What all retirees need to know before they make use of new pension flexibility rules.
Unless you’ve been living on a desert island for the past year, you’ll be aware that from 6th April the rules on how benefits can be taken from money purchase/defined contribution pension plans, changed to provide total flexibility as to how and when funds can be withdrawn.
While this new flexibility will provide useful opportunities for some, for many people it will represent a significant risk to their long-term financial security.
A guaranteed income is what most retirees want and need
Most people don’t want to take the risk of running out of money or be making complex investment and tax decisions in later life. The UK’s Financial Conduct Authority (FCA) has carried out research on annuities and it found that a guaranteed annuity is, contrary to popular belief, very good value for money. It is also an extremely simple and low cost way of securing a lifetime income.
But annuities are poor value…aren’t they?
The main way to measure the value of an annuity is called Money’s Worth (MW). MW provides a simplified measure of how much of an annuity premium the average annuitant gets back in income payments, taking into account life expectancy, interest rates and annuity rates. Any amount over 85% is considered good value. FCA found that between 2006 – 2014 the average MW was 94%, but the MW for the best value open market annuity was 99%.
“Our economic analysis….has shown that for people with average sized pension pots and low risk appetite, the right annuity purchased on the open market offers good value for money relative to alternative drawdown strategies.”
(Source: FCA, Occasional Paper No. 5: The value for money of annuities and other retirement income strategies in the UK. Dec 2014).
While the FCA paper conceded that NOT buying an annuity would be attractive for some people, it referred to the extensive independent research which suggests that even wealthy people should annuitise at least 50% of their pension wealth. The average optimum amount to allocate to annuities was about two thirds of pension wealth, with higher amounts for less wealthy people.
“….for the vast majority of people, annuitising a substantial part of their wealth at retirement is very likely to be the right choice…”
A fool is easily parted from his money
An annuity won’t be right in every situation and one needs to take into account total level of wealth, income tax, health status, age, dependants, personal risk profile/preference and the desire to leave a legacy. But retirees should compare all alternative retirement income strategies to the simple, low cost and low risk provided by a guaranteed annuity.
Likewise, if you have any deferred defined benefit pension entitlement, you need to think very carefully before giving up these guaranteed benefits for a cash transfer payment. If the transfer value is greater than £30,000, then it is now a mandatory requirement that the member has been given individual advice from a UK regulated financial adviser. Pension trustees can only make a transfer payment if they have received a letter from the adviser, confirming that they have given the member full advice on the transfer.
If you can’t work out what to do on your own then by all means seek either free guidance from the government sponsored Pension Wise service or pay for advice from a professional financial adviser (which you must do for defined benefit transfers > £30,000). Just don’t rush into doing something that you may regret for the rest of your life.
This article was generously contributed by Jason Butler, who is a Chartered Wealth Manager with City based Bloomsbury Wealth Management and author of The Financial Times Guide to Wealth Management.