Talbot and Muir

Taking Benefits

Benefits may be taken from a private pension from the Normal Minimum Pension Age (NMPA) of 55. When taking retirement benefits there are several choices as to the form in which pension payments are made. The main options are:

• Lifetime/Open Annuity
• Scheme Pension
• Capped/Flexible Drawdown Pension
• Phased Retirement

Each time an individual elects to take the benefits from (crystallise) one of their pension plans this is treated as a Benefit Crystallisation Event and will be checked against the Lifetime Allowance (LTA) at that time. Exceeding the LTA at a Benefit Crystallisation Event can lead to a tax charge deducted from the pension benefits.

It is only by assessing a client's current position and listening to their requirements in retirement that an adviser can put forward a detailed planning proposal. Making the wrong decision at retirement can negate a considerable amount of good work carried out in the run-up to retirement in building up the pension fund.

Lifetime Annuity

In simple terms, an annuity is an insurer's promise to pay an income for life - on terms agreed by the purchaser and the insurer - for a set purchase price. An annuity is a secured form of pension income, and there are several types of annuity available.

Adding factors such as a spouse's/dependant's pension or inflationary increases on pensions in payment will reduce the initial income payable.

There are also capital protected annuities, which pay a lump sum on the death of the annuitant. These allow an annuity provider to return the capital used to purchase the annuity less any payments made. Any lump sums returned in this way are taxable at 55%.

Lifetime Annuities have many advantages:

• Annuities are a simple structure. The pension fund is passed to an insurer and in return the insurer provides a guaranteed level of income for the life of the annuitant.
• It is possible to guarantee future pension payments for up to 10 years after commencement to provide some protection of the capital on early death.
• Annuities guarantee the level of retirement income, and therefore eliminate exposure to any direct investment risk during retirement. The investment risk is ordinarily passed to the insurer.
• Upon the annuitant's death, a dependant's annuity can be paid to a surviving dependant for the remainder of their lifetime, although making provision for this will reduce the income payable during the lifetime of the original annuitant.
• A Pension Commencement Lump Sum can be taken at the outset.
• Income from Lifetime Annuities counts towards the Minimum Income Requirement for accessing Flexible Drawdown (see below).

Annuities do have certain disadvantages:

• The structure of the annuity means that once established the terms cannot be changed in any way.
• The income under investment-linked annuities could fluctuate in payment.
• Control of the capital value of the pension is lost, and is passed instead to the annuity provider (although investment-linked annuities do offer some investment control).
• Under many circumstances benefits cannot be passed on to future generations, although capital protected annuities do offer a degree of protection.
• Over recent years, annuity rates have remained at historically low levels but may be even lower in the future. Alternatively, if annuity rates increase after the purchase of an annuity the chance to secure a higher income will have been lost.
• Non-increasing annuities will not offer protection against inflation, reducing the value of the payments over time.

Open Annuities

This is a relatively new product, which offers the following features:

- Wide investment powers.
- Variable income levels.
- Income level reviewed every five years or annually.
- Convertible to a conventional annuity.
- On death, remaining funds can be left to a nominated charity.

Scheme Pension

Like an annuity, a scheme pension is a secured income, and will be payable from retirement for the remainder of the lifetime of the scheme member. The most common form of scheme pension is that paid under a defined benefit pension scheme (in fact no other form of pension income can be taken from a DB scheme). A scheme pension may also be paid under a money purchase scheme.

A scheme pension is calculated according to a range of actuarial factors: age, gender, health, and attitude to risk can all be factored into the calculation. Scheme pensions are reviewed at least every three years.

A scheme pension must be paid at least annually and, except under very limited circumstances, once the pension has been calculated it must be paid for life. Actuarial reasons - including a reduction in the value of the pension fund - may be used to justify a reduction in the level of pension income, but HMRC will only allow this under certain circumstances.

A scheme pension has the following advantages:

• A Pension Commencement Lump Sum can be taken at the outset.
• A scheme pension can offer a higher level of income than that available under an annuity or a capped drawdown pension.
• The level of payments can be guaranteed for up to 10 years.
• When paid by the pension scheme administrator, investment control over the pension scheme assets can be maintained. Equally, a scheme pension can be paid by an insurance company, and the investment control and investment risk passes to the insurer.
• Benefits used to purchase a scheme pension are not subject to a Lifetime Allowance test at age 75.
• On the death of the member a scheme pension can be used to provide a dependant's pension or annuity, the continuation of guaranteed payments, or a lump sum subject to a 55% tax charge.
• Scheme pensions paid by an insurance company can count towards the Minimum Income Requirement for Flexible Drawdown (see below).

Scheme pensions also have the following disadvantages:

• If the scheme pension is reduced except under circumstances covered by an HMRC exemption any future pension payments are deemed to be unauthorised payments (attracting a minimum 55% tax charge).
• If the scheme pension is reduced below 80% of its original level the pension commencement lump sum paid at the start of the scheme pension may also retrospectively be subject to tax charges.
• Scheme pensions cannot be increased in excess of the growth in RPI, or a further test against the Lifetime Allowance will be triggered.
• The operation of a scheme pension is fairly complex and will require a review at least once a year. The complexity and requirement to review these arrangements regularly means that, from a charges perspective, scheme pensions are more expensive than conventional annuities.

Drawdown Pension

A Drawdown Pension is an unsecured pension arrangement, and offers the opportunity to take the maximum tax-free cash and invest the remaining fund whilst also taking regular withdrawals from the fund if desired. Under a capped drawdown arrangement the maximum level of drawdown income available is calculated with reference to limits set by HM Revenue & Customs. If an individual is entitled to a certain level of secured pension income they can access potentially unlimited income withdrawals under a flexible drawdown arrangement (see below).

Strictly speaking drawdown pensions are not income payments but withdrawals of capital, which may reduce the pension fund. Any income/capital withdrawals received are taxable as earned income under the PAYE system.

Taxation is subject to future legislative change and depends on individual circumstances.

The funds invested need to achieve a sufficient investment return if the level of income withdrawals over time is to keep pace with the total benefits that would have been achieved had an annuity been secured at outset. A portfolio of low risk investments such as bonds and cash is unlikely to generate the returns required to make income drawdown a viable proposition. Exposure to equities is potentially more suitable, but consideration should be given to whether the risk associated with equity-style investment is appropriate for the individual.

The main attractions of drawdown pensions are:

• A Pension Commencement Lump Sum can be taken at the outset.
• The ability to defer locking into annuity benefits whilst drawing income from the pension fund in the meantime. It should be noted, however, that annuity rates could be lower in the future.
  
• Flexibility to vary income as circumstances require.
• All or any proportion of the fund can be used to provide a drawdown pension. Any funds not utilised can be used later.
• Investment control of the pension fund is maintained, and investment returns on the fund will continue to be largely tax-free.
• The ability to pass on retirement funds to future generations, subject to Inheritance Tax as applicable.
• Benefits for a spouse/dependant do not need to be purchased at the outset, and various options are available to the member's spouse or dependants concerning the way that they receive retirement benefits following the death of the member.

Drawdown pensions do have certain disadvantages:

• Income is not guaranteed, as the fund is subjected to an ongoing investment risk. The value of the funds invested can go down as well as up.
• If investment returns are poor and/or annuity rates fall, the member could receive inferior overall income from a drawdown pensions than if a conventional annuity had been purchased at the outset. 
• As annuity rates fluctuate, it is possible they may be worse if the member eventually decides to purchase an annuity.
• The operation of drawdown pensions is fairly complex and will require a review at least once a year. The complexity and requirement to review these arrangements regularly means that, from a charges perspective, drawdown pensions are more expensive than conventional annuities.
• Drawdown pension income does not contribute towards the Minimum Income Requirement.

Capped Drawdown

Under a capped drawdown arrangement the maximum pension withdrawals are calculated at 100% of the age-related income factors produced by the Government Actuary's Department (GAD). The minimum withdrawal is nil. These limits are recalculated every three years before age 75, and every year after age 75. Income can be received monthly, quarterly, or annually, and the frequency of income can be varied as required (up to the GAD maximum allowable).

Flexible Drawdown

Provided an individual is entitled to receive a certain level of secured pension income for life, they can apply for unlimited drawdown pension payments under a flexible drawdown arrangement.

The level of secured income required to access flexible drawdown is called the Minimum Income Requirement (MIR), and is currently set at £20,000 per annum. The MIR will be reviewed by the Treasury at least every five years. The following types of secured income count towards the MIR:

• Payment of a scheme pension or dependant's scheme pension provided by a defined benefits scheme that has 20 or more pensioner members.
• Payment of a scheme pension or dependant's scheme pension provided by a money purchase arrangement that is not paid by the scheme administrator, or that has 20 or more members receiving a scheme pension.
• Payment of a lifetime annuity or dependant's lifetime annuity.
• Payment from an overseas pension scheme which, if it were a relevant UK scheme, would fall into any of the above categories.
  • State pension benefits.

Like income under a capped drawdown arrangement, income withdrawals under flexible drawdown are subject to income tax under the PAYE system.

Phased Retirement

This option may be suitable if the maximum tax-free cash payment is not required when benefits are first taken.

Phased retirement works on the basis that the fund is notionally divided between a large number of segments. This allows specific segments to be vested each year to generate the net income required. When benefits are taken from each segment, ordinarily up to 25% of the value of the segment is available as tax-free cash. The remaining 75% is used to provide income in the form of a secured pension, an unsecured pension, or a combination of both (see above).

Phased Retirement needs to be monitored carefully as each tranche of withdrawal represents a Benefit Crystallisation Event and could result in a tax charge if funds exceed the Lifetime Allowance at that time.

Phased Retirement is suitable for individuals who:

• Do not require their full tax-free cash entitlement when benefits are taken.
• Require the ability to vary their income during retirement to suit circumstances.
• Wish to reduce their income tax liability. Using tax-free cash to form part of an individual's annual income can reduce their overall income tax liability.
• Wish to defer the decision of purchasing benefits for a spouse as long as possible. Various options are available to the spouse/dependants following the member's death.
• Would like the potential to pass funds on death to future generations.
• Require control of their pension funds, are prepared to take an active role in their retirement planning, and accept the investment risks associated with Phased Retirement.