End of annuities?
JULY 22ND, 2010 By DAVID
Further details are emerging following the headline Budget announcements by George Osborne. One of the latest topics to be thrown up for debate is the proposal to scrap the requirement to annuitise by age 75.
The Coalition Government is entering a consultation period and after looking through the proposals I am inclined to agree with them.
Prior to 2006 every member of a defined contribution pension scheme that reached age 75, and had not purchased an annuity, had to purchase an annuity (after taking a tax-free pension commencement lump sum). An annuity is a life policy that converts money from a pension fund into a secure pension income for life.
Annuities are not perfect and the main criticisms of them are that the annuity features have to be selected at outset and cannot be altered, and the death benefits are usually limited to a dependant’s pension and/or a guarantee period/value protection. Another problem is that some individuals have had to buy an annuity at 75 when annuity rates have been low and/or after the stock market has fallen.
The previous Conservative Government tried to address some of these issues in 1995 by introducing unsecured pension (USP), which allows an individual to draw an income from the residual pension fund (after taking the pension commencement lump sum) and thus defer the purchase of an annuity to age 75.
The main attraction of USP is the ability to vary the income taken and the fact that the pension fund can
potentially benefit from future investment growth. In the event of death prior to age 75 the residual fund can usually be paid as a lump sum death benefit less a 35% tax charge.
However, in reality USP only provides temporary relief, as the vast majority of individuals in USP currently live beyond 75 and are thus caught by the age 75 rule.
In 2006 the Labour Government introduced alternatively secured pension (ASP) so that individuals who have principled objections to annuitisation did not have to purchase an annuity at age 75.
Although ASP is based on the USP model, the income limits are more restrictive. It was not intended to be a mainstream alternative to an annuity and the tax rules (including tax charges on the residual fund which can be as high as 82%) mean that most people continue to purchase an annuity at age 75.
It is intended that the new rules will come into force on 6 April 2011. The key proposals are:
• No requirement to take benefits from a pension scheme at any age
• ASP will be abolished and USP will be available beyond age 75
• USP will be available in two formats: capped and flexible
• A 55% tax charge will apply to lump sum death benefits paid from pensions in USP and to pensions where benefits have not been taken by age 75
The Coalition Government has reiterated that the main aim of a pension scheme is to provide a replacement income in retirement and not to provide a vehicle for the accumulation of capital sums for the purposes of avoiding inheritance tax.
To that end, the Coalition Government has said that inheritance tax will not ordinarily apply to unused pension funds, but it will monitor the situation to ensure that the system is not abused.
The Coalition Government’s proposals are designed to give individuals more choice which is clearly a good thing. It should be borne in mind that the increase in the tax charge applied to the USP lump sum death benefit prior to age 75 has to be balanced against the reduction in the tax charge applied after age 75.
It is also true that annuities will continue to meet the requirements of most individuals e.g. those with small
pension funds/individuals who require the certainty of a defined income stream. This is because annuities provide a guaranteed income and ensure that an annuitant will not run out of money during their retirement.
Posted in: Retirement planning