Craig has been made redundant from his job with a large engineering firm at the age of 59.
He is hopeful of obtaining another job within the next 12 months but will need income to support himself and his family in the meantime. Unfortunately, Craig has also been diagnosed with a medical condition which does not in itself reduce his life expectancy but it does make it more likely that he could suffer from a related issue which could be life-impairing.
Craig wants to know if he should withdraw money from his pension fund to pay off his mortgage and provide him with an income until he finds a new job. He hopes that with his qualifications and experience it will not take him longer than a year to secure a new position although he may need to work reduced hours. He estimates he can earn £25,000 p.a. and ideally work for another five years until he is 65 although his health is creating uncertainty.
Recognising the immediate requirement for cash Craig’s adviser asks him to confirm the income he wishes to obtain and his priorities:
|1. To pay off the mortgage
2. To make up income shortfall until he secures a new job
3. To provide for his family in the event of his death
|Future income requirements in present day value|
|Income desired up to state pension age||£60,000 p.a.|
|Income desired in early retirement||£50,000 p.a.|
|Income desired in later life (after 75)||£40,000 p.a.|
Craig’s uncrystallised self-invested personal pension (SIPP) plan is currently worth £436,000 and he has an occupational pension already in payment at £20,000 p.a. He does have some income from consultancy work, which may cover some of his expenses but it is ad hoc and cannot be relied upon. He also has cash savings of £10,000 that he wants to keep as an emergency reserve.
His wife Caroline has a very small scheme pension already in payment but no other income or assets beyond her share of the house, which is currently worth £750,000.
They have one son who is 25 and financially independent.
Craig could withdraw up to £109,000 in tax-free cash by crystallising his whole fund. This could be used to pay off the mortgage and provide a tax-free surplus in year one of £39,000.
Alternatively, he could crystallise £280,000 to release £70,000 tax-free cash now and withdraw the balance in tax-free instalments over the coming years. Drawing tax-free cash to meet income requirements would reduce his ongoing income tax liability. This could be particularly useful as Craig expects to continue earning for a few years.
Given Craig’s medical condition his adviser starts by contacting providers of enhanced annuities for a quote of the income which he could receive now. As his life expectancy is not directly affected, the best quote offers him an enhanced rate that would provide a secured income of £8,000 after tax index-linked.
The adviser then carries out an inflation-adjusted cashflow analysis to show how the annuity would augment his and Caroline’s other sources of income over the next 30 years.
The model shows if his earnings are limited to £25,000 he will face a shortfall in his income requirements which he thinks he could possibly cover from consultancy work until he retires. More importantly, however, there would be a larger shortfall after he retires:
The adviser then considers the effect of delaying annuity purchase until he is 75, adopting flexi-access drawdown in the meantime. Under this model is able to meet his income objectives:
In both scenarios, his eventual income should exceed the £40,000 (inflation-adjusted) he estimates he will need from age 75 although there are investment risks associated with pension drawdown.
The drawdown analysis assumes a real investment return of 3.7%, based on a balanced investment portfolio with 70% equity exposure. The adviser demonstrates the impact of a stock market crash and the possibility of his drawdown fund running out before 75. Craig is happy with this as most of his later income requirement is still covered.
The adviser assesses that the annuity does not meet Craig’s need for flexible income and that Craig’s has sufficient capacity to withstand the potential risk of loss as a result of his SIPP fund remaining invested until 75.
He, therefore, recommends phased crystallisation of his SIPP into flexi-access drawdown.
This solution will provide him with £70,000 tax-free to pay off his mortgage, plus the flexibility to adjust his income withdrawals in line with his varying income requirements before securing his remaining income at age 75. The plan will be kept under annual review and can be revised should Craig’s earnings not match his expectations or if his health should decline further.
Fiona Tait is technical director at Intelligent Pensions