MONEY COMMENT
Earn Up To 14.6% A Year

By Cliff D'Arcy
May 20, 2004

I've recently had a clutch of emails (is 'clutch' the correct collective noun for emails?) from older Fools, asking me to write more articles that will appeal to the over-fifties. I'm happy to oblige: there's a cunning way to turn capital into a high lifetime income, using what's called an immediate vesting pension (IVP). Here's how it works:

Almost anyone can have a stakeholder pension (SHP): children, students, unemployed or retired people, self-employed or employed workers. One notable exception is members of a company scheme who have earned £30,000 or more in each of the last five years.

The maximum you can contribute to a stakeholder without reference to your earnings is £3,600 per tax year. The taxman gives everyone - regardless of their earnings - 22% tax relief on every penny that goes into a stakeholder. Higher-rate taxpayers (those earning over around £36,000 a year) can claim a further 18% tax relief through their tax returns, or by using the Inland Revenue's PP120 claim form.

So, to get £3,600 in your pension, you put in £2,808 and the taxman puts in £792 (22% of £3,600). Higher-rate taxpayers can reclaim a further £648 (18% of £3,600).

Now here's the clever bit: with an immediate vesting pension, you put your money into a stakeholder and immediately withdraw 25% of the £3,600 total as tax-free cash. So, you hand over £2,808, the taxman chips in £792 and you get back £900 in tax-free cash (a quarter of £3,600). You now have a pot that you use to provide you with an annuity (an income until you die). Here's how the sums add up:

IVP calculation
Your contribution	£2,808
plus tax relief	£792 (22% of £3,600)
Equals	£3,600
less tax-free cash	£900 (a quarter of £3,600)
Equals	£2,700

So, you've put in £1,908 (£2,808 less £900 cashback), but your pension pot is worth £2,700. This will buy you a fixed annual annuity of:

Male
Age	Annual income (£)	Lifetime income (£)	Effective return on £1,908 (%)
50	121.59	3,526.11	6.8
60	151.64	3,032.80	8.6
70	207.93	2,703.09	12.2
74	243.16	2,674.76	14.6

Female
Age	Annual income (£)	Lifetime income (£)	Effective return on £1,908 (%)
50	113.43	3,743.19	6.3
60	138.65	3,327.60	7.8
70	189.62	3,033.92	11.0
74	223.97	2911.61	13.3

 
Please note:

1. These figures are based on life expectancy figures from the Government Actuary's Department. If you live considerably longer than predicted, your returns improve dramatically. Also, annuities are lower for women because, on average, they live longer than men.
2. Once you've bought an annuity, this income continues until you die. However, your capital is lost forever - even if you die the very next day!
3. The actual income you receive will depend on your age, sex, state of health, plus prevailing interest rates. Your annuity is paid yearly in advance, which means that you get your first payment on day one then each anniversary thereafter.
4. You have to be over 49 and under 75 to buy an immediate vested pension (if you are 75 or over, you can no longer contribute to personal pensions).
5. These are not 'purchased life annuities', so this income will be taxed at your usual rate for earned income.
6. If you have made contributions to another personal or group pension plan or stakeholder plan in a particular tax year, you may not be eligible to have an IVP that year.
7. If you didn't make pension contributions last year, you may use the 'carry back' provision to double this year's IVP contribution to £7,200.

Many thanks to Hargreaves Lansdown for providing the figures for this article.

More: Learn more about pensions in our Pension centre.