London Life - Pensions News - Annuity Purchase (Annuitisation) At Age 75

Terms in italics are explained in our jargon buster .

In brief

With effect from 6 April 2011:

Tax law will allow the purchase of an annuity to be delayed beyond age 75, and
Tax law will allow certain lump sum benefits previously available only before age 75 to be paid after age 75. Some of these payments will, however, be subject to a tax deduction.

Who’s affected

Individuals with a money purchase pensions fund which has yet to be used to provide retirement benefits; and
Individuals who have started income withdrawals, or have that option under their pension scheme or arrangement.

In detail

Background

As part of its desire to foster a savings culture in the UK, the coalition government has considered what steps it could take to make savings more flexible and attractive. They hope that people will take a greater responsibility for their financial future, and pension savings need to play a significant role if that goal is to be achieved.

Government felt that inflexibility in retirement ages, particularly for those reaching age 75, and the restrictions applied to the use of pension funds at that time were acting as disincentives to save.

With people living longer and longer – today a healthy male aged 65 can now expect to live, on average, 21 years and a healthy female of the same age for 24 years^(*) – the impact of this inflexibility was likely to grow. As a result, they pledged to make changes.

In the June 2010 budget, some short-term measures were made available to pension schemes, and the government stated that permanent revisions to the law would follow.

Many schemes did not offer the interim measures since they were quite complex. Government’s goal was for simplicity, so people could be enabled to make appropriate decisions about their retirement options.

In December 2010, details of the permanent revisions were announced and these are summarised below. These significant changes to tax law will, from 6 April 2011, allow (but not require) pension schemes to offer much more flexibility to their members, especially those approaching, and passing, their 75th birthday.

^(*) 2008 based cohort life expectancy, Office for National Statistics.

What this means for - those with a money purchase pension fund who have yet to buy an annuity.

Prior to 6 April 2011, the vast majority of money purchase pension schemes required a member reaching the age of 75 years to convert their pension pot into a pension income through the purchase of an annuity.

The only way in which this restriction could be avoided was to transfer the pension fund into another pension scheme that offered a special type of income withdrawal known as “alternatively secured pension” or ASP for short.

However, with ASP there were still special rules as to how much income could be taken (see ‘What this means for – those taking, or with the option of taking, income withdrawals’ for details), and any funds left upon death were liable to heavy tax charges.

From 6 April 2011, if the pension scheme’s rules permit it, on reaching age 75 a member can simply choose to leave their pension fund invested until such time that they need to generate a retirement income from it.

In addition, some lump sum benefits which could only be paid prior to age 75 will be available at any age. However, to ensure that pension savings continue to be made for the provision of a retirement income, rather than to solely seek tax relief from the exchequer, when paid after age 75 they will be subject to a tax charge.

The table below details:

(a) the key restrictions which tax law normally applies until 5 April 2011 (except for funds in drawdown, including ASP, which are covered later in this document); and
(b) the more flexible options available from 6 April 2011, subject to the rules of your pension plan.

Action / Option	Pre 6 April 2011 restrictions	Post 5 April 2011 flexibility
Buying your pension income (annuity)	Had to be done before reaching age 75	Can be delayed beyond age 75 for as long as required
Death before buying an annuity, but after age 75 – lump sum benefit	Not available	Can be paid at any age, but subject to a 55% tax charge if paid after 75
Trivial commutation (small funds) lump sum	Not available after age 75	Can be paid at any age, subject to an income tax charge
Serious ill-health lump sum	Not available after age 75	Can be paid at any age, but subject to a 55% tax charge if paid after 75
Retirement tax-free lump sum	Entitlement had to be established prior to age 75, and payment made before age 76	Can be paid at any age
Transfer after age 75	Not available	Can be paid at any age
Annuity protection lump sum	Not available after age 75	Can be paid at any age, subject to a 55% tax charge

Reaching age 75 will remain an important point though since it is, notionally, the age at which a working life is deemed to end. As a result, on reaching age 75, tax relief on pension contributions ceases to be available, and an overall check on the combined value of a person’s pensions has to be done to see if any tax charge (lifetime allowance charge) is due.

What this means for - those taking, or with the option of taking, income withdrawals.

The ability to draw an income directly from a pension fund and delay the purchase of an annuity has been available since the mid-nineties. However, until the simplified tax regime was introduced in April 2006, annuity purchase could only be deferred until age 75.

Whilst the simplified tax regime allowed annuity purchase to be delayed beyond age 75, it was introduced primarily to encourage pension savings by members of certain religious groups. Those people’s beliefs are such that they cannot benefit from another persons misfortune, and since each annuity carries a cross subsidy in respect of other annuitants who die early, they cannot therefore buy an annuity. Post age 75 income withdrawal was known as alternatively secured pension (ASP). To try and ensure that pensions remained true to their goal, of providing an income in retirement rather than passing on tax privileged funds upon death, the income that could be drawn was restricted and lump sums paid on death were heavily taxed.

In light of increasing longevity, and the government’s desire to promote choice, the existing income drawdown rules have been reviewed, and several relaxations become available on 6 April 2011.

The most significant change is the introduction of two forms of income withdrawal, namely “capped drawdown” and “flexible drawdown”.

Capped Drawdown

Under capped drawdown, the amount that can be drawn is limited and that same limit calculations basis applies regardless of age. The current, more restrictive, post age 75 limitations will no longer apply.

The table below highlights the differences between the income withdrawal (unsecured pension) rules which apply until 5 April 2011, and the capped drawdown rules which become available from 6 April 2011.

Option / Rule	Pre 6 April 2011 rules	Post 5 April 2011 rules
Availability	For unsecured pension - from age 55 to 75	Age 55 onwards for both capped drawdown and flexible drawdown
	For ASP – from age 75 onwards
Limits on the income available in each year	Until age 75 – 0% to 120% of the basis amount	0% to 100% of the basis amount, regardless of age
	From age 75 – 55% to 90% of the basis amount
Limit review period	Until age 75 – every 5 years	Until age 75 – every 3 years
	From age 75 – annually	From age 75 – annually
Tax due on death lump sum from unused drawdown funds	Death before age 75 – 35%	55%, regardless of age
	Death after age 75 – up to 82%
Short term (temporary) annuity option	Until age 75 - available but term must end before 75 is reached	Available at any age with no age restriction on annuity term
	After age 75 – not available

The new capped drawdown limits apply from the first income withdrawal limit review completed after 5 April 2011. Those that start to take income withdrawals just before the change can therefore use the higher pre 6 April 2011 limit for up to 5 years.

Flexible Drawdown

Under flexible drawdown, the amount that can be drawn is NOT limited, so, it would be possible to draw an entire pension fund as a one-off income payment, subject to income tax under the Pay As You Earn system.

However, to be eligible for flexible drawdown, an individual must be able to demonstrate to their pension scheme administrator that they have a guaranteed income, from other sources, above a prescribed threshold.

This threshold is known as the minimum income requirement (MIR). It has initially been set at �20,000 per annum but will be reviewed every five years.

The MIR must be met at the point, or each point, that flexible drawdown is used. Only pensions and annuities in payment which are guaranteed to be paid for life can count towards the MIR, so, State Pensions and lifetime pension annuities can count, but a deferred pension which comes into payment in the future cannot count.

Important Notes

This document outlines our understanding, as of December 2010, of the changes in pensions and tax law introduced through the Finance Bill 2011. The changes are summarised here but this document should not be treated or relied upon as a statement of law. Whilst every effort has been made to ensure that it is correct, it does not constitute legal advice and London Life cannot accept any legal responsibility for it. London Life always recommend that you seek independent financial advice regarding the matters raised in this document.
There may be a difference between what the law will permit and what your pension scheme, or other pensions arrangement, is willing to offer or support.
Further information about the simplified tax regime introduced on 6 April 2006, and income drawdown, can be found:
= on our website at www.london-life.com/simple
= from HMRC’s website manual at www.hmrc.gov.uk/manuals/rpsmmanual
For news of the latest changes affecting pensions, go to the latest news section of our website.
For advice - If you require financial advice as a result of the changes in pensions law and taxation outlined in this document, please speak to your financial adviser. If you do not already have a financial adviser, then you can find details of the advisers in your area on the IFA Promotion Ltd website (www.unbiased.co.uk). Please note, financial advisers may charge you for providing advice.