Case Studies

Many retirees make the mistake of seeing their retirement strategy as being a choice between either buying an annuity or taking out Pension Fund Withdrawal (the two most commonly used types being Income Drawdown and Phased Retirement. Following a transfer into an invested pension, multiple income strategies can ensure diversification to protect the retiree against future economic cycles of inflation and volatile equity returns. The need to consider a raft of income streams in retirement has been made more pressing given the increased volatility of equity and gilt markets, as well as the future possibility of entering into a much higher inflationary economic cycle. There are so many alternative retirement strategies both within and outside of the pension world and this menu of options can be accessed by using a split transfer to create a diversified retirement income. Below are three case studies which demonstrate how diversification of multiple income streams can be achieved.


Case Study 1

Younger retiree (aged 55), divorced, no financial dependents, healthy, medium low attitude to investment risk with a 400,000 pension. Their income is 20,000 less than the Higher Rate Tax threshold:

Given the age of the client and fairly cautious attitude to investment risk, it is imperative they protect themselves against the long term erosive inflationary risk.

The client is immediately attracted to the idea of linking the annuity to the Retail Prices Index, which is possible with a conventional annuity. They have compared RPI indexed annuities with level, conventional annuity rates and have worked out how long it takes for the RPI indexed annuity to match the income available from a level annuity. Depending on the assumptions used, they calculate this to be approximately 12-13 years. They also feel that a younger annuitant is likely to be able to run a car and go on holiday more often than a much older annuitant. Consequently they decide that whilst RPI indexation is desirable, the much lower initial income is too low and takes too long to catch up with a level annuity.

They consider a With Profit annuity to be a more reasonable way to protect against inflation. In particular, the ability to change the Anticipated Bonus Rate each year gave an element of control which could favour a relatively higher income in the earlier years of retirement, compared to less income later. An element of diversification was achieved by spreading the risk with a split transfer to enable the client to take out With Profit annuities with three Life Offices- the Prudential, Aviva and Liverpool Victoria.

The client decided to take their 25% tax free cash lump sum, which gave them 100,000. They invested 15,000 into an ISA in the current tax year and wait for April 6th for the next tax year before investing the maximum into another ISA. These ISAs were invested in low/ medium risk sectors with the emphasis on finding higher, sustainable yields which were paid directly into the client's bank account to add to their income. To further boost income, they used 30,000 for a 15% deposit to fund a "Buy to Let" property, with rent being used to service the mortgage and supplement their retirement income.

As a Basic Rate taxpayer, earning 20,000 below the Higher Rate Tax threshold, under the new pension freedoms due to come into force in April 2015, accessing some of their pension in excess of their 25% tax free cash lump sum prior to any annuitisation was considered. The client did not want any of their pension to be taxed at the higher rate, so decided to access 20,000 and pay tax at the basic rate. They left a sufficient amount in the pension to take out the maximum in the following tax year whilst keeping the withdrawals just below the Higher Rate Income Tax threshold. Some of the proceeds were invested in unit trusts, outside of the ISA wrappers and the intention was to utilise the client's capital gains allowances each year to continue to fund their ISA allowances. This can be done by "Bed and ISA'ing" the unit trusts, by selling amounts sufficient to utilise ISA allowances. Additional gains held within the unit trust portfolio can be disposed of, again not to exceed the yearly Capital Gains Allowances but care needs to be taken not to repurchase the same unit trust fund since this would fall foul of the "30 Day Bed and Breakfast" rule. Instead, a similar fund which is comparable in terms of risk should be purchased.

The client decided to limit the investments in unit trusts outside of ISA wrappers to no more than 100,000 to ensure a prudent headroom of potential future growth which would be unlikely to exceed their ISA and capital gains tax allowances. The remaining funds outside of the pensions environment were invested in Guaranteed Investment Bonds and withdrawals of 5% per annum of the original investment were taken to supplement income. After careful consideration, the client decided to invest in three Guaranteed Investment Bonds, from Aegon Scottish Equitable, Liverpool Victoria and Metlife.

Case Study 2

Older retiree (aged 73), married, healthy, medium high attitude to investment risk with a 400,000 pension. In the year of retirement they are earning 10,000 less than the Higher Rate Tax threshold:

The client has no immediate need for any tax free cash lump sum. Of particular importance to the client are the death benefits because his spouse has not accrued much in the way of pension rights in her own name. Whilst the client knows that it is possible to add a 100% spouse's pension to a conventional or a with profits annuity, he also wishes to pass on a legacy to his children and an annuity will extinguish on second death. He is a sophisticated investor with a medium high attitude to investment risk and decides to use Phased Drawdown, instead of Income Drawdown or any of the annuity options, including unit linked and with profits annuities.

The client predeceased his wife, who inherits the Phased Drawdown arrangement. She is more cautious than her husband but shares his desire to pass on a legacy to her children. Following an on-going monitoring and supervision meeting, it is decided to switch funds within the portfolio in order to reduce its exposure to equities and lower its volatility. Funds which were commensurate with the risk profile of the client included Corporate Bond funds, Property funds and funds containing Government Gilts. On her death the Phased Drawdown plan is taxed differently depending on whether it contains vested benefits, or unvested. Unvested benefits would not be subject to tax, whereas the vested benefits would bear tax at 55%. This 55% tax charge is proposed to be scrapped in April 2015, allowing the nominated beneficiaries to receive the vested portion free from taxation.

Case Study 3

Retiree aged 65, single, diagnosed with Diabetes Type 2, prescribed medication for high blood pressure and high cholesterol, low attitude to investment risk with a 250,000 pension. He is earning 15,000 below the Higher Rate Tax threshold.

This client has no children but has a financially dependent mother who is receiving full time residential care. The cost if these care fees needs to be met by the client out of his income and he feels it unlikely his mother will live more than another two or three years. The client wishes to protect the downside of his pension pending the purchase of an impaired life annuity so switches his pension fund into a cash deposit fund where there is no risk of last minute volatility. We obtain medically underwritten offers from the 8 impaired annuity providers. The client expressed some concern about future inflation and reviewed offers both with and without indexation with the Retail Prices Index. After consultation with us, the client decided to take out two annuities, one for a level annuity with a 5 year guarantee, the other for a level annuity, also with a 5 year guarantee. The guarantees were included so that if the client died within the first 5 years, benefits would continue to be paid into his Estate which would cover his mother's care costs.

The client is aware that annuity rates are closely correlated to the yield from 15 year gilts and fluctuate significantly even when interest rates are low and do not change. Whilst his pension fund is held in cash, the client carefully monitors 15 year gilt yields published by the Financial Times on 15th day of each month and waits for them to reach acceptable levels by deciding on a "trigger point". We help the client by showing them ways to speed up the conveyancing process, ensuring any buying opportunity presented by rising gilt yields is secured quickly. One way to do this is by obtaining a discharge form from the pension provider and requesting that the pension benefits are paid to the annuity provider using a Telegraphic Transfer to avoid delays through the clearing system.

Prior to the "trigger point" being reached, the client accesses portions of their pension arrangement to serve as income to live on. This is not a viable long term strategy, since inflation would erode the value of the pension scheme which is held in a cash deposit account paying a low rate of interest. Once the "trigger point" is reached, a requote is requested from the most generous impaired annuity provider(s) which extends the period their offer is guaranteed for. An application is made and the discharge form, signed by the member (the client) is included. The event that secures the annuity rate is the arrival of the cleared funds from the pension provider into the annuity provider's bank account.