Make the most of that pension pot

If you are approaching the age when you want to convert your pension pot into a pension you have chosen a very bad time to do so. The pension you can buy with your pension pot has fallen as low as it has ever been. There are several of reasons. First, we are all living longer. That means that any pension you buy has to stretch over more years. In 2010 alone life expectancy at age 65 rose by two months – to 83 for men and more than 85 for women. Since 1982 the length of life after 65 has grown by around four years or nearly 30%.

Second, when we buy a pension for life – called an annuity – the insurance company uses your pension pot to buy safe, guaranteed investments to pay it – typically Government bonds. Recently the demand for those bonds has risen sharply and that puts up the price. One reason is that the Bank of England is buying £375 billion of them back from the companies which hold them in a process known as Quantitative Easing – often referred to as printing money, though in fact the money to buy the bonds is just magicked out of thin air. And the crisis in Europe means that other investors are buying UK Government bonds as safe havens. That raises the price more, cuts the return on every £100 invested, and cuts the value of the annuity that is paid out.

So now is the time to make sure you get the very most from your pension pot if you are about to convert it into a pension for life – an annuity.

Guarantees
Arthur’s father was a teacher and brought him up to know the importance of a good pension. So when Arthur started work in the 1970s he picked a firm with a pension scheme. And when he struck out on his own in 1985 he opened what was then called a section 226 retirement annuity contract – that was before the razzamatazz of personal pensions – and he regularly paid in what he could afford.

In April this year Arthur decided he wanted to retire. He was very depressed about the low annuity rates so he went to an Independent Financial Adviser. Arthur got two nice surprises. First, between the pension from his old employer and his s.226 plan he had a fund worth £120,000. It sounds a lot but at current rates that would buy him a pension of only about £6,250 from the insurer he had saved up with. Then came surprise number two. His IFA told him he started his pensions so long ago they came with what are called ‘guaranteed annuity rates’. These were given on schemes taken out before July 1988. Arthur’s guaranteed rates averaged 11.5%. So for his £120,000 he got a pension of £13,800 for life.

Always check if your scheme has guaranteed annuity rates before moving or consolidating it or converting it to an annuity.

Smoker
Janice knows she shouldn’t smoke and tries to cut down but she can’t give up. That may be why she now finds her work as a sales executive quite tiring. She travels a lot and is on her feet much of the day. So when Janice reached state pension age in July she decided it was time to put the money she and her firm had paid into her pension to good use. She never looked at the annual statements so she didn’t know whether to be pleased or not that her pension pot amounted to around £50,000. But she was certainly not happy to be told that as a 61 year old woman it would only buy her a pension of £2,534 a year. Her state pension will be far more than that – around £6,000 a year.

Janice went for help to a specialist annuity provider who asked if she smoked and about her health and weight. With a bit of gentle prodding the adviser gets the truth out of her, sends her for a cholesterol test and finds an annuity that will pay her 15% more - £2953 a year. That is less than she hoped but better than nothing.

Janice has heard that women may get a better deal on annuities later this year. At the moment men and women get different rates because women live longer so their money has to stretch further. But from 1 December 2012 the EU says that must stop so men and women of the same age and health must be given the same amount. That should mean men will get less and women more. But her adviser says don’t wait. Although annuity rates for women will probably rise slightly in December overall rates may fall further and in any case she would be giving up three months’ income – around £650. It would take her many years to get that back even if she got a slightly higher rate from 1 December.

Always get advice and mention any health problems honestly. It can boost your income for life.

Lump sum and inflation
Amanda already gets a pension of £8,500 a year from her time in the civil service. She is 64 and has deferred her state pension which will now be around £9,360 a year when she gives up her part-time job and draws it at 65 in a few months.  Because she has deferred it for five years it is boosted by 52%. She has been saving into a personal pension for ten years. And recent bonuses have gone straight into her fund. She was quite pleased to discover it was worth almost exactly £80,000. She wants to take the maximum £20,000 out as a tax-free lumpsum. That leaves £60,000 for her annuity. She checks online and finds she can get just £3,329 a year from the top provider! If she was a man she would get £3472 so it is clearly not worth waiting in the hope that annuities for women may rise a bit in December. So she rethinks the lumpsum. Why not convert all her pension pot to a pension? Adding back the £20,000 would boost her pension by more than £1000 to £4369. But she decides to keep the lumpsum and put it in a high interest savings account which will earn nearly £500 a year after tax and the capital is accessible for car repairs or an emergency – which could include a nice holiday!

Amanda is worried that £3,329 does not sound much today – and may well sound a lot less in 20 years. So she checks what she would get is she asked for an index-linked pension that goes up with inflation. But to do that she would only get just £1,883 a year. Amanda works out it would be 18 years before her index-linked pension was as much in cash terms as her flat-rate one with inflation around 3.5%. So she sticks with the flat-rate, knowing that both her state pension and her company pension do rise with inflation each year.

Spouse
James is 67 and over the years has assembled quite a few little pension pots totalling £130,000. His pension provider says that if he takes a £30,000 tax-free lump-sum (slightly less than he is allowed) the remaining £100,000 will give him a pension of just £5,400. But James is worried about his partner Mary who is ten years younger. He asks for his pension to be guaranteed so it will be paid for five years even if he dies before that time is up. Second he wants Mary to have a widow’s pension after that. She reckons half his pension would be enough. On that basis his pension provider will give him only £4,800 a year then £2,400 to Mary after he dies.

James goes to an Independent Financial Adviser who specialises in annuities. He suggests extending the five year guarantee to ten years. That only costs another £25 a year off his pension. He gets quotes from other providers and tells James he could get £6,100 just for himself. But with a ten year guarantee and a 50% pension for Mary he can still get £5,275 a year. James says ‘yes’. And starts planning to dip in to the £33,000 tax-free lump sum for their first retirement trip.

Never accept the offer from your own pension provider. Get advice and look around. A five year guarantee can cost nothing or just a few pounds.

e-mail Paul Lewis on paul@paullewis.co.uk