Drawing your pension income

What the new retirement rules could mean for you

Deciding how to take your pension benefits is one of the most important financial decisions you’re ever likely to make. As part of the new 2011 retirement rules, from 6 April this year the pension annuity rules will change, meaning that UK pensioners will no longer be forced to use personal pension funds to buy an annuity.

Freedom to choose
Investors will have the freedom to choose when and how they take their pension, with the compulsory annuity age of 75 being withdrawn. Under the new annuity purchase rules, the compulsory element will cease. From 6 April 2011, investors will be given more flexibility about how they choose to use their retirement savings. You will still be able to convert funds to an annuity if you wish, but you will also have more options such as Income Drawdown and continued pension investment.

Individuals who are already in drawdown will not be immediately subject to the new requirements; however, transitional rules will apply. If this applies to you, you’ll need to adopt the new rules either at the end of your current review period or earlier if you transfer to another drawdown plan.

Investors will be able to use Income Drawdown or take no income at all from their pension for as long as they require. However, tax charges on any lump sum death payments will prevent this option being used to avoid Inheritance Tax (IHT). The rules regarding Alternatively Secured Pensions (ASPs) will be repealed; existing ASP plans will convert to Income Drawdown (currently known as Unsecured Pension, or USP) and will be subject to the new rules.

Flexible Drawdown
A new drawdown, called Flexible Drawdown, will be introduced. This will allow those who meet certain criteria to take as much income as they want from their fund in retirement. It will normally only be available for those over 55 who can prove 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 will be restrictions that are designed to prevent people from taking all their Protected Rights or from using Flexible Drawdown while still building up pension benefits.

The current drawdown option after 6 April 2011 will become known as Capped Income Drawdown. The maximum income will be broadly equivalent to the income available from a single life, level annuity. This is a slight reduction on the current maximum income allowed. There will be no minimum income, even after age 75. The maximum amount will be reviewed every three years rather than every five years. Reviews after age 75 will be carried out annually. Unlike the current ASP, the income available after age 75 will be based on your actual age rather than defaulting to age 75.

Death benefits and tax charges
The changes to death benefits and tax charges mean that if you die while your pension fund is in either form of drawdown, or after the age of 75, all of 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 (or nil charge if paid to a charity). Previously, a tax charge of up to 82 pr cent applied on lump sums paid after age 75, making it now far more attractive for people to pay into their pension and consider the IHT benefit of doing do so.

Currently, a pension fund which has been ‘crystallised’ by using Income Drawdown is subject to a tax charge of 35 per cent if the member dies and any surviving spouse chooses to take the fund as a lump sum. From 6 April this will increase to 55 per cent, and applies to plans currently in force. It is also worth noting that, after age 75, this 55 per cent tax charge will apply even to funds that have not been crystallised (from which no lump sum or income benefit has been taken).

Annuities themselves have not been changed; however, the minimum age at which you can buy an annuity is age 55. An annuity will still be the option of choice for a lot of retiring investors because, unlike Income 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.

From 6 April the maximum pension contribution limit will be reduced to £50,000 (down from £255,000). However, investors will benefit from tax relief at their highest marginal rate. The previous government’s more complicated rules surrounding high earners and restricted tax relief will be discarded.

From 6 April 2012 the lifetime allowance will also be reduced. The full lifetime allowance will be reduced to £1.5m, down from £1.8m.

The coalition government has also brought back the carry forward rules, enabling anyone who wishes to roll up any unused contribution allowance to do so and take advantage in a future tax year. The £50,000 allowance can be carried forward for as many as three tax years. This roll-over relief comes into full effect on 6 April 2011.

Although investors will not have to annuitise pension savings from 6 April this year and could, as an alternative, draw down income as cash lump sums, there are still rules to be followed to prevent investors running out of retirement income and becoming dependent on State benefits.

Past performance is not an indication of future performance. Tax benefits may vary as a result of statutory change and their value will depend on individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts. A pension is a long-term investment. The fund value may fluctuate and can go down as well as up and you may not get back your original investment.