The big shakeup
Until the shakeup announced for pensions in the recent budget, people coming up to retirement had few options. The most common option was to buy an annuity, where your pension pot was used to purchase a fixed sum of money payable to you for the rest of your life. With annuity rates linked to interest rates, and with interest rates at unprecedentedly low levels, annuities represented poor value for money.
For example, a sixty five year old who had built a pension pot of say £300,000 could take a tax free lump sum of 25% straight away. The remaining £225,000 would be used to purchase an annuity, which would give them a taxable income of approximately £10,000 per annum payable for the rest of their life. That sum would be fixed and the effects of inflation would erode the real value of that income over time. Worse still, the annuity would die with them, so for example, if they lived until they were 75, they would effectively have lost £125,000.
A myriad of baffling choices
Options such as inflation linked annuities and guaranteed pay-out periods exist, however it’s a bewildering and difficult choice and everyone agrees that annuities are restricted and dysfunctional. These restrictions have been discouraging for younger savers building a fund and for those at retirement; effectively having to second guess when they are likely to die before choosing which annuity option may be best for them.
The annuity conundrum may now be a thing of the past, with the Chancellor deciding that people now have the freedom to do whatever they want with their pension pot – taking the entire pot in one lump (subject to tax) if they wish. This increased flexibility is great news for savers and even greater news for those close to retirement. The problem is, will it be abused?
Open to abuse?
I was listening to a radio program recently where this very subject was under discussion. A gentleman called in and said that he would be using his entire retirement fund to purchase a yacht and would hire it out to holiday makers in the Canary Islands, using that income to fund his retirement. Not a bad idea, but it didn’t come across as very well thought through. I wanted to ask him what would happen in the off-season? And how would he cope if business took a dive through recession or increased competition? And whether the stress of running a yacht hiring company could really be considered retirement?
Antony Lopez, IFA at Sterling & Law says, “The greater freedom is welcome. After all, it’s your money and you should be able to do with it whatever you see fit.” On the subject of abuse and purchasing that Lamborghini, his response was this: “Anyone who has saved a large enough pension pot to buy a Lamborghini would probably be a fairly prudent person in the first place and therefore trustworthy enough to manage their money responsibly.”
My opinion is that people will continue to buy annuities, as they are a tried and tested option. The Buy to Let market will surely explode with purchasing a property to let becoming an extremely popular choice for retirement income. The one single common denominator is that getting financial advice from a good financial adviser will be absolutely crucial. Start thinking about it now!
Akwasi Duodu, Sterling & Law Independent Financial Consultants