The decision to abolish compulsory annuitisation was a no-brainer from the outset. Forcing people at age 75 to take their pension savings and buy a product which locked them into a rate of return based on interest rates at the time, just didn't sit comfortably with industry calls for 'flexible' retirement solutions and government initiatives aimed at encouraging people to save more for their old age.
But come next April, you will no longer be 'forced' into purchasing an annuity at age 75 (or be left with the only other option: an Alternatively Secured Pension (ASP) and its nasty tax implications). Instead you will have a choice: buy an annuity or opt for a retirement alternative which allows you greater investment control over your pension pot: income drawdown. Under the new proposals you will further be able to choose between a 'capped model' of income drawdown with restrictions on how much income you can draw or a more flexible model of income drawdown which will allow you to access money in excess of the cap provided you can prove that you will not need to fall back on the state. The greater investment choice and flexibility is certainly welcomed (especially after more than 30 years of 'forced' annuitisation) - but be aware of the risks that come with an income drawdown strategy.
The costs
Income drawdown's 'formal' name - unsecured pension (USP) - is such for a reason. While an annuity guarantees you an 'income for life' there is no such guarantee with income drawdown. Yes, under income drawdown you are the 'master of your own destiny' with the ability to decide where your pension money is invested and how much income you will draw from your pot. However this comes with a significant dollop of risk. In 2008 many retirees in drawdown watched in horror as the volatile stock market nosedived, taking a significant chunk out of their pensions savings with it. Then there is also the risk of running out of funds during drawdown - a risk which increases with advancing age.
Another drawdown risk which has recently made headlines is the the issue of high charges eating away at pension pots. Thomas Rampulla, managing director at Vanguard, says that in the UK the combination of management costs and commission costs are having a significant impact on an individual's personal savings pot, much more so than happens in the US. He comments: "Savers who invest into their company pension scheme pay around 0.3 to 0.5 per cent (both here and in the US) - that's because the schemes are typically arranged by fee-based advisers and make more use of passive investment. However, for those taking control of their own pension pot, using products like self-invested personal pensions (Sipps) and drawdown, it is much more expensive in the UK, with an average charge of around 150-200 basis points, as opposed to a US charge of 75-80 basis points. The difference is that commission and high-cost active investment funds are more prevalent in the UK whereas US advisers have switched to fees and lower-cost passive investments, just as with a defined contribution pension scheme."
Higher fees can influence how comfortably you retire. Mr Rampulla says that with the rules on taking an annuity by age 75 changing, income drawdown is set to become more popular but charges could have a huge impact. "The difference for a 65 year old, between a 0.27 per cent (low cost, passive) and the more typical 1.66 per cent annual total expense ratio (TER) is the difference between their pot running out at age 88 rather than 85, or being able to take a 15 per cent higher income," he adds.
Investing your pension pot in passive vehicles such as exchange-traded funds (ETFs) or trackers can bring costs down significantly but there are caveats. For example, many tracker funds held exposure to BP by reference of the index they tracked and have been badly hit by the oil giant's fall in profits and dividend suspension. An actively managed fund would have been able to exit the position and relocate funds elsewhere. The issue of whether an ETF has UK distributor status is another concern for investors putting their pension into passive plays. If they don't, ETFs are subject to income tax at 50 per cent rather than capital gains tax (CGT) at 18 per cent or 28 per cent, which is normally applied. ETFs domiciled in France and the US for tax purposes, but with a listing in the UK, can also be subject to a foreign withholding tax.
The admin
Concerns have also been raised around the current rules and administration burden surrounding income drawdown arrangements. According to Skandia each time a proportion of a pension fund is moved into income drawdown it can take on a timetable of its own in terms of the maximum income levels that can be taken and the dates when these are reviewed. For people phasing into retirement this can result in them having multiple income drawdown arrangements all operating to different time tables. This can often turn into an administrative nightmare for both investors and their financial advisers.
Adrian Walker, pensions specialist at Skandia, says it is not uncommon for someone to end up with eight different income drawdown arrangements resulting in eight review packs being issued, all at different times. Some of these will have a formal five year review of the maximum income, others will not. This makes it very difficult for financial advisers to recommend the correct income strategy for their client and for the investor to understand the overall level of income available to them. Ultimately the current rules can lead to increased costs as well as greater complexity.
The positives
Investment risk, costs, and cumbersome administration aside, there are of course a number of advantages to the new changes. For anyone with commercial property invested in a Sipp, the need to buy a pension annuity at age 75, had meant the property would have had to be sold before the annuity could be purchased. In the current market this may have been very difficult unless the property price was significantly reduced.
David Platt, partner at law firm Adams & Remers, says the abolition of compulsory annuitisation is good news for those with sufficient pension funds to invest in commercial property. He adds that while there certainly are some well priced opportunities for those with the cash or funding in place, this has to be balanced against the possible constraints on the future growth of commercial property values and income voids on rent while the economy is struggling out of the recession - and withdrawing the need to sell property in order to buy an annuity gives a certain amount of flexibility to some investors.
But Mr Platt points out that there is one sting in the tail of the government's announcement. Under current legislation, if a person dies before age 75 having drawn down income (albeit at a capped rate) under an USP arrangement any funds not drawn down can be paid out as a lump sum, taxed at 35 per cent. However, the government now proposes that, in those circumstances, any unused funds on death will be taxed at a higher rate of 55 per cent. This will be unwelcome for pensioners wanting to pass on their remaining pension funds to their next of kin.
He agrees with many pension industry experts that the real benefits of the new flexible drawdown proposals will only be felt by those with a very large pension pot given that investors will need to demonstrate they have sufficient pension income for life without having to rely on a state pension at a later date.
