Why scheme pension is going mainstream

Martin Tilley, director of technical services at Dentons, discusses the pros and cons of scheme pension...

Previously I have written that, with the options available to clients at retirement, the pensions industry and advisers “have never had it so good”.

With the features available through phased, capped and flexible drawdown, the retiring client should be confident that retaining control of their income, investment and capital is for many the correct choice.

One thing that is certain is that clients’ circumstances change. Whether this is because of health, inheritance, luck or otherwise, very few peoples’ lives pan out quite the way they thought they would 20 years previously.

Why then are clients currently undergoing reviews of income drawdown, with some doubting the decisions they made when they retired?

Annuity deferral

Despite the latest government hype, it was from April 2006 that the requirement to purchase an annuity at age 75 was removed with alternative secured pension (ASP), but annuity deferral as an option, dates back further than the introduction of income drawdown through SIPPs and some personal pensions in 1995.

Small self administered schemes (SSASs) from the 1970s were permitted to defer the purchase of an annuity for up to five years post retirement for the purposes of timely disinvestment and selection of the most appropriate time to enter the annuity market.

In practice this is often the way that income drawdown is promoted. To tread water, avoiding an irrevocable decision by purchase of annuity, when circumstances may change or particularly when annuity markets may be better than they are now.

Unfortunately, historical data reflects that this “better market” has not been forthcoming. The table at the bottom of this page reflects the level annuity yield on capital for a male age 65 and 15 year gilt yield at intervals over the last 20 years.

With steadily-dropping annuity yields and increasing life expectancy, the other variable offsetting the decline would be investment return. Sadly, although there have been bright periods, the overwhelming trend has been that returns have failed to compensate and income levels have invariably dropped.

The question now being asked is how much worse can it get? The withdrawal of the 20% uplift, which came into effect on 6 April 2011 and which applied previously to pension income drawdown, has also had a severe impact on members’ pensions.

In addition, the introduction of non gender-specific income and annuity rates from 2013, would suggest that for males a little further hurt might still be to come.

With gilt yields continuing to fall HMRC has confirmed that a minimum Government Actuary’s Department rate of 2% has been set – irrespective of yields falling below this level.

Scheme pension

Many advisers or clients may be tempted to consider looking at setting up scheme pension. It is an alternative way to take benefits which enables clients, particularly those aged 75 and over, to provide continuing income post-death.

Additional members can be included in the scheme enabling the plan to be used as a group or family SIPP.

There are some issues with scheme pension as some providers have been promoting this as a solution providing a higher initial level of income than income drawdown. Certainly for impaired lives, properly underwritten scheme pension should result in higher levels of income.

However, scheme pension, like an annuity, is a lasting decision and should result in a secure lifetime income based on criteria at the outset. Scheme pension cannot always pick up good investment performance as upward increments in excess of inflationary indexation could give rise to lifetime allowance charges.

Care should also be taken as the temptation to seek out the highest initial level of scheme pension might backfire; if HMRC believes that unsupportable assumptions have been used in the initial setting of the income level, it may seek to retrospectively tax excessive pension payments.

For this reason, investment markets aside, for newly retiring, so-called “baby boomers” of sufficient wealth, it would seem that income drawdown now does represent an appropriate choice, since there must now be every chance that over the next 25 years “things can only get better”.