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General Election 2017

We are living through interesting political times and this year’s General Election did not fail to deliver. The Conservative gamble that a snap election would strengthen their hand in Brexit negotiations and allow (current) Prime Minister May to pursue her version of “hard” Brexit has failed to pay off. Now the Conservatives are relying upon a confidence and supply deal with the Democratic Unionist Party who, whilst in favour of Brexit, do not want a hard Irish border. Throw in the various factions within the Conservative party and the phrase “coalition of chaos” seems quite apt.  

The outcome of the election, assuming further voter fatigue is not endured by returning to polling stations before Christmas, should lead to a softer version of Brexit being pursued – something which may see Nigel Farage return to front line politics to ensure the "will of the people" is honoured. Irrespective of which coalition is in place it would be naïve not to acknowledge that the UK’s negotiating position has been seriously weakened due to the absence of a government with a strong mandate.  

Sterling has weakened as a result of the hung parliament, which will further fuel the inflationary pressures on UK households. In times of uncertainty households and businesses usually defer spending and this is something which would further dampen a slowing economy. One positive note for Sterling is another Independence referendum could be off the table for the time being. Moreover, if the long-term direction of travel is towards a softer Brexit, then the appreciation of Sterling should follow suit. Conversely, if the coalition government collapses and Brexit negotiations became acrimonious then Sterling will weaken further. 

In the immediate aftermath there has not been a mass selling off of UK Gilts (bonds issued by the government) which is normally a sign of a loss of confidence in UK plc. The outcome for Gilts is a bit unclear at present; future higher borrowing (e.g. to fund infrastructure spending) would likely lead to a sell off but in the short-term, with the Brexit outcome unclear, UK Gilts are likely to hold steady.

Until the strength or weakness of the new government is revealed in practical terms, it will be impossible to accurately predict its strategy for the economy and Brexit; therefore market reactions in the coming weeks and months could be…unpredictable.

Fact or fiction: Are annuities poor value for money?

Since the introduction of the pension freedom legislation, annuity sales have fallen significantly. There are a variety of reasons for this but one that is often mentioned by clients is they are “poor value for money”. Whilst it is true that annuity rates are not as attractive as they once were, the perception of poor value is open to challenge.

The change in legislation has made income drawdown available to the masses, providing greater flexibility on when and how much pension benefits are drawn during retirement. Moreover, the potential for investment growth and the ability to pass on the capital value of pension savings on death is attractive, especially as it will usually be free from the clutches of inheritance tax and potentially income tax.

Income drawdown, whilst attractive, does come with the challenge of sustainability. As a society we are living longer and this has implications for income drawdown users, especially as there is a tendency to underestimate one’s own life expectancy. According to the Office of National Statistics a 65 year old male will on average live to age 86 but they also have a:

• 25% chance of reaching 94.
• 10% chance of reaching 99.
• 7.2% chance of reaching 100.

These figures show that a significant number of retirees will rely upon their pension to provide them with an income for 30 years or more. Therefore, the sustainability of an income drawdown strategy is crucial to making retirement a success.

There are a number of risks when using income drawdown but the most significant is investment risk. There is no getting away from it – poor investment performance will have an impact on retirement income, especially if it is endured over a prolonged period of time.

A great deal of research has been conducted on what rate (%) income can be withdrawn from a pension in order to provide a sustainable level of income for life. For a number of years conventional wisdom stated 4% was an appropriate starting withdrawal rate for a portfolio split 60/40 between equities and bonds. This rate would then be increased by inflation each year. However, a recent study by Morningstar UK found that for such a portfolio:

• An initial withdrawal rate of 4% only has a 78% chance of lasting 30 years.
• An initial withdrawal rate of 3% has a 90% chance of lasting 30 years.

Clearly this shows the risks facing drawdown users. An income drawdown contract with an appropriate and diversified strategy has the potential to provide investment growth in excess of the rate of withdrawal; however investment returns are seldom linear. A drawdown contract spanning 30 years will inevitably endure periods of underperformance. If such periods are prolonged income may need to be reduced to ensure the pension fund remains sustainable over the long-term. As an example, a portfolio which falls by 5% requires a return of 5.3% to recoup the losses; whilst a loss of 20% requires a return of 25% to break even. Some individuals, will be able to tolerate a small drop in the value of their pension but few will be able absorb larger drops in value.

So how is this relevant for annuities? An annuity, if bought for life, is guaranteed to provide an income until death and also has the option of building in a spouse’s pension. The main drawbacks, apart from “poor” annuity rates, are the loss of capital on death and the inability to alter income once it has commenced. 

Annuity providers are offering a variety of features to make these contracts more appealing such as fixed term contracts with a guaranteed maturity value and the ability to protect the purchase price which creates the possibility of being able to pass on a capital lump sum on death. Based on current market rates a 65 year old male with a pension of £100,000 (after tax-free cash) could receive a starting income of £3,250 p.a. from an annuity which:

• Is on a single life basis.
• Income increases by 2.5% p.a.
• Is payable for life.
• Will return the annuity purchase price, less any income received upon death to a beneficiary of the annuitants choosing. 

This income is at a starting rate of 3.25%, higher than Morningstar’s suggested rate, provides certainty during retirement (i.e. the income will not run out); an element of inflation proofing and it still provides the potential of a lump sum to a beneficiary of the annuitant’s choosing. Moreover, health factors (e.g. high blood pressure) could lead to a higher rate being offered. The drawbacks – the income cannot be changed once it has commenced and there is no opportunity to benefit from investment growth. 

For many individuals annuity purchase will not be appropriate but a successful retirement plan is about finding the right balance between security and opportunity. When structuring a retirement plan it is desirable to have all essential expenditure secured by guarantees thereby eliminating investment risk. Essential expenditure is the daily cost of living and this cannot be stopped or reduced. Annuity contracts, final salary pensions and State Pensions play an important role in providing security and eliminating investment risk in retirement.

Once essential expenditure has been secured, discretionary expenditure can be withdrawn from invested assets. If investment performance is poor over a particular period, then discretionary spending can usually be deferred or reduced. Essential expenditure cannot.

Taking a pragmatic approach to securing and structuring retirement income in this manner can help lay the foundations for a stress free retirement. 

Annuity rates are not as attractive as they once were, but in an environment where retirement is lasting upwards of 30 years, sustainability of income is crucial. Given this backdrop, can a product which provides certainty of income, potentially at a higher rate than the recommended “safe withdrawal rate”, be considered poor value for money?

If you or someone you know are approaching retirement and would like to discuss their options, please get in touch via the contact details below for a free no obligation meeting.

Protecting yourself against the lifetime allowance reduction

For pension savers affected by last year’s lifetime allowance reduction, HMRC have introduced two forms of protection, Fixed Protection 2016 (FP 2016) and Individual Protection 2016 (IP 2016), which can potentially help reduce or eliminate any lifetime allowance tax charge. FP 2016 will provide the individual with a fixed lifetime allowance of £1.25 million whereas IP 2016 will provide a personal lifetime allowance ranging from £1 million to £1.25 million. The conditions attached to both protections are shown in the table below.

Protection Lifetime Allowance Conditions
Fixed Protection 2016 £1.25 million • No further pension contributions can be made to a money purchase arrangement by the member or on their behalf by a third party (e.g. an employer) after 5 April 2016.
• The value of any final salary benefits cannot increase annually by more than increases in CPI after 6 April 2016.
• The individual cannot set-up a new pension after 6 April 2016 unless the plan is to receive a transfer of existing pension benefits.
• The individual does not hold Enhanced or Fixed Protection 2012/2014.
Individual Protection 2016 £1 million to £1.25 million • The value of all pension benefits at 5 April 2016 must exceed £1 million.
• Primary Protection is not already held

FP 2016 is suitable for individuals who do not anticipate making any further pension contributions or being an active member of a final salary pension scheme after 6 April 2016. Unlike FP 2016, holders of IP 2016 can continue to make pension contributions or remain an active member of a final salary scheme without losing their IP 2016 status. The only scenario that may result in a loss of IP 2016 2016 is if pension rights are shared as part of a divorce settlement. Both FP and IP 16 can be obtained by applying online via the following link: https://www.gov.uk/guidance/pension-schemes-protect-your-lifetime-allowance The tax charges for exceeding the lifetime allowance are punitive, so careful planning is required to ensure when benefits are drawn from a pension, this is done in the most tax efficient manner. If you are affected by the above or would like to speak to someone regarding your retirement planning, please contact us via the number below or using the web enquiry form.

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