Alternative options for investors

The Treasury published its draft Finance Act legislation on 9 December 2010. The rules revolutionise the way pension benefits are taken and are designed to make retirement more flexible.

There is no longer a requirement to set up benefits by age 75. Whilst the majority of retirees will still want a secure income at the point of retirement, this change provides an alternative option for investors who would prefer to have greater control and flexibility over how and when their pension income is paid.

The age 75 rule has been abolished and there is no longer a requirement to take pension benefits by a certain age. Historically, individuals have had to set up an annuity or move into an Alternatively Secured Pension (ASP) by the age of 75.

Taxable income
It is now possible to leave your pension fund untouched for as long as you like. If you still have enough income from employment or other savings your pension can continue to grow free of UK Income and Capital Gains Tax. When you are ready you can still take up to 25 per cent as tax-free cash and use the remainder to provide a taxable income using an annuity or Income Drawdown.

However you need to bear in mind that the death benefits change once you reach age 75 if you have not taken benefits at this point. Retirees can use Income Drawdown indefinitely and use this or take no income at all from their pension for as long as they want. However, tax charges on any lump sum death payments prevent this option being used to avoid Inheritance Tax. ASP, which had a number of restrictions and limited death benefits, has ceased.
If at age 75 and you decide to remain in drawdown you can still benefit from the same income rules and death benefits as pre 75. It is also now possible to defer drawing any income until after age 75.

Flexible Drawdown
A new drawdown option has been introduced called Flexible Drawdown which allows those who meet certain criteria to take as much income as they require from their fund in retirement. It will normally only be available for those over 55 who can prove that they are already receiving a secure pension income of over £20,000 a year when they first go into Flexible Drawdown.

The secure income can be made up of State pension or from a pension scheme, and does not need to be inflation proofed – investment income does not count. There are restrictions that are designed to prevent people from taking all their Protected Rights or from using Flexible Drawdown while still building up pension benefits.

If you meet the set criteria, Flexible Drawdown will allow you to draw as much taxable income from pensions as you need, when you need it. It will also be possible to use part of your pension to buy an annuity to secure the £20,000 and then move the rest of your pension to Flexible Drawdown.

Capped Drawdown
The previous name for drawdown is replaced with Capped Drawdown. The maximum income is broadly equivalent to the income available from a single life, level annuity. There is no minimum income, even after age 75 and the maximum amount is now reviewed every 3 years rather than every 5 years.

Reviews that take place after age 75 are carried out annually, unlike the previous ASP, the income available after age 75 is based on your actual age rather than defaulting to age 75.

Capped Drawdown is very similar to the previous drawdown system. The main changes are that the maximum income available under age 75 is a little lower than previously and the maximum income over age 75 is a little higher. There is no longer the requirement to take an income after age 75. Under ASP it was assumed you are 75 when calculating your income limits. Under Capped Drawdown your actual age is used, meaning the percentage of your pension that can be drawn should increase as you get older, rather than remaining static.

If you die whilst your pension fund is in either form of drawdown, or after the age of 75, all your remaining fund can be used to provide a taxable income for a spouse or dependant. Alternatively it can be passed on to a beneficiary of your choice as a lump sum, subject to a 55 per cent tax charge.

For investors in drawdown before age 75, the tax charge is now higher if you want to pass your remaining fund as a lump sum in the event of your death, however this is more than balanced out by the fact the tax charge is significantly reduced for passing your fund on after age 75. It is also important to note that the 55 per cent tax charge will be applied on death after age 75 even if you have not purchased an annuity or moved into drawdown.

Transitional rules
Individuals who were already in drawdown will not be immediately subject to the new requirements however transitional rules will apply. They will need to adopt the new rules either at the end of their current review period or earlier if they transfer to another drawdown plan.

Investors already in drawdown can benefit from the new rules and can continue in drawdown past age 75. However it is likely that when they adopt the new rules, they may see a reduction in the maximum income they can take.

The ability for most people to take up to a quarter of the pension fund as tax-free cash is still available when the individual sets up an annuity or goes into Income Drawdown, even if they take no income.

Annuities themselves have not been changed however it is now possible to buy an annuity at any age after 55. An annuity will still be the option of choice for most retiring investors because unlike drawdown it provides a secure income for life. Annuities are expected to be used to secure the minimum income requirement of £20,000 to allow investors to use the rest of their pension to go into Flexible Drawdown.

A drawdown pension, using income withdrawal or using short term annuities, is complex and is not suitable for everyone. It is riskier than an annuity as the income received is not guaranteed and will vary depending on the value and performance of underlying assets.

Bear in mind that a pension is a long-term investment. Your eventual income will depend on the size of fund at retirement, future interest rates, and tax legislation.