Your retirement choices unravelled
Being a dentist in private practice you have had to manage your own finances. You will have (hopefully) been paying into your own private pension plan for a number of years. It makes sense to ensure your pension savings work as hard as possible, when you turn them into an income to live on.
Here, I’ll try to shed some light on the main options.
Until the 1990s, the only real choice for anyone with a maturing pension plan that wasn’t a final salary scheme, was to buy an annuity. Annuities came in differing shapes and sizes – single or joint life, with or without inflation proofing – but they weren’t that exciting.
I do think the ordinary annuity is a much better product than many give it credit for. It does one thing very well – it guarantees you an income for the rest of life, no matter how long that is. Nothing else does this. The virtue of such a guarantee is that it leaves you with more flexibility to manage the rest of your money creatively, knowing that your annuity will keep paying out.
Annuity rates vary enormously between insurers. Retiring investors should always shop around to ensure that they get the highest annuity rate; this can be done easily by using annuity comparison websites.
The annuity your existing pension company offers you may represent dreadful value for money. On average, an investor can improve their pension income for life by more than 15% by shopping around. As the typical 65 year old will live for another 20 years-plus, this additional income can amount to thousands. This is a one-off decision, so get it wrong and it could prove to be an expensive oversight.
The following table highlights the best-buy deals, based on a fund of £100,000. These deals change frequently, so ensure you always get the most current rates available.
Age 60: Level pension £6,726 (male) £6,378 (female)
Age 60: RPI-linked pension £4,033 (male) £3,672 (female)
Age 65: Level pension £7,459 (male) £6,974 (female)
Age 65: RPI-linked pension £4,768 (male) £4,311 (female)
(Source: Hargreaves Lansdown)
Are annuities good value?
In the short term, rates are near a four-year high, so many investors consider this to be a good time to buy an annuity. Bond yields have significantly widened in the wake of the credit crisis, which has been helping to push up rates. There’s a fierce price war amongst the top annuity insurers. The consumer should benefit.
Future annuity rates
We are all living much longer and insurers have lowered rates to reflect this. Life expectancy at age 65 has risen at a rate of three months a year over 25 years, adding several years on to the average annuity payment period. This is set to continue, with a corresponding knock-on effect of lowering of annuity rates.
Rising commodity prices and the credit-crunch are causing real inflationary fears that could push annuity rates up.
We might look back on 2008 as an annuity highpoint.
Some insurers will pay a higher income if you have certain medical conditions. Statistics show that people with some health conditions have a shorter than average life expectancy. These specialist insurers use this to your advantage: they will pay you a higher income because they calculate that, on average, your income should be paid out for a shorter period of time. About 40% of people could obtain enhanced rates. Don’t miss out.
It might seem counter-intuitive, but you should paint the blackest (but truthful) picture of your state of health. If you smoke 20 cigarettes a day, shout about it. Everyday conditions – 1500 and rising and including being overweight and diabetes – could qualify you to an enhanced annuity.
Here are examples of the rates available for relatively minor conditions. (£50,000 fund for a 65-year-old male, single life, no escalation or guarantee.
Annuity p.a. % Increase over ordinary annuity
Best Ordinary Annuity £3,719
Smoker £4,447 20%
Enhanced annuity, based on high blood pressure, cholesterol and obesity £4,245 15%
(Source: Hargreaves Lansdown)
This is an alternative to buying an annuity. You draw an income directly from your pension fund, whilst the fund remains invested. It allows you to retain ownership of your investments. You continue to manage your pension fund and make all the investment decisions. The amount of income you receive each year can be altered, which is useful if you are gradually reducing your workload at your practice. However, there are no guarantees. If your pension savings are decreased by withdrawals or poor performance, your fund and income will be reduced. You bear the investment risk – unlike an annuity. You need to be comfortable to accept this risk. If you’re not, it may be sensible to buy an annuity instead.
Drawdown investors can withdraw their tax-free lump sum at age 50 (55 from 2010), and leave the balance of their pension fund invested until they need it, perhaps ten years later. Given recent stockmarket turbulence, some investors have been doing this as way of generating income for the next few years, but leaving the majority of their pension savings intact in the hope that markets will recover.
Death benefits for drawdown plans are a definite attraction. An annuity’s main problem is that once you have made your choices, you’re stuck with them forever. With drawdown, nothing needs to be decided in advance. On your death, your surviving spouse can carry on with the drawdown plan as if it were their own; take the entire fund and buy an annuity for themselves; or take the fund value as cash, less a 35% tax charge.
If you’re comfortable with making your own financial and investment decisions, there are a number of companies that will offer fantastic value for money for both annuities and income drawdown plans. Some will offer top-notch investment research and state of the art web-based service. Any web engine search will throw up a number of possible candidates. However, if you unsure or need advice, make sure you see an appropriately qualified IFA.
• For further information, contact Nigel on 0117 980 9970 or email him at [email protected] Hargreaves Lansdown are at Kendal House, 4 Brighton Mews, Clifton, Bristol BS8 2NX.