent period, he may be eligible for an enhanced pension at the end of the term. The plan should not be recommended if a client would not be able to withstand a reduction in income at maturity due to falling annuity rates.
Recent innovations have meant some of the providers now offer the ability to transfer out during the fixed term if client is eligible for an enhanced annuity, on death of a spouse/civil partner or divorce or if client now qualifies for flexible drawdown. The transfer value of these break options is currently unclear, so there is the risk element here, so a client looking to take out this type of plan needs to be made fully aware and all the risks be explained.
It is imperative that any client considering fixed-term annuities are made fully aware of the benefits and risks in adopting this pension retirement strategy but for the right type of client, fixed-term annuities certainly should not be discounted out of hand.
Aj Somal is a chartered financial planner at Aurora Financial Planning