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TEPs: Tep forward for annuity alternative

The ruling that obliges all members of money-purchase company pension schemes and holders of personal pensions to buy an annuity at or before age 75 has caused much concern among the financially conscious population.

People are forced to buy an annuity with accumulated pension funds knowing that if they die soon after buying the annuity most, if not all, of the value they diligently saved will be forfeit to a pension provider to fund the pensions of longer living folk.

The compulsory annuity purchase date was extended to 75 years because of increased longevity. The need for a compulsory conversion of pension savings into an annuity is due to the Government fearing that retirees will run amok with their pension funds, fritter away their savings and then expect state support for the remainder of their lives.

It could be argued that those who have had the foresight and financial ability to ensure that they are able to draw an income from their investment after retirement age are hardly likely to choose to blow their assets and then elect to live on state benefit. That said, with no alternative to annuities that can provide a regular income facility to everyone, the Government is unlikely to overturn the ruling compelling one to convert pension savings to provide an annuity sooner or later.

In recent times, the pension problem has been subtly compounded by the steady shift of performance risk from pension fund managers to investors. This is a direct consequence of the increased popularity of unit-linked products as the promoted investment as opposed to more conventional with-profits products. If a unit-linked fund does not perform, the manager still gets its fees in full and the investor suffers the consequences.

Where a 1 per cent annual charge is levied from a client&#39s funds by a fund manager who has, in today&#39s terms, done relatively well to achieve growth of 3 per cent on the portfolio, the year&#39s performance does not even beat inflation. This is particularly hard on the investor who has to purchase an annuity with these funds during a year when performances are even worse.

The conventional with-profits products offered by life offices add bonuses on an annual basis as an allocation of profits made in the preceding period. Once they are added, these cannot be retracted. Unlike those managing unit-linked products, the institutions managing with-profits funds have to perform to pay their commitments on the maturity date, irrespective of what has happened in the markets.

While it is acknowledged that the performance of recently demutualised life offices has debased this commitment due to the pillaging of with-profits funds to pay shareholders and even salesforces in recent years, the devastation for investors has been less than for those who invested in unit-linked products.

The effect on the with-profits products has been to reduce the funds available to sustain bonus rates for future adverse market performances. On the other hand, unit-linked managers simply continue to levy their fees at the agreed rate, irrespective of how their funds perform. The risk of performance has been cunningly passed from the institutions to the investors.

So, for those who have the means to invest in income-generating investments designed to protect capital for reinvestment, what alternative is there to a straightforward pension scheme – an alternative that need not be converted to an annuity, reduces the risk of loss and safeguards the capital sum for reinvestment and inheritance?

We believe we have come up with an alternative that gives the investor control over his or her investment, allows the residue to pass to the heirs and carries with it the ability to change the income stream to suit changing circumstances. In addition, it may be set up to pay an above-average income compared with a conventional annuity. This is especially useful if the investor is a basic-rate taxpayer approaching or starting retirement.

The basic principle of this alternative is that the investor deposits a lump sum of money into a plan to purchase traded endowment policies which, in turn, are used as collateral with a designated bank to obtain a credit line. The bank credit is used to acquire more policies and at the same time ensure that all the future servicing costs of the arrangement – policy premiums included – are met from within the plan. Once the plan is set up, the investor has nothing further to do.

Plans can be set up to provide rolled-up growth for a number of years before the withdrawal of a regular income stream. The timing of the income is set to suit the individual&#39s needs, with some income streams starting almost immediately after the plan has been set up while others are deferred until nearer the end of the plan.

As plans grow with each passing year, they may also be extended by the addition of policies that will mature in succeeding years. This allows the plan to benefit from the spreading of capital gains tax liabilities to utilise allowances from a number of years.

Further benefit is gained from progressively increasing the capital available to fund an eventual income stream due to the addition of annual bonuses that boost the surrender values of the policies within the plan.

For those potential investors with high net assets who, even into retirement, are likely to be higher-rate taxpayers, there are a number of innovative and tax-efficient structures that can be established to minimise the tax payable on the gains made from these products. These structures can be bequeathed to heirs on the death of the investor and can be switched from a wealth accumulation vehicle to an income source as an investor&#39s circumstances change.

Another very useful way to look at these plans is to view them as pure savings plans which have already been taxed at the basic rate applicable from year to year. The accumulated funds can be used how the investor chooses after the plan maturity date. The investor has total control over how he or she invests the money further and does not have to satisfy any conditions imposed by the Government or anybody else.

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