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Ill-gotten gains

At age 54, I have accumulated over £290,000 in various pension funds.

My plan is to take early retirement and poss-ibly continue with some

consultancy work. I quite like the thought of taking tax-free cash now but

will need only a modest level of inc-ome in the short term.

I take an active interest in investments and most of mine are planned to

mature in 10 years or so. While my health is not too good (two heart

attacks in the last five years), I think I am too young to buy an annuity.

What should I do?

At 54, you may consider yourself too young to purchase an annuity. Many

people consider them to be poor value for money currently. But don&#39t be too

dismissive as they do provide a guaranteed stream of gross income for life

even if, in many other respects, they are a little inflexible.

As someone who might be described (excuse the industry jargon) as an

“under-average life”, you can benefit from improved annuity rates as a

result of your increased mortality risk. Even leaving that aside, it is

possible to purchase a unit-linked or with-profits annuity where future

income is linked to ongoing investment returns.

Although you wish to consider alternatives to annuity purchase, we can

conveniently use that option as a comparative reference point.

You state that you want to take tax-free cash from your pension fund now

and that may well be perfectly possible. The amount you receive will depend

on a number of factors, principally, the nature of the pension fund. If it

is a personal pension where the fund has been accumulated as a result of

your own and possibly your employer&#39s contributions, then the tax-free cash

lump sum will be 25 per cent of the fund value.

Occupational pension scheme rules for the calculations of tax-free cash

are very different and, depending on the tax regime applicable to your

pension fund, could be inthe order of up to 1.5 times your final earnings.

However,I suspect you will not beable to have such a big amount due to your

early retirement.

If you decided to transfer your occupational scheme benefits to a personal

pension, the maximum tax-free cash would be carried over by virtue of a

rule which requires tax-free cash certification for anyone transferring

over the age of 45. The Inland Revenue is paranoid that occupational scheme

members will transfer to personal pensions simply to obtain greater

tax-free cash although the reality is somewhat different.

What will happen to the balance of the fund? If you do not use it to

purchase an annuity, the fund will continue to be invested but you will be

required to draw some income from it. This is the income drawdown route

perceived by many commentators as being risky.

The risks, however, can be quantified. Put simply, they are:

Investment risk: Dep-ending on the selected investments, the capital value

of your pension fund might go down rather than up. The future value of the

fund may not be able to provide you with an appropriate level of income.

Interest or annuity rate risk. As you get older, annuity rates tend to be

higher. But with increased life expectancy and falling long-term gilt

yields (on which annuity rates are based), there is no guarantee that

future rates will be better than they are today.

Mortality drag. Put simply, if you delay buying the annuity, you miss out

on some of the profit inherent in annuity rates as a result of some

annuitants dying sooner than expected. Sounds bizarre but it is not to be


You must also take into account that you will have to pay charges to keep

the pension fund invested.

If you do decide to go for income drawdown, I recommend that you use a

self-invested personal pension as the drawdown vehicle.

You can retain complete investment control and, typically, a Sipp is going

to be cheaper than a conventional insurance product, with explicit fees

charged by the provider and IFA rather than commission payable to the IFA

by the provider.

Remember to review the plan on a regular basis, at least yearly, and

adjust the chosen investments over time to reflect the needs of the fund

and your changing attitude towards risk/reward and volatility.

Finally, an income drawdown fund retains the potential for a capital sum

to be paid in the event of your early death.

With a conventional annuity, provision can be made for a surviving spouse

to continue to receive an income, with a consequential reduction in the

starting income for you. It may also be possible to guarantee an income for

a minimum number of years.

With income drawdown, on an option is for your survivors to take the

capital value of the fund, less a 35 per cent tax charge. With your medical

history, you might want to hedge your bets and keep such an option open.


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