Drawing a pension

Posted on: 14 March 2008 by Gareth Hargreaves

Confused about choosing an annuity? Experts explain where to begin.

As the time to draw a pension nears, those without a final salary scheme may be wondering what to look for in an annuity. Others may be contemplating whether to opt for an annuity at all and wish to explore other ways to secure a comfortable income during retirement. Read on for some answers.

I'm 61 and will retire soon. I have a company pension. What are my options for drawing an income - should I stay with my pension provider or shop around for an annuity? Are there other options?

Robert Edge, Annuity Direct:

In short you should contact an Independent Financial Adviser as your company pension may be a lot less than what you could receive by transferring your pension to another company.

How much you receive is undoubtedly important but before deciding what to do the following needs to be considered:

  • Does the pension need to continue after your death to provide for a spouse?
  • Are you, and or our spouse, taking any medication and do you smoke?
  • Does the pension need to increase each year to protect against inflation or will other incomes / investments provide protection?
  • What is your attitude to investment risk?

As an annuity purchase is just one option available it is important that you receive specialist advice at this time.

Jason Witcombe, Chartered Financial Planner, Evolve Financial Planning:

You mention that you have a company pension. If this is not a final salary pension, you should almost certainly shop around. Logic suggests that only one pension provider can be offering the best annuity rate at any given point in time so the odds are that it is not your pension company.

One exception to this is where you have special guaranteed annuity rates via your pension. These are often well in excess of what you would be able to obtain on the open market.

If you are a smoker or are in poor health, you may be able to obtain an enhanced annuity.

To get an idea of what annuity rates are available, visit the annuity tables page on the FSA (Financial Services Authority) website. Alternatively, contact an IFA through Unbiased.

If you don't want to buy an annuity for a particular reason, speak to an IFA who will be able to run through the alternatives. These involve some form of investment risk but can suit certain investors.

Donna Bradshaw, Financial Planning Strategist, IFG Group PLC:

Your options will depend on the type of pension scheme and the scheme rules.

If it is a defined benefits scheme for example, you will receive a pension based on your service and salary - these schemes are commonly referred to as final salary schemes. The scheme may also have attractive dependents benefits and the pension will be guaranteed and increase each year. These are expensive benefits to buy and very difficult to match in the open market.

The scheme rules may also impose restrictions on transferring the pension. You may also be entitled to take a tax free cash; however, make sure you check the rules, the rates for converting pension to cash can be highly unattractive with the amount of cash received far lower than it would cost to replace the pension given up - be sure to check the rules and if you have an AVC (Additional Voluntary Contribution), rules permitting, take the cash from that.

If your pension is a defined contribution scheme the story is different as you will have build up a pension fund which is then used to provide an income for the rest of your life.

Independent financial advice is essential and the IFA's fees will be more than offset by the boost you will receive in pension income.

They can advise you on whether income drawdown is appropriate, for people with smaller pension funds and no other income or income generating assets drawdown is higher risk and expensive.

If annuity is the right route, they will source the best rates on the market; there are significant differences between the best and worst annuities.

They will also take into account among other things; your total assets, your attitude to risk, tax, your future income needs, whether you have financial dependents and their need for income and your state of health; when working out the most appropriate planning for your needs.

You can get a list of independent financial advisers in your area from Unbiased.

Christopher Wicks, Certified Financial Planner, Director, N-Trust Limited:

Your options depend on the type of scheme that you are in. If it is a defined benefit (final salary) scheme you will not normally have the option of shopping around different providers since responsibility for meeting the pension promise made by the scheme rests with the trustees.

If you are in a defined contribution scheme - for example Personal Pension, Stakeholder Pension or an Occupational Money Purchase Scheme - you will be able to shop around.

Before you do this you need to consider your requirements. For example, if you are married you may want to include provision for your wife. You may also wish to build in a guarantee period which will ensure that if you die with a specified period after the annuity has been set up that the payments continue for the remainder of the period. You may also wish to build in some inflation proofing although the age at which the total income received under an index linked annuity catches up with a level annuity tends to be around age 84. This means that for most people a level annuity is likely to be best.

Once you have considered your requirements, possibly with the advice of an independent financial adviser, you should then obtain quotes from the scheme of which you are a member for the types of annuity which you are interested in. You should also ask them to provide the Open Market Fund Value as well as confirmation that you can draw the benefits without penalty or loss of guaranteed benefits.

You can then obtain quotes from other providers to see who will provide you with the best rate.

It's as simple as that! Bear in mind that once you have made your choice and the money has changed hands you may not change your mind, so don't make a mistake!

Of course, there are a range of other options including Unsecured Scheme Pensions and Phased retirement which involve continued investment and give additional flexibility which you may find useful particularly if you have to wait four years before the state pension kicks in.

This is an area where there is a huge range of options and the best recommendation I can give you is to take some advice from an independent financial adviser specialising in pensions.

Billy Burrows, William Burrows Annuities:

Although you are retiring, you don't necessarily need to take your pension, therefore there are three very important questions:

  • When do you take benefits?
  • What type of pension? Annuity or drawdown?
  • What options are best suited to your circumstances?

If you need tax free cash or pension then obviously take benefits now. However if you don't need cash or income you could defer taking your pension until a later date. There is now an option to take tax free cash but no income until age 75.

The type of annuity or drawdown will depend on the following factors:

  • Your income requirements
  • Attitude to risk
  • Your personal circumstances
  • The need for flexibility

In general terms, risk adverse investors will purchase annuities. Those wanting to benefit from investment growth will be interested in drawdown. With-Profits annuity provides the potential for growth within an annuity. Those who place a high value on income flexibility and lump sum death benefits will consider drawdown. Don't forget you can have a bit of each.

The actual choice of annuity options depends on personal circumstances but the following guidelines generally apply:

If you are married you should consider a joint life annuity. You can choose the level of the spouse's pension but the normal choices are:

  • 100%
  • Two thirds
  • 500%

Some people consider a single annuity with a 10 year guarantee as an alternative. If you are single you obviously consider a single annuity but should consider a guarantee period:

  • 10 year guarantee
  • 5 year guarantee
  • No guarantee

Although a level annuity pays the highest income initially, overtime inflation will reduce the purchasing power. Therefore it is important to consider an escalating annuity:

  • Level payments
  • 3% escalation
  • Inflation linked (RPI)

The final choice is payment frequency. The main choices are:

  • Monthly
  • Quarterly
  • Half yearly
  • Annually

Payments can be in advance or in arrears.

Finally, don't forget you shop around for the best annuity and if you are in poor health you can qualify from an enhanced annuity.

Steven J Robinson, Managing Director, Clarke Robinson & Co Ltd:

With a company pension it's the trustees of the scheme who have the real control over what will happen. As trustees they have to act in your interests and should act according to your wishes and within the rules of the scheme.

Having said that the answer depends on the type of company scheme you have.

If you have a Defined Benefit (Final Salary Scheme), ie one where you earn a fraction of your salary for each year of service, for example 1/60th, the questions don't really arise because the level of pension is guaranteed and the pension provider is not relevant. You probably just need advice on whether or not to take the tax-free lump sum. Most people shouldn't.

Your question suggests that you have a Defined Contribution (Money Purchase) scheme ie a fund of money has built up which can be used to provide a pension. In which case:

The trustees will automatically provide you with a choice of the figures from the existing pension provider. This would usually be a range of options, pension with cash lump sum; pension without cash; single life pension, pension with widows pension, level pension, increasing (index linked) pension and variations of this.

After you select one of these then the trustees' advisers should then shop around for the best deal for you and this is where it most often falls down. It is the trustees' responsibility but most small schemes will take the default option and you end up with the same provider. As an independent adviser to trustees I always shop around at this stage so the trustees always get the best deal for the members but many schemes deal direct with the provider so no alternatives are sought. The trustees don't have a pension specialist independent adviser. I guess that at some stage in the future a lot of trustees will find themselves answering some embarrassing questions.

If you were the trustee of a money purchase scheme or you had a personal pension and were in control of the process then the answer is:

Firstly you can take 25 per cent as a tax-free lump sum then:

For drawing an income:

You may purchase an annuity on the open market - called an open market option - with the highest rate available. It is always recommended to shop around but you also need to check if your existing pension provider has guaranteed annuity rates - some do and a client I advised in February had rates which were 90% higher than the open market option.

If any of the following apply then you may get better rates with a specialist company for health reasons:

You are - or were - a smoker, have worked in industry, mines, blue collar, have had health problems, heart attack, high blood pressure, high cholesterol, and so on.

The annuity can be single life or joint life, can be level or increasing at a fixed rate - for example 3 per cent - or index linked. It can have a minimum guaranteed period - if you die early it carries on for a while - or can even be capital protected - it almost all pays out eventually.

Other options depend on how much money is in the fund and your other personal financial; circumstances but can include:

Income Drawdown - leaving the money invested to grow and drawing the pension directly from the fund - this needs £100,000 as a minimum starting point to be viable normally - unless you have plenty of other money and can take the risk.

A With Profits annuity, similar to drawdown as the funds remain invested but with just one company and the growth depends on bonuses.

There are other variations on these themes as well.

You can find the answers to all of these questions and maybe get a good deal yourself by in depth research on the internet. Some internet advisers offer a fixed price for buying an annuity but I have yet to see one that not only mentions all the comments above but also has the background to understand the options mentioned - and those that aren't - and can fit them into your own circumstances. You need to find an Independent Financial Adviser with a G60 qualification and make sure it is this person who advises you and not someone else at the same firm.

Julie Bayley, Keswick IFA:

The options for this case will in some way depend on the scheme rules of the company pension in question.

If the scheme is a defined benefit or final salary scheme, then the employee will in most cases be offered a sometimes optional, tax free cash lump sum plus a pension income, which is defined in £s. This income can increase in line with for example RPI (Retail Price Index) each year again depending on scheme rules. Also the employee may have made some additional voluntary contributions to the company pension, which he may now take tax free cash/pension income from.

If the company pension is alternatively a "money purchase" scheme, where the value of his pension pot buys an annuity, then it may be possible to compare the company pension provider's annuity quote, then if appropriate exercise the open market option and shop around for the best annuity rate for him. For instance, if this person has health issues or smokes, he may get a better income by arranging an impaired life annuity.

In short without seeing the scheme rules or discussing his individual circumstances, it would be hard to advise this client. I would recommend he seeks Independent Advice as even if he chooses to take company pension as quoted, he still may have options for investing any lump sum tax free cash into tax efficient investment vehicles ie ISAs for income or capital growth and so on, which can be important after 75 due to age allowance factors.

Alan Dick, Forty Two Financial Planning:

It is difficult to be specific about your options without knowing the details of your company pension scheme. There are several different types of scheme available all with different features. In addition to this each scheme has its own set of rules which govern the options available to you.

The first thing you need to do is find out which type of scheme you are a member of and check the scheme rules which will determine your options. The company will have a pension adviser who can answer questions on the scheme rules. This may be someone in the HR department or an external adviser.

Most schemes allow you to take part of your pension as a lump sum. This is often attractive as it is tax free and may allow you to achieve a specific once in a lifetime goal. Even if there is no immediately need for the lump sum it could be invested and provide a cushion for future unexpected outgoings that can't be covered by monthly income.

You need to be careful with tax free lump sums though - particularly from final salary schemes - as they do not always represent good value. The cost of providing a final salary pension can be horrific so taking the lump sum and investing it may result in a lower overall return in the long term.

If the scheme allows you could consider transferring to an alternative provider to secure a higher annuity rate. This may be particularly attractive if you have suffered any serious illnesses in the past such as cancer, heart attack or stroke. Smokers can often increase the level of pension available by transferring to an impaired life annuity provider. In some cases the uplift can be as much as 30 per cent.

In many cases company schemes dictate the format of your pension - for example increasing in line with inflation and providing a widows pension of two-thirds. In some cases members may want to draw their benefits in a different format such as level in payment with no widows pension. This can be important if the scheme rules don't recognise your preferred beneficiary - some schemes only recognise legal married couples, some don't recognise civil partnerships and so on - if you are single or if your spouse has sufficient income in their own right to not need a share of your pension.

If the scheme doesn't allow you to draw benefits in the form you require you may need to transfer to an alternative annuity provider. However, you should think carefully about whether you require inflation protection or spouses benefits before giving them up. Many people underestimate average life expectancy and consequently the period they will be reliant on their pension income. They also underestimate the dangers of inflation.

Another option that may be available to you is to take your pension in the form of income withdrawals (Unsecured Pension). Most schemes are unlikely to allow this option but you may be able to transfer to a personal pension to gain access to the increased flexibility. However, the increased flexibility of both income and death benefits offered by USP comes with a high degree of investment risk. If your company pension is going to be your only source of income in retirement and you are likely to need a high proportion of this to meet your normal living expenses the investment risk may be too great to be worth taking.

 

Find An IFA

 

Search for Independent Financial Advisers in your area.

Need Advice?

If you require any assistance you can contact:

Annuity Direct: 020 7684 5000 or: www.annuitydirect.co.uk

Evolve Financial Planning: www.evolvefp.com

IFG Group: www.ifg.co.uk

N-Trust: www.n-trustgroup.co.uk

William Burrows: www.williamburrows.com

Clarke Robinson & Co: www.clarkerobinson.co.uk

Keswick IFA: www.keswickifa.co.uk

Forty Two Financial Planning: www.fortytwofp.com

Financial Services Authority (FSA): www.fsa.gov.uk

Independent Financial Advisers (IFAs): www.unbiased.co.uk

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