Here we provide a brief overview of the four main methods available for taking
income in retirement from 6th April 2006. The four methods available are -
- scheme pension
- lifetime annuity
- unsecured pension
- alternatively secured pension
Scheme Pension
This is the only option available to members of defined benefit (i.e. final salary) schemes. The pension
may be paid directly out of the scheme's assets or as an annuity from an insurance company chosen by the scheme administrator.
Scheme pensions must be paid at least annually for life and may have a guarantee of up to 10 years. the
guarantee must be paid as a pension; a cash lump sum cannot be taken.
The maximum tax-free cash when taking a scheme pension from a defined benefit scheme is 25% of the crystallised
value of the total benefits.
If taking a scheme pension from a money purchase scheme, the tax-free cash will be calculated as 25% of
the fund value.
In contrast, defined contribution schemes (i.e. money purchase arrangements) can offer a scheme pension,
lifetime annuity or unsecured pension prior to age 75. Defined contribution schemes can pay a scheme pension only after the
member has been offerted the opportunity to purchase a lifetime annuity.
Lifetime Annuity
The regulations state that an annuity will be a lifetime annuity if:
- it is paid by an insurance company which the member has freedom to select;
- it is payable until the later of the member's death and, if selected, the end of a guaranteed payment
perriod not exceeding 10 years;
- the amount in payment cannot decrease, unless in specific circumstances prescribed by HMRC.
The definition of an increasing annuity is being relaxed to allow one-off icnreases in the amount of the
annuity (rather than requiring it to increase each year).
With this new flexibility, annuity providers will be able to offer an annuity providing one-off icnreases
in specified circumstances, for example where a member becomes seriously ill and requires long-term care.
A lifetime annuity is able to provide death benefits and can offer either -
- a guaranteed payment period of 10 years - this cannot be commuted for a lump sum on death
- value protection
The key benefit of value protection is that if the individual dies before reaching age 75,
his/her pension benefits will not be extinguished. Instead if any surplus exists between the amount invested in the annuity
and the gross income that has been paid out at the time of death, this difference is returned to a beneficiary or the estate
as a lump sum less a 35% tax charge.
Unsecured Pensions
This option is available up to age 75 and is provided either by income drawdown or through short-term
annuities not exceeding five years in duration. The rules are:
Income Drawdown
- a maximum income of 120% of the highest level of income determined by GAD annuity tables based on long term gilt rates (see here for sample rates)
- the maximum income available must be reviewed every 5 years and this will be determined in the same way
as the initial maximum income.
- the lower income limit is removed completely - therefore it is then possible to take tax-free cash but
not draw any income.
Short-term Annuities
These are payable by an insurance company and are designed to provide a guaranteed income for fixed periods
of up to 5 years ending no later than than the members 75th birthday. The remaining fund will stay invested as an unsecured
pension.
At the end of the term of the initial annuity the exercise may be repeated and another short-term annuity
purchased (provided the member is under age 75) or a lifetime annuity purchased.
Short-term annuities may prove attractive for individuals with fund values not considered large enough
to support drawdown within unsecured pension. They will also enable individuals to keep their annuity options open, for example
if their health deteriorates during the initial trm annuity, they can plan their subsequent short-term annuity accordingly.
As is currently the case with income withdrawals under personal pensions, a member will be able to transfer
their unsecured pension from one registered scheme to another.
As at present, a return of fund, less a 35% tax charge, will be permitted as a lump sum death benefit.
At this stage (pending Finance Act 2006) the sum is not likely to be liable to IHT.
Alternatively a dependant could purchase a lifetime annuity or continue with unsecured pension until the
day before the dependants 75th birthday. If the dependant is over 75 then Alternatively Secured Pension may be selected.
Alternatively Secured Pension (ASP)
ASP is effectively a continuation of unsecured pension beyond age 75, although the rules are slighly more restrictive:
- a maximum income of 90% of the appropriate annuity rate, always using age 75, can be drawn. This
is to designed to mitigate the possibility of exhausting an individual's pension fund before death;
- the maximum income is reviewed annually, starting from age 75, using fund values and GAD table rates
on a day up to 60 days before the review date;
- minimum income of 55% of the equivalent annuity rate is required
- ASP payments may be guaranteed for up to 10 years. The continuing payments can be paid to any person
but cannot be commuted as a lump sum;
- when a member dies during ASP, the residual fund reverts to the scheme and where there is a surviving
spouse must be used to provide a pension for them.
If there is no surviving spouse any remaining lump sum will be liable to penal tax charges of upto 82%.
The range of available retirement options has now expanded considerably, each with its own potential benefits
and pitfalls. Taking advice is now more essential than ever and, as appropriately qualified and expereinced financial
planners, we will be pleased to discuss your needs with you - we assist client's from across the UK and therefore you
do not need to be able to visit our offices for us to be able to assist you. Please see our New Clients section for further information or Contact Us without obligation.
