The start of the baby boomer generation reaching state pension age is creating a new and significant retirement advice marketplace. Statistics provided from the 2011 census show that over three million people will reach state pension age over the next five years.
With people living longer and looking forward to a period of active retirement, managing and delivering effective retirement income from their accumulated savings will be key to that process.
A proportion of these clients will have benefited throughout their working life from the best value the state pension system will deliver, as well as receiving benefits from final-salary scheme pension arrangements that many were members of for at least part of their working life.
Guaranteed pension income from the state and from final-salary pension arrangements can provide a bedrock of guaranteed income with potential inflation proofing applying to at least part of that income base. Money-purchase pension savings, alongside other savings clients may have, are the potential areas where advice is needed on how best to use those savings to deliver income needs. Such advice can add real value to client relationships.
The money-purchase pension savings element of a client’s overall savings presents a number of income alternatives.
For many, the purchase of a lifetime annuity will be the only real option available and effective use of the open market option to secure the best available rates is now an essential “to do” action.
People with larger pension savings may want the ability to take income but continue to retain control of their investments, at least for the foreseeable future and is something they are happy to embrace. The use of capped drawdown is a solution that these individuals may seek to use, giving them control of their pension capital and access to a regulated annual income.
Timing of capped drawdown
Timing the move to capped drawdown to achieve the income levels they require can be fraught with difficulty, something which is becoming increasingly difficult as more and more legislative changes come into play.
So much has changed in just the last few months, from the changes as a result of gender neutrality in December 2012, to the increase in income factors by 20 per cent that started to take effect from 26 March this year, to the latest announcement of a new consultation on the GAD tables. It is no wonder advisers and their clients find it hard to keep up and the financial planning process has become increasingly complex.
Factors such as gilt yields that currently determine the maximum income available from capped drawdown arrangements fall outside an individual’s control.
Phasing in of retirement income from pension savings is becoming increasingly used as a means of retaining as much of a client’s pension savings for future use while at the same time creating effective generational tax planning if a client dies before age 75, lessening the tax charges on death.
Avoid the headache with flexible drawdown
Flexible drawdown would help avoid some of the headaches caused by today’s regulatory and economic environment for clients wishing to take full control of how they deliver income from their pension savings.
To benefit from flexible drawdown, people need to have a guaranteed pension income of £20,000 a year, so it is not available for everyone.
Someone retiring today at the age of 65 could potentially need to use up £260,418 of their money-purchase pension fund to meet the £20,000 per annum income criteria (to buy an annuity of £14,273 a year to top up their £5,727 a year basic state pension, assuming no final-salary pension and 25 per cent tax free cash taken).
They then have unrestricted access to the remainder of their money purchase pension savings.
Estate planning benefits
Flexible drawdown has many advantages over capped income withdrawal, but the estate planning advantages are possibly the most significant.
Phasing in their money purchase pension savings to produce the required income uses up less of their pension savings than capped drawdown would require. This leaves more of those savings for future use, and for payment of any lump-sum death benefit (which is not subject to the 55 per cent death tax before age 75).
Of course, once they approach age 75, the estate planning issues are even more prevalent.
Rather than leave money in a pension fund, subject to a 55 per cent tax charge on death, flexible drawdown enables them to withdraw more of their capital immediately, either to take as income or to gift to their beneficiaries while they are still alive, thereby making their overall estate more tax-efficient.
It gives clients complete control of how they want to use their pension savings to deliver their retirement income strategy, without the changing controls imposed under capped drawdown.
Holistic financial planning benefits
People with significant pension savings are also likely to have other savings, and looking at the client’s portfolio as a whole will enable the adviser to put a holistic financial plan in place.
As an example, someone with significant Isa savings could use that to provide tax free income in the early stages of retirement, initially leaving their pension untouched, meaning more could pass on to beneficiaries outside of their estate and free of tax
(if they die before age 75).
They could supplement their Isa income with some income from their pension savings under the flexible drawdown route – so still only moving into drawdown exactly what they need.
Meeting the flexible drawdown criteria is a one-off event. Once this is met, the individual can simply choose as and when they take their pension savings.
The Government has scheduled its review of the flexible drawdown £20,000 minimum income threshold for 2016.
The benefits of flexible drawdown are significant to eligible clients. Not only does it help protect their income level in retirement from any adverse regulatory conditions, but it gives them control and flexibility over how they use their money-purchase pension savings as part of an overall retirement income strategy.
Adrian Walker is pension specialist at Skandia