Prior to the UK General Elections, both the Conservatives and Liberal Democrats had pledged to end compulsory annuitisation. In the June Budget the age by which a pension holder needs to buy an a
Prior to the UK General Elections, both the Conservatives and Liberal Democrats had pledged to end compulsory annuitisation. In the June Budget the age by which a pension holder needs to buy an annuity was increased from 75 to 77. A consultation paper published by the Treasury on 15th July goes even further by saying that, from April 2011, there should no longer be a deadline by which people ?effectively have to annuitise?.
The purpose of consultation process is to enable the government to thrash out the finer detail of the new regulations. The two year window till age 77 is expected to be long enough to allow the consultation and agreement to be finalised.
Financial secretary to the Treasury, Mark Hoban, said that, ?to encourage people to take greater responsibility for their financial future, including in retirement, we need to give people greater flexibility over how they use the savings they have accumulated?.
Under the current rules, if you do not buy an annuity by age 77 you are automatically transferred into an Alternatively Secured Pension (ASP). When you buy an annuity you usually cannot pass the balance on to your heirs (other than a spouse?s or dependent?s pension) and the rates are currently low. ASPs offer lower levels of income to drawdown and a much higher tax charge on death ? up to 82% compared to the 35% applied to income drawdown. You cannot defer your pension income or tax free lump sum after age 75 or delay buying an annuity till after age 77.
Now, under the proposals in the consultation document, from 6th April 2011 UK pension holders will be able to buy an annuity at any age they like. If they choose not to buy one at all, they will no longer be transferred into an ASP. In fact the government has said that with no age limit to annuitise, it will be unnecessary to continue to offer ASP as an option.
For those who do not buy an annuity, the same drawdown system that currently exists pre age 77 will apply post 77, but with the new name of ?capped drawdown?. There will also be a second choice of a new ?flexible drawdown? system.
Capped drawdown
Under this regime, income can be withdrawn subject to annual Government Actuarial Departments (GAD) limits. Those in drawdown can currently take income of up to 120% of GAD limits, but this limit will be reviewed. It is expected to be conservative to ensure that people do not take too much income and risk running out of money and having to fall back on the state for support.
Flexible drawdown
Under this regime pension holders will be able to take more than one lump sum and as much as they like, provided they can show that they have already secured ?minimum income requirements? (MIR). The aim of the MIR is again to ensure that retirees do not withdraw too much and end up relying on the state.
The definition of MIR ? i.e. the amount of income you need to have ? will be determined after the consultation. It may vary according to age and/or marital status.
Only pension income will be used to determine your MIR ? any income generated from your other savings and investments will not count, even if you have substantial personal wealth. It can include state pensions and other pensions already in payment provided they are guaranteed for life and take inflation into account. Annuity income will be considered provided it increases by the same level of inflation or by 2.5% each year and is guaranteed and immediate in payment. You could therefore use part of your pension pot to purchase an annuity to meet your MIR target for the balance of your pension funds.
Besides the level of MIR, the government needs to establish what constitutes secure income; the age at which the MIR has to be determined and how it should be assessed.
Tax charges on death
The good news is that those who do not want to buy an annuity will no longer be faced with a tax charge of up to 82% on the residual fund left on death. Instead it will be subject to a recovery charge of 55%.
The bad news is that for those who die at age 77 or younger, the tax charge increases from 35% (the rate currently charged on income drawdown) to 55%.
And while 55% is obviously an improvement on 82%, while you can leave the balance of the fund to your heirs (which you cannot do if you buy an annuity), the taxman will still take over half of your fund, leaving just 45% of it for your heirs.
The current 82% charged on ASP includes inheritance tax (without it is 70%). Under the consultation IHT will no longer ?ordinarily? apply on death after 75. However the government has said it will monitor the situation and that it will clamp down on any signs of abuse. If IHT were applied, the total tax rate would be 73%.
This 55% tax is ?designed to recover past tax relief?, but considering that for the majority of people only receive 40% or 20% tax relief, it seems rather unfair that they will be taxed 55% on death.
The consultation document also proposes that the tax free lump sum can be taken after age 75.
The consultation period ends on 10th September. When the final version has been announced I will write another article to explain how the new regulations will work.
While we welcome the demise of the ?annuity trap?, we still need to find out exactly what the new regime will entail. It appears that the MIR rules to be applied on flexible drawdown could be very complex. 55% is also a rather punitive tax charge for the balance of the fund.
QROPS (Qualifying Recognised Overseas Pension Schemes) continue to look attractive for expatriates who have pension funds totaling over ?100,000. Provided you have been non-UK resident for five complete and consecutive UK tax years at the time of your death, your fund will escape all UK charges on death, whether it is 35%, 55%, 82% or IHT. If you wish to buy an annuity you may do so.
For expatriates in countries like Spain, France and Portugal a QROPS also provides tax savings during your lifetime. No UK PAYE is payable on income from a QROPS; your pension can roll-up tax free and taxation of withdrawals is usually more beneficial than if you keep a UK pension fund.
You can also set up the fund and income in Euros to avoid exchange rate risks and costs, and provide increased investment and income flexibility.
Seek advice from a wealth management professional like Blevins Franks to explore your options and ensure if a move into QROPS would be an appropriate move for you.
By David Franks, Chief Executive, Blevins Franks
23rd August 2010
