Alternatives for a man with a fat pension

Paul came to see me recently. He is a client of some six or seven years' standing. He was quite a wealthy man until he lost much of his money on the Lloyd's insurance market.

Fortunately, his wife is running a very successful business and is helping him financially. However, he is due to retire within a couple of years and when he came to see me he was wondering what his options were.

Paul is in a final salary pensionscheme, but because of his wife's success he was not necessarily interested in obtaining the maximum pension but in making maximum use of all his assets.

I suggested that we look at an income withdrawal plan and compare it with his final salary benefits, which are based on the number of years of service and depending on his scheme's rules provide a pension of up to two-thirds of his final salary.

In normal circumstances his widow would also receive a reduced benefit if he should pre-decease her, the benefit often being two-thirds or half his own pension.

With final salary schemes, however, there will be no benefit to children when the pensioner dies (excluding benefits to children under 18, which is not a common state of affairs for those at normal retirement ages).

Switching to an income withdrawal plan involves converting the final salary scheme into a capital sum, called a transfer value, and transferring it to a personal pension, which should provide the equivalent of the final salary pension and the widow's benefits.

However, I found that it was possible to more than match his final salary benefits by investing the lump sum in low-risk corporate bonds, without using up any of the capital in the personal pension.

After going down the income withdrawal route, there are two possible scenarios: the first depends on whether Paul's health is such that he is likely to die before he reaches the age of 75 and the second if he is more likely to live beyond 75.

In the event of his death before 75, his widow would have the choice of receiving either 65 per cent of the fund value as a lump sum or alternatively using the lump sum to purchase a single life annuity - that is a fixed income for the rest of her life.

If I were asked today, I could provide a higher net yield from a lump sum equal to 65 per cent of the capital, guaranteed for life, compared with the net return from a single life annuity. An additional advantage of this approach is that a proportion of the capital will be preserved and will accrue to the children, without any loss of income to the pensioner.

The second option is in the event of Paul's death after the age of 75. The current rules require that at the age of 75 an annuity must be purchased. By investing the capital until then in corporate bonds or permanent interest- bearing shares (PIBs), the annuity to be purchased at age 75 can protected, because annuity rates and interest rates move together in the inverse to the capital value of the bond, with the purchasing power remaining roughly constant.

There is one major exception: annuity rates rise with age. If the client reaches 75 and if his wife has pre-deceased him, the capital will buy a substantially larger annuity than at 70 or 65. As the principal requirement in Paul's case was to try and make up the capital he has lost for the children, he could purchase an annuity with a five or ten-year guarantee of payment at 75 and still have a reasonable possibility of having some additional capital to leave to the children.

There has been much comment that people should not transfer from final salary schemes to personal pensions, but Paul's circumstances suggest that blanket advice of this nature is clearly not always good advice. Everyone who is coming up to retirement should consider all the options before making a choice.

For example, someone in ill-health would be better opting for a personal pension with a level annual payment rather than remaining in a final salary scheme, which since 1990 has had to provide an indexed pension.

The indexed pension will start off less than the equivalent level pension, and it takes around eight years for an indexed pension to catch up with a level pension, assuming the same annuity purchase price is available. It takes a further four years for the indexed pension to make up for the previous eight years and break even, which is not much use if you are likely to die before the 12 years are up.

Michael Royde is an independent financial adviser. He can be contacted on 0171 792 3700.