The Chancellor’s 2014 Budget was designed to assist “the doers, the makers and the savers”, and it contained major and unexpected improvements to both pensions and savings.
Who needs annuities?
George Osborne’s statement that as a result of his changes, “no one will have to buy an annuity” triggered major falls in the shares of annuity providers. But are annuities so undesirable?
The main problem with annuities is that annuity rates, and interest rates in general, are close to historically low levels and the prospects are for rates to continue indefinitely at much lower levels than have applied in the past.
Annuities have also received bad press recently as a result of inadequate efforts by annuity providers to encourage retirees to shop around for the best rates.
Add to this the fact that buying an annuity involves permanently surrendering capital in exchange for an income which is determined at least in part by current interest rates, and the reasons for Osborne’s aversion become clear.
There are two elements in each payment received by an annuitant – the income received by the annuity company on the sum invested, and a part repayment of the capital. The annuity provider aims to ensure that the investment will be repaid over the life of the average investor, after deducting its own charges.
The older the annuitant, the shorter their life expectancy is assumed to be and the greater the proportion of each annuity payment which takes the form of capital. So the older you are, the less impact current interest rates will have on the value of any annuity you might buy.
Health is also an important consideration, and enhanced annuity rates are available for those with reduced life expectancy due to medical conditions, so annuities of this sort can be particularly valuable to elderly people.
Many people will find the alternatives to annuities attractive. However, the great advantage of annuities is that they provide the security of a guaranteed lifetime income and avoid the fluctuations in values of stock market investments. But how much security does one really need?
Over the limit? Tax penalty!
HM Revenue & Customs have disclosed that since the 2007/8 tax year, 4,000 people have received tax bills averaging £50,000 as a result of having exceeded the lifetime allowance for pension savings. Most are assumed not to have realised that the limits have been progressively reduced.
With effect from 6 April 2014 the limit will be £1.25 million unless protection is obtained of a higher value of not more than £1.5 million.
Individual Savings Accounts are to be re-named New ISAs (‘NISAs’ – much nicer!) and all existing ISAs will become NISAs. As from 1 July 2014 the amount which can be invested is to be increased to £15,000 p.a. (from the current £11,520) and the range of permitted investments is to be increased.
Contributions can be made wholly into either cash or stocks and shares NISAs (previously the cash component was limited to half the total) or a mixture of the two. Also, transfers will be permitted between cash and stocks and shares NISAs.
The annual investment limit for children’s Junior ISAs is to be increased to £4,000 p.a. as from 6 April 2014.
Also on the savings front, the investment limit for Premium Bonds is being increased in June 2014 from its current level of £30,000 to £40,000 and will be increased further to £50,000 in 2015/16. In addition, a fixed-term Pensioners’ Bond Is to be introduced by National Savings & Investments in 2015, which is expected to provide market-beating interest rates.
Of potentially greater significance, the options for those who prefer not to have to purchase an annuity with their pension savings to provide a retirement income are to be greatly improved. As from April 2015, people who have built up a lump sum in a personal or other defined contribution scheme will be able to take the funds as cash or draw them down over time, subject to tax, instead of having to apply them to buy an annuity.
Currently, only those with a guaranteed retirement income of at least £20,000 p.a., whether provided by State pension, annuity and/or occupational schemes, are permitted to enter into “flexible drawdown”, which enables them to draw down as much of their pension pot as they wish whenever they wish. This qualifying income requirement is to be reduced to £12,000 p.a..
For those who are unable to meet the income requirement for flexible drawdown, “capped drawdown” is available but currently permits withdrawals equal to no more than 120% of the equivalent annuity rate. This limit is to be increased to 150%.