Pensions and annuities confusion explainedPosted on: 13 December 2011 by Andrew Stallard
Andrew Stalllard looks at pros and cons of annuities, income drawdown contracts and your pension.
Amid all the gloom and bad news of the past weeks, a discussion on death and taxes with one of my clients didn’t seem inappropriate and the proverb attributed to Benjamin Franklin one of the Founding Fathers of the United States came to mind:
“In this world nothing can be said to be certain, except death and taxes”.
Is the tax part really true when it comes to pensions though?
My client expressed the view of many people that his pension fund would be lost if he didn’t live until retirement. He was surprised to learn that in the event of his death before retirement, the whole fund - tax free - would go to his wife and family.
Paying money into a UK pension fund is a good way to fund a long and happy retirement, and it also provides protection and financial security to your family if you don’t make it. Sounds good. But (you can usually also be certain of a 'but' somewhere) not all pension schemes are the same. Some pension schemes will only repay the premiums you have paid, not the years of growth. What this means is that a £100,000 fund in this type of contract might repay as little as £15,000 to your family. It’s well worth checking with your financial adviser to see if you have one of these pension contracts.
So was my client wrong in thinking your pension fund dies with you? No not completely. He was thinking of one of the huge drawbacks of buying an annuity. Many people want to convert their pension fund into a secure income for life when they retire by buying an annuity. When you buy an annuity, you exchange your pension fund for a guaranteed income for life, either on a level basis or rising with inflation.
How much you get depends on your age, health, where you live and crucially whether you or your financial adviser shop around for the best rate. Despite this, many people don’t take advice or compare the rates offered by other insurance companies, often to their detriment. The potential problem is that if you purchase an annuity and die under a bus the next day then your hard-earned pension fund is lost to the insurance company in a screech of tyres and a puff of diesel smoke.
If you're one of a couple, there are other things to consider, too. You might want to purchase a partner's pension, which preserves part of the pension until the remaining partner dies. You could also consider a guarantee period, so in the event of an unfortunate omnibus encounter, your pension is paid at least for the term of the guarantee.
Is there any way to leave part of your pension to the next generation?
Yes, there is an alternative and with annuity rates currently low, it is one many people are considering, which is the use of an income drawdown contract, sometimes referred to as an unsecured pension.
With an unsecured pension, the funds remain invested and income is usually taken monthly. The hope is of further fund growth and rising income in the future. Doing things this way means that an annuity can be purchased at a later date when rates might be higher. But, the warning is in the name “Unsecured pension”. Your income is not guaranteed and can decrease as well as increase, or even be completely run out if your income requirements exceed the growth of the fund.
Income drawdown contracts are not for everyone, but many people value the control and freedom this gives them. With this arrangement the fund can still provide a partner's pension in the event of death and be left to the family when both of you have died… but only after a tax charge. There are some things you can always be certain of!
For a free consultation about your pension, call Andrew Stallard on 0845 230 9876, e-mail firstname.lastname@example.org or take a look at our website wwfp.net probably one of the biggest financial advice resources online.
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