Personal Pensions

Despite the legal obligation to provide access to a stakeholder pension plan, if no other pension provision is made for staff, many employers still do not offer a scheme into which they contribute. It is possible for individuals to take out individually either a stakeholder plan or a personal pension scheme, normally through a large company or investment institution.

A personal pension scheme offers a number of additional features on top of those attached to a stakeholder scheme. Contributions still receive tax relief within Inland Revenue limits and can still be varied from year to year with additional capital sums being added from time to time. One of the major additional benefits is the ability to have greater control over the investment of the contributions. Most insurance providers and investment institutions offer a wide range of fund choice and for a small additional annual charge will offer a vast majority of their funds to the investor. This is not necessarily the case within stakeholder contracts.

There is still a view that says that the biggest single charge upon any investment contract is poor performance. Therefore this ability to have a greater element of control over the management of the fund can be very useful.

Executive Pensions

For those who have control of a business, either as a self-employed individual or as a director, there can be many tax advantages to be gained by the disposal of surplus income into some form of retirement planning. It is possible to reduce, under the right circumstances, corporation tax, income tax and even national insurance liability by the careful use of pensions. At the same time you can be creating a private fund of money that potentially can support the expansion of the business which, under the right circumstances, can provide a very attractive alternative to banks and which all of your interest payments can go straight back into your pension fund. There may also be advantages in the purchase of corporate property and could even be used to smooth the transfer of a company from the older to the younger generation.

There are many factors to be considered and the charges levied under these types of schemes are likely to be greater than those levied under stakeholder and personal pension arrangements. The decision as to whether to invest in these types of schemes will be dependent upon many factors including the ages of the business owners, their individual aims as well as their existing pension arrangements. Indeed investing in any form of self invested or executive scheme should not be done purely for tax reasons however if the provision of a retirement fund can be done more tax efficiently under these types of schemes then clearly they should be given serious consideration. The very complexity of this area means that advice is extremely important as is ongoing consultation.

Annuities

Life and pension annuities provide a guaranteed income for life. A lump sum of money, normally provided from the residue of a pension scheme, is used to purchase an annuity from a life assurance company. A company will quote a rate of return, which will be based upon the estimated life expectancy of the individual who is investing the money, together with interest rate levels and other factors such as the provision of indexation and a spouse’s pension upon death. The older the investor, or annuitant, at the time of purchase, the higher the annuity for a given sum will be.

An annuity payment, other than a pension annuity, is deemed to be part income and part repayment of capital, normally therefore upon death of the annuitant there is no residual value. It is however possible, under pension annuities, to build in a spouses pension upon the death of the annuitant. These types of schemes, joint life, second survivor schemes, are likely to provide a lower initial level of income because of the increased life expectancy on two lives.

It is also possible to have increasing annuities as well as to guarantee a period of payment however some or all of these features are likely to reduce the initial amount of income.

Annuities are a key element in pensions provided by stakeholder and personal pension schemes, freestanding additional voluntary contributions schemes and money purchase schemes. With the exception of the tax-free cash lump sum, a pension fund must be invested under current legislation in an annuity and this must be done before the annuitant reaches age 75. The level of pension will therefore depend upon the age and interest rates applicable at the time of retirement. Income from a pension annuity is treated as wholly earned income and is therefore liable to tax in full.

Phased Retirement

More and more people approaching the age of retirement do not now wish to give work up completely, many will prefer to make a gentle move from full time working to eventual retirement, enjoying increased leisure time on the way. Most personal pension plans are arranged so that individuals can take just part of the scheme at a time leaving the rest to grow in a tax free environment. This enables individuals to defer taking their full pension entitlement.

Most modern day pension schemes are based upon a “clustering” arrangement. This enables people to draw income from parts of the pension plan, the clusters, both as an income and potentially as part of the tax-free cash. This may mean that a fund can be gradually phased into the income stream by taking part of the clusters tax-free cash with the balance of the cluster being converted into the annuity. This enables part of the pension fund to continue growing but has the advantage of providing a specific amount of income at the time it is required. This phased approach, taking the effect of taxation into account, is becoming more important and used as we start to retire gradually.

As the phase into retirement gets greater so more clusters are converted into part tax-free cash and part annuity although the balance left must be converted by age 75.

As well as having advantages with regards to phasing in retirement, it also could increase the annuity rate that the balance of the invested money receives because as individuals get older, annuity rates tend to rise. In addition it is also possible to be used as a way of increasing income at certain specific times in direct coloration to an individuals tax position.

There is however the possibility that fund values will fall and that annuity rates, already low, may deteriorate further thus resulting in the need for a larger proportion of the fund to be utilised as well as not providing the anticipated income when eventually converted. Again individual advice is crucial if considering this type of action.

Because of the flexibility of phased retirement it will be of interest to many and can be utilised in connection with Drawdown.

Drawdown

During the last ten years annuity rates have fallen significantly, caused primarily as a result of lower interest rates and improved life expectancy. Both are major determinants in how much an insurance company can afford to pay out an income. In addition lower Government borrowing has also reduced the yield available from gilts, which are used by insurance companies to back annuities.

Until the mid 1990’s the only alternative to purchasing an annuity at retirement was not to do so but to rely on other income in the hope that the annuity would improve later. This changed however with the introduction of pension fund withdrawal, or Drawdown as it is known. Since then it has been possible to take the tax free cash from a pension plan and draw an income directly from the fund, between certain limits set by the Government. This income can be varied from year to year, which makes it far more flexible than so called phased retirement. But the cost can be higher and many consider that this form of investment is not normally appropriate for smaller pension funds or where there are other income producing assets.

The minimum and maximum income levels are set for three years, at the end of which new limits are set by reference to the individuals’ age, the pension fund and the Governments actuary tables.

As with phased retirement, with which pension fund withdrawal or Drawdown can be used, it has the major advantage of delaying the purchase of the annuity in order to see whether investors can get a greater return whilst allowing the majority of the fund to continue growing in the tax advantageous environment provided by pensions. This means keeping the pension fund invested rather than having to convert to gilts, which are what annuities are based upon. However the value of investments can go down as well as up and annuity rates could get worse therefore leaving the individual with a smaller income in the future.

Recent changes have also made it now possible to change the fund manager up to once a year therefore if investment performance deteriorates, or charges become unacceptable, moves can be made with the balance of the fund although not all insurance companies have yet implemented this facility.

As with phased retirement this arrangement cannot run beyond age 75, which means that an annuity must be purchased by that age. This facility can be even more strengthened by being used in conjunction with phased retirement but again because of its complexity professional financial advice should always be sought before taking this option.