"The question to consider now is whether pension freedoms, increased longevity, and changing financial conditions mean that different approaches have to be considered?"
Recently I have been talking a lot about the vast majority of retirees who do not have sufficient money in their pension pots to provide them with the necessary lifetime retirement income. If they are going to draw down retirement income from their total wealth, including housing wealth, how should they do this?
The conventional route, before the introduction of the pension freedoms, was to take tax-free cash and an annuity at retirement from their pension, and when the tax-free cash had been used, to then consider equity release to top-up the annuity income. However, the question to consider now is whether pension freedoms, increased longevity, and changing financial conditions mean that different approaches have to be considered?
Ignoring housing wealth for the time being, given a portfolio of different assets in different tax wrappers, to drawdown the required income priority should be given to that which can be drawn without incurring tax, (using capital gains, interest, dividend and personal allowances), while drawing down assets that are in non tax-exempt vehicles before using any tax-exempt assets. This acts to damp down the sequence of returns risks.
The above is a generalisation of course on the basis that it is better only to draw down the £16,000 income you actually need without paying tax instead of drawing down £20,000 and paying £4,000 to HMRC. Similarly, assets in tax-exempt wrappers, for example, pensions and ISAs should over time grow faster than those held in taxed wrappers. On this basis, the drawing of pension assets should be left to last. Pension income is taxed; pension growth is basically tax exempt.
Many commentators state that currently annuity purchase should not take place until early seventies. It is not until then that the advantage mortality pooling has any material impact. Therefore by purchasing an annuity at an earlier age the purchaser is only receiving a return of their capital before they reach their early seventies.
We therefore have two arguments for deferring the drawing of pension benefits.
If an individual is going to utilise their housing wealth to augment their retirement income by downsizing, using the above arguments, would they be better off doing so at the time of retirement? They should then give primacy to the drawing down of the downsize proceeds. Only when they have expired should they fully draw on their pension savings.
So, where does this leave the use of equity release? Because equity release is essentially a mortgage, e.g. borrowing, it is looked upon as the solution of last resort. Should that premise now be challenged?
Modern equity release drawdown contracts include guarantees on the interest rate being used and no negative equity guarantees. Should they therefore be looked at as financial instruments that generate liquidity from an otherwise illiquid asset - the residential home?
Equity release interest rates have never been lower; therefore should advantage be taken of those rates to provide income in the early years of retirement? Rates can often be obtained that are far lower than the deferment roll-up for the state pension. The fact that rates are so low is reflected in annuity rates that have fallen again following the 'Brexit' referendum result.
In the current financial climate should the new ‘Order’ be to draw on some housing wealth either through downsizing or equity release, taking the tax-free cash and then buying an annuity at an age when annuity rates do what they say they do on the tin.
To follow conventional practice a client could buy an annuity at the wrong time; be using highly risky income drawdown in volatile markets and when they get to use equity release, interest rates could be much higher than those available today. I can hear the Speaker shouting “Order, Order, Order”.
By locking into a low equity release rate today, a risk-adverse client may find more security in what is being recommended. Of course, as always, the advice given to an individual client will depend upon their personal circumstances, attitudes to risk and their personal objectives.
