Pension Income Options

The minimum retirement age will rise from 50 to 55 in 2010.

Under the present rules if you want to receive an income from your pension without buying an annuity between 50 and 75 years of age you can opt for Income Drawdown.

This facility will continue but be renamed 'Unsecured Pension' and the rules will be amended slightly. The big change will be the introduction of the Alternatively Secured Pension as an alternative to buying an annuity at age 75. Although this development is being widely welcomed, it is still believed that annuities offer an excellent solution, especially for people who will be relying on their pension income.

Annuity rates are based on the life expectancy of the member. Those that live longer than others will, over time, receive their original pension fund value plus interest. Some members will die without receiving even their original fund value. This results in a mortality profit.

If the pension scheme member, at retirement age, chooses Drawdown rather than an Annuity, the member will not benefit from the mortality profit and will thereby creating a mortality risk. To compensate for this loss of mortality subsidy, the pension drawdown will have to achieve an extra investment return. This also applies to anyone that chooses to delay purchasing an annuity in the hope that the rates will improve in the future.

The Financial Services Authority (FSA) estimates that at age 60 the extra return required is 1% but by 75 it could be as high as 4%. This will result in a mortality drag and is effectively a loss against the investment return as a result of the member deferring the purchase of an annuity.

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Annuities

The benefits of annuities are that income will continue to be paid throughout your life. In addition, there is no need to continue monitoring performance and asset allocation. They also have the added benefit of relatively low administration charges.

However, they can also be inflexible as terms cannot be changed after purchase. Due to it being a ‘lifetime only’ investment, there is no fund to pass on to the next generation. In addition, the real value of a level annuity declines over time.

Income Drawdown

Opting for an income drawdown will give you the ability to vary income within a wide range of options and also has the benefit of being a fund that can be passed to the next generation. A tax-free lump sum can also be drawn instead of an income. Another plus is the potential to benefit from future investment growth.

On the downside, a cautious investment policy is unlikely to generate sufficient returns to compensate for ‘mortality drag’ and the policy is vulnerable to extended life expectancy as well as stock market declines.

Opting to take a higher level of income will have the effect of depleting the fund more quickly.

Alternatively Secured Pension

This type of annuity allows for a level of income that can be varied within certain guidelines. The fund can also benefit from future investment growth and any funds remaining upon death can be passed to future generations.

But again, an alternatively secured pension is vulnerable to extended life expectancy. It is also subject to stock market declines and the income is likely to be lower than from an annuity.

How much income will you get via an annuity?

This depends on your age, sex and what options you buy with your annuity, for example spouse's pension and inflation-linking. Rates vary between providers and can change significantly over time. It is best to take independent financial advice to discuss your individual requirements.

Drawdown Income Rules

You can take up to 120% of the Government Actuary's Department (GAD) drawdown rate from your fund each year. For a man age 65, the GAD rate in May 2005 was £870 per £10,000 of pension fund. This would allow for an income of up to £1,044 to be taken. The calculation, and hence the income you can draw, is reviewed every five years.

Alternatively Secured Pension Rules

You can take up to 70% of the GAD drawdown rate from your fund each year. Because the GAD only publishes rates to age 74, that rate applies until you die although the calculation is applied to your fund every year. For a man aged 75 the GAD rate in May 2005 was £1,190 per £10,000 of pension fund, giving an annual income of up to £833.

What happens when you die?

If you have not taken pension benefits...

Your pension fund can be passed as a lump sum to beneficiaries if you have not taken pension benefits. Any non-protected amounts in excess of the Lifetime Allowance will be subject to the Lifetime Allowance charge of 55%.

Your fund can be used to provide a pension for any dependents. The fund is not tested against the Lifetime Allowance so there is no risk of tax.

If you have already taken pension benefits...

As long as pension income has not been 'secured' on pension benefits the full value of the fund will be available as a lump sum on death subject to a 35% tax charge.

If pension benefits are being provided using an Alternatively Secured Pension, any funds remaining on death after age 75 must be used for the provision of a dependent's pension.