13th November 2007

50 is the new 60

50 is the new 60

by Fiona Tait, Technical & Research Manager – Marketing Individual Business, Scottish Life

The link between stopping work and taking pension benefits has been broken creating a brand new market for income drawdown.

Taking out a pension used to be a two-stage process. Clients saved while they were still working, then took benefits when they stopped. At this point they may have had a discussion with their financial adviser about whether an annuity or income drawdown was the most suitable way to provide those benefits.

Following A-Day the pension lifecycle is likely to become a three or four-stage process for many people, which will result in a greater focus on the client’s immediate financial needs and create a new opportunity for 50-something clients.

Using income drawdown, clients can access their pension fund while still working, take out a tax-free lump sum, and pay off some or all of their debts without having to take any pension income.

Debt Management

The issue of debt management has become extremely important for many clients, especially those in their 50s who have been used to the relatively easy credit facilities available since the 1980s. Many will also be in the latter stages of supporting their children, perhaps into higher education or in their first steps onto the property ladder.

If the need for cash is the number one financial priority then the ability to withdraw a lump sum from their existing pension plan becomes very attractive. Who wouldn’t prefer to do this than to take out further borrowing or have to live on a reduced income? The same risks relating to drawdown plans apply, however they are more likely to be outweighed by the client’s need for immediate finance. This is particularly true where the client is still in the position to continue, or indeed increase, their savings for future retirement.

We are not advocating clients stripping large amounts of money from their pension plan to simply spend on their cherished pipe dream, this is responsible financial planning. If clients are able to access their pension at age 50 evidence already shows they will want to do so. The role for the financial adviser is to ensure that it is done for the right reasons and with the right consequences.

Example

Jim is aged 50 and has an outstanding debt of £100K on his repayment mortgage, plus a number of miscellaneous debts totalling £5K. His pension is currently worth £220K and he is contributing £6K p.a. He does not want to retire until he is 65.

By crystallising the full value of his pension he releases £55K which he uses to pay off his miscellaneous debts and reduce his mortgage to £50K. This saves him £5,472 a year in interest which he redirects into his pension (in addition to his existing contributions).

Over the next 15 years, Jim withdraws 2 further lumps sums, the first at age 55 to pay for his daughter’s wedding and the second at age 60 to pay off his remaining mortgage. The resultant saving is redirected into the pension plan. He has therefore had very good value from his pension before he retires; the question is how has this affected his future pension?

Result

At age 75	No DD	With DD
Retirement Fund	£721K*	£776K
Max income	£46,700 p.a.	£64,000 p.a.

This result is achieved because of the savings in interest that Jim has made over the years and the extra pension contributions he makes. If he did not use drawdown at age 50 he would not have been able to afford to do this.

*This includes PCLS which has not yet been taken. Jim has already benefited from this using drawdown. The example assumes an interest rate of 5.5% p.a. on the mortgage, 15% p.a. on the other debts and 7% p.a. growth on the pension fund. A Financial Adviser’s Fee (FAF) of 3% is payable from the fund at each crystallisation event, plus 45% FAF on the pension increments.

Annuity Purchase

When they finally do stop work clients with an income drawdown plan in place are able to access the income they need to live on without having to purchase an immediate annuity.

Under current legislation it is likely that most clients surviving into retirement will be advised to buy an annuity at some point. At the very least clients who do not have financial dependants when they reach age 75 are likely to find the idea of a tax charge of up to 82% on the fund payable from an alternatively secured pension in the event of their death unacceptable.

One of the advantages of the drawdown plan is to allow clients to decide when conditions are right for them to commit their money. In other words, it is no longer a choice between drawdown or annuity, it becomes a case of drawdown and annuity.

Summary

If you can provide a way for clients to reduce their monthly outgoings, create more income, and save more towards retirement, then this is good advice. Income Drawdown allows clients to do all of these things.

Scottish Life will be launching a new income drawdown facility that is specifically aimed at attracting these clients, so if you think you have no drawdown clients in your files then it’s worth thinking again. Quotes are now available so please visit www.scottishlife.co.uk/incomerelease for more information.