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Time is running out for pensioners to take up a rare government offer that doubles the income they can receive on some of their savings.
Yet take-up of this golden opportunity to turbocharge retirement income is reported to be “extremely low”.
The Government has offered up to 12 million senior savers the chance to convert a lump sum into a guaranteed income for life on terms that are up to 133pc better than those available on the open market – yet the public has largely ignored the deal.
Steve Webb, the former pensions minister who launched the scheme, said: “From what I hear, take‑up has been low. I think part of the problem is that people don’t really understand it.”
Certainly the offer is not straightforward.
Individuals must calculate whether it pays them to invest, depending on their age, health, marital status, tax bracket and inheritance plans.
When the scheme was launched in 2014, for many it was a finely balanced decision. However, following further falls in interest and annuity rates, the attractions have grown substantially.
According to figures compiled by pension consultants Hymans Robertson, almost everyone would gain by taking part, other than pensioners who pay higher-rate tax and have lower life expectancy.
Chris Noon, a partner at Hymans, said: “This will be a sadly missed opportunity for many as take‑up has been extremely low.”
The Department for Work & Pensions said no figures for take‑up were available. Ministers launched the scheme to appease millions of individuals who had retired on the old basic state pension of about £120 a week and were aggrieved that they would not get the higher, “flat-rate” pension of £155.65, introduced in 2016.
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Anyone who reached state pension age before April 2016 was given the opportunity to boost their pension by up to £25 a week via a lump-sum investment.
This additional weekly amount will rise in line with the consumer prices index, and half can be passed on to a spouse on death. It doesn’t fully bridge the gap between the old and new amounts but offers a halfway house of £144.30 in total weekly income.
However, the lump sum has to be invested before April 2017, when the offer closes. Those who qualify can in effect buy a government-backed index-linked annuity that pays almost 6pc at the age of 65, compared with the 2.5pc return available on the open market.
It gives you complete certainty, and the comfort of knowing that your spouse can inherit part of the pension should you die
Chris Noon
But, as with any annuity, if you die early the cash is lost. The income is also taxable, so individuals need to weigh their individual circumstances carefully.
Mr Noon said: “It offers a guaranteed income, inflation-proofing and a survivor’s pension. These are very expensive to buy on the commercial market.”
But there are risks, and not all investors will benefit equally. We explain the conundrum.
How the scheme works
Essentially, each £1 of additional week’s pension costs a 65-year-old £890, a 70-year-old £779, a 75-year-old £674 and an 80-year-old £544. So the full additional pension of £25 a week (or £1,300 a year) would cost £22,250 for a 65-year-old, £19,475 for a 70-year-old, £16,850 for a 75-year-old and £13,600 for an 80-year-old.
These are equivalent to annuity rates of 5.8pc at 65, 6.7pc at 70, 7.7pc at 75 and 9.6pc at 80, Hymans said. The rates rise as you get older because the cost of buying the income falls as the likelihood of dying increases. Rates on the open market, if indexation and a survivor’s pension are included, are around 2.5pc at 65, 3.1pc at 70, 4.3pc at 75 and 5.8pc at 80.
Those in poor health may get more on the open market, while the state’s offering takes no account of medical conditions that could affect longevity.
What does this mean in cash terms?
Using the same sums to buy an annuity on the open market might provide an annual pre-tax income of £558 at 65, £603 at 70, £720 at 75 or £782 at 80, according to Hymans – significantly lower than the amount available from the Government. These numbers have fallen sharply since the scheme was launched, when the £22,250 investment at 65 would have produced an income of about £780 a year.
What about tax?
Tax is a major consideration, which is why many pensioners may have concluded that they would be as well off leaving cash in Isas, from which income can be taken tax-free.
For a basic-rate taxpayer the maximum £1,300 income from the government scheme will fall to £1,040, which is still likely to beat returns on the open market for all but 80-year-olds in very poor health. The gap narrows, however, for the average pensioner who pays the higher rate of tax, when the net income plunges to £780.
This still outperforms the private annuity at all ages, although it could be a poor return for those who do not enjoy a happy old age.
If you want to pass money on to your children free of inheritance tax it may be better to pay for the government “annuity” from your Isa and leave pensions intact.
How long will I live?
No one knows of course. However, analysis from Hymans should sound alarm bells for any higher-rate taxpayer who dies early. A 65-year-old higher-rate taxpayer who dies after 20 years in retirement can expect a return of minus 1pc a year from the Government scheme.
A non-taxpayer who dies 20 years into retirement will still enjoy a 4pc annual return, but that figure falls to 1.7pc for a basic-rate taxpayer.
Tom McPhail, the head of retirement policy at Hargreaves Lansdown, the investment firm, said: “If you were planning to buy an annuity on the market anyway, it makes sense to exploit this offer first. But as with all annuities, it is a gamble.”
Mr Noon added: “It gives you complete certainty, and the comfort of knowing that your spouse can inherit part of the pension should you die.”
What else could you do with the money?
Hargreaves estimated that a 4pc annual return from a basket of income funds might, before income tax, produce annual income of £890, £779, £674 or £544, for the same investment required to buy the additional state pension at 65, 70, 75 and 80.
However, this income, and the capital value, could fluctuate – although you do hang on to your capital, which could be passed on to the next generation.
