Less than half (46 per cent) of couples in the UK make joint retirement arrangements to ensure that, when they die, their partners will continue to receive income, according to new research from Prudential.
A study of 2,002 couples over the age of 40 reveals that one in four (26 per cent) couples have never discussed what will happen to their pensions if one partner dies before the other. Thirteen per cent admit that making a will is the only financial planning activity they have done together.
Seven per cent of those interviewed admit that they will be completely dependent on their partner's income in retirement. Women are twice as likely as men to be dependent on their partner in retirement, with 10 per cent planning to depend on their other half, compared with 5 per cent of men.
Although younger generations are moving on from the days where the husband had a pension and a wife had a husband, with many older couples this is still the situation.
Where a woman has not worked and taken care of her husband, her home and children and doesn't have an income in her own right, it is sensible for the husband to make provision for her income after he dies. Women tend to live longer than men, so if the husband had a good job and a good pension package, but doesn't make provision for his wife, that lady would be at risk of having to live in poverty or fall back on assets such as the family home to make ends meet.
One solution to leaving an income for your spouse is to buy an annuity on a joint life basis. This provides an ongoing income stream for your spouse or partner should you die prematurely. The alternative is to use income drawdown as your spouse can continue receiving an income from this after you die. Most people when comparing the two options look at the income levels.
However, when choosing between income drawdown and annuity purchase there is a key comparison that many investors fail to make. This is the difference in treatment of the pension when you die, which can have significant financial implications for the spouse and family that you leave behind.
Under an annuity, the income and capital are inaccessible once you die, or in the case of joint life annuities on the death of the second spouse. The death benefits under income drawdown - the alternative to annuities - are generally more favourable than annuities. This is a common reason why people enter into income drawdown.
INCOME DRAWDOWN DEATH BENEFITS
In the event of your death while you are in income drawdown your beneficiaries will have the following options:
Taking a lump sum
Any beneficiary can inherit some or all of your remaining fund as a lump sum less a 55 per cent tax charge (note this charge is not inheritance tax, pensions are usually held in trust outside your estate and therefore inheritance tax isn't usually applied).
Continuing with income drawdown
Your spouse or any other dependant can continue to receive your fund as income drawdown (or flexible drawdown if they already have a secure pension of £20,000). This would be based on the age of the spouse or dependant plus GAD rates applicable at the date of designation. The pension pot is not usually subject to inheritance tax, but the income payments are subject to income tax depending on the recipient’s tax band.
Converting your drawdown to an annuity
Your spouse or any other dependant can use your remaining income drawdown fund to purchase an annuity. The pension pot is not usually subject to inheritance tax, but the income payments are subject to income tax depending on the recipient's tax band.
If you enter into income drawdown you need to be aware that there will be different income outcomes for your surviving spouse, depending on investment performance and the age at which you die.
ANNUITY VS DRAWDOWN SCENARIOS
Bob Woods, chairman of Mattioli Woods, a provider of self-invested personal pension schemes and small self-administered pension schemes, has modelled two comparisons for a hypothetical married couple, being a male aged 63 and a female aged 60, who have investments of £350,000 in a pension fund. On a joint life basis they could buy an annuity of £16,837, which would provide a 50 per cent spouse's benefit after the first death of £8,418.
Each scenario was then modelled on two investment return assumptions for income drawdown - the first, a mediocre return of 3 per cent per year net of expenses, and the second a high return of 5.5 per cent per year net of expenses.
Mattioli Woods found that whether or not the member dies early or late in his retirement, the widow would be substantially better off under a drawdown scheme than if the husband bought the joint life annuity.
SCENARIO 1: the husband dies prematurely, predeceasing his wife at age 68 (widow aged 65).
Under the early death scenario, even if the funds in income drawdown only grew at 3 per cent per annum the residual widow’s pension would be £17,150 compared to her half of the joint life annuity of only £8,418.
Under the same early death scenario, using the higher drawdown return assumptions of 5.5 per cent per year, the residual widow's pension would be £19,595 a year, double the annuity.
WINNER: INCOME DRAWDOWN
SCENARIO 2: the husband enjoys a long retirement, pre-deceases his wife at age 88 (widow aged 85 - annuity options restricted after age 85).
If the husband dies late in retirement, they found that the widow's pension is still higher than the annuity, at £12,407 on the lower investment returns, but a massive £52,700 a year if the fund achieves the higher investment returns.
WINNER: INCOME DRAWDOWN
Please note that the comparison is not perfect as it assumes that annuity rates for the surviving spouse remain unchanged, as Mattioli says annuity rates are "imponderable under current economic conditions". In reality a surviving spouse may be able to buy a higher annuity income the residual drawdown fund due to ill health at a later stage in life.
However, if the widow chose not to purchase an annuity but to continue in drawdown, there would also be some residual value for their children after the imposition of the 55 per cent tax charge on her death.
She could also opt to receive pension as a lump sum instead of continuing to draw an income. In this case in the early death scenario, under the 3 per cent investment return assumption she would receive £141,152, and under the 5.5 per cent investment return assumption she would receive £161,233.
In the later death scenario, she would receive £45,234 (3 per cent returns) or £191,714 (5 per cent returns).
HOW EARLY DEATH AND LATE DEATH WORK OUT FOR YOUR SPOUSE
Scenario 1: £350k pension. Drawdown level £16,837
Member dies aged 68 therefore investment returns less pension paid as follows:
|3% return per annum less expenses||£|
|5.5% return per annum less expenses||£|
|Therefore spouse can either take fund less 55%||3%||£141,152|
|Pension from fund or annuity||3%||£17,150|
Scenario 2: £350k pension. Drawdown level £16,837
Member dies aged 88 therefore investment returns less pension paid as follows:
|Therefore spouse can either take fund less 55%||3%||£45,234|
|Pension from fund or annuity||3%||£12,407|
Source: Mattioli Woods
Read more on retirement income.