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't 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's 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
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.