6 - Drawing Benefits

Question 1

Scheme Pensions

Which type of pension can result in benefits paid as a scheme pension?

Answer 1

• DB Schemes always pay out benefits as a scheme pension;
• DC Schemes can also offer this, but they must also offer the member the choice of buying a lifetime annuity from a provider of their choice first.

DB members don’t need this choice because their level of annual income is already guaranteed by the DB scheme terms. DC schemes however are defined by the value of the assets, and different providers will offer different levels of income in exchange for the same starting value.

Question 2

Scheme Pensions

How is a scheme pension secured?

Answer 2

Ultimately a scheme pension means the scheme has commited to provide you with a certain level of income, so you don’t care how they secure the income!

The scheme provider might engage in an annuity contract with an insurance company to pay your benefits. It’s up to them which provider they use. Or they could keep the pension assets, hope to grow them and pay your pension out of the pot each year.

Note that the scheme provider will usually choose to secure the annuity in their own name, but they have the option of securing it in the members name.

Question 3

Scheme Pensions

Restrictions around the PCLS (timing not amount)

Answer 3

The PCLS must be related to starting to take income.

It must be taken in a window starting 6 months before the pension comes into payment up to 12 months afterwards.

Question 4

Scheme Pensions

What flexibility is there around when income is drawn?

Can it be drawn in stages?

Answer 4

Other than being above normal retirement age there are no laws, it’s down to the scheme rules.

The scheme might allow phased drawing of the pension, or might not.

This means you start some of your income now and the rest later, it does NOT mean you have the flexibility to take a different amount each year.

Question 5

Scheme Pensions

What are the HMRC rules around scheme pensions?

Answer 5

• Income must be paid at least annually and for the life of the member;
• Can include capital protection lump sum on death, but maximum guaranteed income period is 10 years;
• Can’t decrease payment level except in specific circumstances (e.g. end of a bridging pension, reduction due to court order - divorce, all scheme members have income reduced due to funding issues). Basically income can’t be reduced flexibly at the choice of the member.

Question 6

Scheme Pensions

What death benefits are available?

Answer 6

• Dependent’s scheme pension;
• Guarantee period;
• Defined benefits lump-sum death benefit;
• Pension protection lump sum;
• Annuity protection lump sum.

Question 7

Scheme Pensions

What is a dependent’s scheme pension?

Restrictions

DC scheme rule

Death benefits allowed

Answer 7

This is a type of benefit, being ongoing income paid to a dependent (not nominee or successor). It doesn’t have to run for their entire life, or be paid at least annually and payments are allowed to decrease.

HMRC limits the amount payable if the member died past age 75, although schemes rarely pay the maximum amount.

If this is from a DC scheme the dependent must be given the option to buy a dependent’s annuity from a provider of their choice.

No guarantee period or lump sum protection allowed, can only be commuted for cash in case of triviality.

Question 8

Scheme Pensions

What is a guarantee period?

Answer 8

For scheme pensions (unlike lifetime annuities) this is limited to 10 years.

It means that even if the member dies at least 10 years income will be paid, either to a dependent, nominee or successor.

Can be commuted for a cash lump sum under triviality rules.

HMRC rules allow it to be stopped if the recipient reaches age 18, stops full time eduction or gets married, but this is rarely used.

Question 9

Scheme Pensions

What is a Defined Benefits Lump-Sum Death Benefit?

Answer 9

Usually this is a death in service benefit (i.e. before you start taking income as a scheme pension) but scheme rules can allow one in retirement in lieu of a guarantee period.

The scheme rules dictate who it can be paid to, and if the trustees have discretion over this then it will be IHT free.

It is also income tax free if it falls within the members LTA.

Question 10

Scheme Pensions

What is a pension protection lump sum?

Answer 10

Pension protection lump sum is a DB scheme death benefit that is rarely used.

It allows for a lump sum to be paid out, limited to the difference between the LTA value of the scheme pension and the amount of income that has been paid out.

EG if the scheme pension was assessed at £200k on crystallisation against LTA and has paid out £15k when they died, limit is £185k.

It is tax free if they died before age 75, otherwise taxed as income on the recipient.

Question 11

Scheme Pensions

What is an annuity protection lump sum?

Answer 11

This is the same as a pension protection lump sum but paid from a scheme pension secured by a DC scheme.

This can also be available with a lifetime annuity.

Question 12

Lifetime annuities

Two main factors affecting annuity rates

Answer 12

• Gilt rates/interest rates - since gilts/bonds are used to invest the lump sum and pay the annuity, the higher current rates the more income they can pay you;
• Mortality rates - increasing life expectancy in general means they’ll have to pay out for longer so can’t afford to pay out as much income each year.

Question 13

Lifetime Annuities

2 methods under which higher annuity rates can be offered based on individual circumstances.

Answer 13

• Enhanced annuities - These take into account lifestyle factors such as smoking, drinking, previous occupation to pay a personalised rate;
• Impaired life annuities - Offer better rates to individuals with serious health conditions affecting their life expectancy.

Note that no bias can be given based on sex due to EU laws.

Question 14

Lifetime Annuities

Restrictions on lifetime annuities pre-flexibility (April 2015)

Answer 14

• Paid at least annually for life;
• Only vary in limited circumstances (eg inflation, pre-specified increases or in line with an investment index);
• No lump sums other than at death;
• Guarantee period no longer than 10 years;
• Bought by a provider selected by the member.

Question 15

Lifetime Annuities

Lifetime annuity restrictions post April 2015

Answer 15

• HMRC rules say the member doesn’t need to choose the provider now, although in reality FCA rules mean they do;
• Still need to pay out for the life of the member;
• Guarantee period can be greater than 10 years now;
• Payments can vary, thus the new flexible annuity. Any annuity with a pre-programmed decrease is a flexible annuity which will bring MPAA into play.

Question 16

Lifetime Annuities

What death benefits are available?

Answer 16

• Survivor’s annuity - These are much more flexible after April 2015, can be paid to anybody nominated (not just a survivor). Must continue for the nominees life (or until re-marriage or for children until they stop being dependent). Survivors annuity can’t have its own guarantee period.
• Guarantee period - After April 2015 legislation doesn’t limit this period. Also unlike scheme pension if they die before age 75 this payout is tax free.
• Annuity protection - Similar to pension protection, this pays out the difference between the LTA value of the annuity and the amount distributed. It’s tax free if they die before 75, otherwise taxed on receiver.

Question 17

Drawdown

What are the two existing forms of drawdown?

In what circumstances can funds be added to them?

Answer 17

• Capped drawdown - No new capped drawdowns after 6/4/15, however capped drawdown funds from before them can continue. You can allocate other funds to your existing capped drawdown if you have one. Capped drawdown can also be transferred to flexi-access drawdown.
• Flexi-access drawdown - Introduced after 6/4/15, it is the only drawdown option available now unless you have an existing capped drawdown scheme.

Question 18

Drawdown

What are the terms of the two drawdown methods?

Answer 18

• Capped drawdown - You can take any amount each year up to a cap. The cap is set at 150% of the income from an equivalent annuity. Rates are published by the Government Actuary Department (GAD) and your cap is recalculated regularly (every 3 years before 75, every year afterwards, also if you buy an annuity or die).
• Flexi-access drawdown - You can draw as much as you want each year, however your first drawdown will trigger MPAA (unlike capped drawdowns).

Question 19

Drawdown

Dates of note for capped drawdown rate assessment

Answer 19

• The reference date is the date the funds were allocated to capped drawdown, and determines anniversary dates when recalculation must take place.
• The nominated date can be up to 60 days before an anniversary date, when the scheme can perform a calculation. This allows them some flexibility to group recalculations together.

Question 20

Drawdown

What happens if you exceed the maximum amount on capped drawdown?

Does transferring capped drawdown to flexi-access drawdown trigger MPAA?

Answer 20

The fund will automatically convert to a flexi-access drawdown fund.

Simply transferring funds from capped to flexi-access doesn’t trigger MPAA. In line with the usual rules for flexi-access drawdown, MPAA is only triggered when income is first taken from the flexi-access drawdown.

Question 21

Drawdown

If you allocate £120k to drawdown, what PCLS can you take?

Answer 21

You can take £40k, i.e. a third.

This is because the £40k will make up 25% of the total funds you are accessing, being the £120k going into drawdown for future income and the £40k PCLS itself.

Question 22

Drawdown

How does allocating funds to drawdown interact with the LTA?

Answer 22

If you’re under 75 allocating funds to flexi-access drawdown is a BCE and will be tested against LTA.

After 75 they will already have been tested against the LTA and will be coming from unused funds, so no further BCE occurs.

Question 23

Drawdown

What is flexible drawdown?

Answer 23

NOT the same as flexi-access drawdown, flexible drawdown is the pre 6/4/15 version of it.

It was available if the individual qualified (had a certain level of guaranteed pension income, initially £20k, then £12k).

They are now all converted to flexi-access.

The major impact of this is that flexible drawdown meant no further pension accrual was allowed. With flexi-access contribution up to the MPAA is allowed.

Question 24

Drawdown

What death benefits are available for drawdown funds?

Answer 24

Generally this is pretty flexible.

• Continue in drawdown - Dependant, nominee or successor can continue to draw down from the funds. If allocated in this way within 2 years of death (2 year window) and the deceased was under 75 then the income is tax free.
• Take as a lump sum - All or part can be taken as a lump sum.
• Buy an annuity - Spend the funds on an annuity, but obviously income only continues as long as the annuitant lives.
• A charity can be nominated by the member or their dependant/nominee to receive a charity lump sum death benefit.

Question 25

Drawdown

Rules for transferring between drawdown providers

Capped drawdown issues

Answer 25

• You can only transfer your entire drawdown fund (not a part of it) and only to a new fund (so you can’t consolidate);
• Transferred capped drawdowns remain as capped drawdown and review dates are not affected by the transfer. If you elect to convert it to flexi-access on transfer then MPAA is triggered (unless this is done by the dependant/nominee).

Question 26

Drawdown

How is drawdown income taxed?

Answer 26

It is all taxed as earned income (this was also the case pre 6/4/15).

So drawing down high amounts will lead to higher income tax charges (20%/40%/45%).

Question 27

Drawdown

What are the risks?

Answer 27

• Running out of money! - This is the key risk, underestimating your life expectancy and using up your funds before you die.
• Investment performance
• Charges - These could go up in the future, and erode your fund, especially if the investments perform badly.
• Annuity rate movement - Your ability to secure a lifetime income will reduce if annuity rates fall while you have funds in drawdown.
• Mortality - Annuities transfer the risk of long life (thus longer income requirement) to the provider, under drawdown you assume the entirety of this risk.

Question 28

Short Term Annuity

What is it?

Capped drawdown concerns

Answer 28

A short term annuity can be purchase out of drawdown funds (by the member or their dependant/nominee) and lasts up to 5 years. The rest of the fund can then be invested for the long term.

You must take care in the case of capped drawdown that the income doesn’t end up exceeding the cap, especially because the annuity income could be fixed for 5 years, but the cap is reviewed every 3 years.

Breaching the cap would convert the fund to flexi-access drawdown.

Question 29

Uncrystallised Funds Pension Lump Sum

What is this?

Which type of scheme can it be taken from?

Answer 29

The UFPLS is a lump sum taken out of pension funds before they have been crystallised, i.e. allocated to drawdown or an annuity.

It can only be taken from DC schemes, not DB.

Question 30

Uncrystallised Pension Fund Lump Sum

How is it assessed against LTA and taxed?

MPAA?

Answer 30

If the member is under 75 years old it is restricted to the remaining LTA and 25% of it will be tax free. Any amount over the LTA is subject to the 55% lump sum tax penalty.

If over 75 they’ve already been assessed against LTA, however they must have some LTA left. 25% of the part within the LTA is tax free.

Any part of the UFPLS which is not tax free (or hit with the 55% charge) is taxed as income. Recall that you can get stung for taking a lot of income in one month as you only get 1/12th annual allowance (overpayment will eventually be refunded).

This is deemed to be flexible access and therefore triggers MPAA.

Question 31

Uncrystallised Funds Pension Lump Sum

Restrictions on when you can take it (age)

Restrictions on who can take it

Answer 31

It can’t be taken before age 55 unless you’ve got protected retirement age or ill health.

Also can’t be taken if the member has primary protection and over £375k cash or LTA enhancement and the UFPLS would be over their 25% maximum lump sum entitlement.

It can also not be taken from any scheme where the member has scheme specific cash protection (i.e. they can take over 25% PCLS from that scheme).

Question 32

Uncrystallised Funds Pension Lump Sum

Risks

Answer 32

Other than the risk of using up your pension fund and getting hit with a big lump sum tax charge, IHT is a key risk.

Death benefits from pension schemes may have IHT protection which is entirely lost if you draw it as a lump sum out of the tax wrapper.

Question 33

Phased Retirement

What is it?

Answer 33

Phased retirement refers to using flexible pension rules to start taking income from your pension in various different ways, aiming to maximise tax efficiency for your personal circumstances.

For example £20k pa income could be taken from £70k funds by buying an annuity paying £2.5k pa and taking the £17.5k lump sum. Then next year buy another annuity to get another lump sum and increase the £2.5k again.

Or alternatively you could use flexi-access drawdown, but with the associated risks.

Or a series of UFPLS could be used, although this will usually not be tax efficient.

Question 34

Small Pots

What are the small pots rules?

Answer 34

An unlimited number of small (under £10k) of occupational pension schemes can be drawn without testing against LTA (from crystallised or uncrystallised funds).

The schemes need to be unconnected (eg can’t be a big pension with one employer broken up into £10k chunks).

Up to three such £10k small pots can be taken from non-occupational pension schemes.

Question 35

Trivial Commutation

What are the trivial commutation rules?

Timing?

What is included in the value limit?

Answer 35

Where total value of all pension schemes is below £30k they can be taken in cash in one go. Relates to DB schemes since this can be done anyway with DC schemes.

Can only be taken if:

• You’re over NRA;
• Value of all pensions <£30k on a nominated date - cash must start to be taken within 3 months of this date, all taken within 12 months of first payment;
• Have remaining LTA (will certainly be the case due to £30k limit);
• Can leave some schemes untouched, but must take all benefits from a scheme if they take any at all (i.e. can’t extinguish a scheme in part).

Question 36

What are the possibilities for ongoing use of small pots and triviality rules.

Answer 36

Triviality is a one time process, once the 12 month window after your nominated date is over you can never use it again.

Small pots can continue to be taken indefinitely (subject to the 3 non-occupational small pots limit).

Question 37

Trivial Commutation

How are benefits valued for this purpose.

Answer 37

First note that previous small pots taken are not a BCE therefore are excluded from triviality test (so a good idea to take them first).

Value using usual LTA rules:

• Pre-A day benefits in payment valued at 25x;
• Benefits in payment on valuation date but after A-day use the value at crystallisation;
• Benefits not in payment at fund value for DC, 20x pension entitlement for DB.

Question 38

Trivial Commutation

What are the two types of death benefit that can use trivial commutation?

Who can do that (d/n/s)?

Requirements

Answer 38

• A dependent or nominee (though not a successor) may apply for trivial commutation of a survivor’s pension;
• Anybody (dependent, nominee or successor) may apply for trivial commutation of payments under a guarantee period.

Note that in all cases they must wipe out the entire value of the scheme.

Anything taken out in excess of £30k is an unauthorised payment and taxed accordingly.

Question 39

Regulations

What communications must be sent by pension providers to members relating to drawdowns?

Answer 39

An ‘open market option’ statement (which lets you know you might get a better deal by shopping around, eg for annuities) must be sent:

• If the customer requests a statement of retirement benefits;
• Between 4 and 6 months before the scheme retirement date if they don’t; and
• Around 6 weeks before retirement.

In addition the communication 6 weeks before retirement should have a note regarding the work of the PensionWise service and a valuation of benefits available for the open market option.

Question 40

Regulations

What risk warnings must be given by providers if the customer indicates they wish to access their pension savings?

Answer 40

If the fund is below £10k there are standard risk warnings (around guaranteed annuity rates, pension scams, importance of shopping around etc.).

Over £10k they must ask questions to determine the manner in which the customer intends to draw benefits, which then impact the risk warnings given.

Question 41

Annuity Features

Which of the following features have the biggest cost (i.e. reduction of initial annuity income amount)?

Annuity Protection, Spouse’s pension, Guarantee, Escalation

Answer 41

• Escalation is the most expensive option (cumulative growth rates applied to the annuity amount quickly add up and make it very expensive);
• Spouse/survivor pension is the next most (since it increases the number of years you are likely to pay out for);
• Annuity protection;
• Guarantee is the cheapest feature to add.

Question 42

What are the two types of critical yield?

Answer 42

• Type A: The yield required to achieve the current annuity rate.
• Type B: The yield required to achieve the members chosen level of income.