Freedom to choose

Mike Morrison assesses the pros and cons of scheme pension.

The dust will finally settle on the Budget changes to tax relief for pensions, particularly the anti-forestalling rules and at that point we will be able to consider the opportunities that remain. 

In the meantime let us not forget that there are a number of key areas that are not immediately affected by the changes, particularly in retirement planning. 

Post A-Day we are all aware that from age 50 (55 from 2010) individuals can commence taking benefits from their pension schemes either via an annuity, unsecured pension (USP) or scheme pension, and from age 75, alternatively secured pension (ASP).

Much has been written about the pros and cons of annuities and drawdown and the penal tax charges associated with ASP. An alternative that is becoming more available is that of scheme pension. 

Scheme pension has long been available for defined benefit schemes, but post A-Day it has become an option for all defined contribution schemes, particularly SSASs and latterly SIPPs. 

What is scheme pension?

Scheme pension is a form of secured pension where the individual gives up control of his/her fund for a level of income that can be paid by that fund for the rest of his/her life. The trustee of the scheme, with actuarial advice will calculate the level of income that the fund can provide for the lifetime of the scheme member.

In effect, the scheme trustee will look at the circumstances of the individual concerned, his age, life expectancy and investment approach and then work out actuarially what his fund can provide. In many cases this will then be reviewed periodically to see whether the actuarial assumptions are being borne out.

The choice of the most suitable retirement option will be a function of a number of factors including the need for income, benefit flexibility, the need for death benefits, attitude to risk and indeed a whole host of other client circumstances.

Two of the most popular questions that will be asked are: 

• How do I maximise the level of income that I can draw?

• How can I maximise the value of the remaining fund on death? 

It is these two questions that can determine the approach to be taken in retirement.

Up until age 75, unsecured pension is likely to offer the highest starting amount of income for someone of normal health with the maximum being based on 120% of GAD annuity rates. With annuities the starting rate of income is maximised by foregoing any ancillary benefits and by the rate offered by the annuity provider. Scheme pensions could be higher for someone with health problems as it is calculated by reference to an individual’s specific life expectancy. In the same way enhanced or impaired life annuities are likely to offer a higher level of income.

After age 75, the level of income available under ASP is quite restrictive and in most cases it is likely that scheme pension will provide a higher starting income.  

Death benefits

For many people death benefits are an important part of the decision making process and in trying to get full value from their pension fund.  

With an annuity the benefits on death are chosen at outset and cannot be changed even if circumstances change. It is possible to build in a spouse’s or dependant’s pension or a guarantee of up to ten years but each have an effect on the starting level of income and cannot be changed. There is also no other return on death other than that chosen. Any balance of a guarantee period will result in a discounted value of the unpaid guarantee being added to the estate for IHT purposes.

In the case of ASP there is no chance to build in a guarantee and although the remaining fund on death can pass to a dependant, there is ultimately what can turn out to be an 82% tax charge (in reality this can effectively be 100% as few providers will pay out the unauthorised payment of 18% and perhaps the only way of maximising benefits under ASP is to opt for the tax free payment to charity.)

Under scheme pension it is possible to build in a fixed payment period of up to 10 years and on death within this period the balance of payments can be paid to a beneficiary as income and so subject to income tax and not IHT. Any remaining fund can be used to benefit a spouse or dependant. If under scheme pension there is a payment to a connected party that triggers an unauthorised payment charge then it appears that it is only taxable about 73% as opposed to 82% and that the surplus will be paid out.     

Scheme pension will not be for everybody but it should at least be considered when looking at the full range of retirement options available for clients. As we all live longer retirement is changing and it is important to recommend a solution that meets the appropriate client needs.

Advantages of scheme pension 

• The starting level of scheme pension could well be higher than ASP. 

• There is no cross subsidy – the benefit is based on that individual only.

• Scheme pension can be underwritten to take account of a shortened life expectancy and consequently be higher than standard. 

• Scheme pension can be paid for a fixed term of 10 years – giving the potential for some tax advantages on death within the fixed term period. 

• Any unauthorised payment charge on any reside left may be less than that on ASP. 

• There might be some advantages when compared to the LTA as scheme pension is multiplied by 20 when tested. 

• There might be the possibility for the trustees to reallocate growth on the fund if it is not needed to sustain the required level of scheme pension.