TPAS - The Pensions Advisory Service

What is a lifetime annuity?

A lifetime annuity is an arrangement that pays you an income for the rest of your life, bought by a pot of money saved in a money purchase pension plan. 

The lifetime annuity is usually a contract between you and the insurance company you have chosen.  In return for your pension fund, they promise to pay you a regular income.

• The income can be paid monthly, quarterly, half-yearly or annually.
• The income is taxable.
• You can choose whether the income stays the same throughout your lifetime or increases each year.
• You can include a guarantee so payments are made for a minimum period of time, such as five or ten years, even if you die within that period.

What is a money purchase pension plan?

This is a plan that you and/or your employer contributes to, the money is invested and a fund is built up. The income ultimately payable at retirement is dependent upon:

• The amount of money paid;
• How well the investments perform; and
• The 'annuity rate' at the date of retirement. An annuity rate is the factor used to convert the fund into an income.

The following are types of money purchase schemes:

• Company money purchase scheme
• Personal pension plan
• Stakeholder pension scheme
• Group personal pension (GPP)
• Additional Voluntary Contribution (AVC)
• Free Standing Additional Voluntary Contribution (FSAVC)
• Section 32
• Retirement Annuity Contract (RAC)

What is triviality?

Under current pension rules, it is possible to cash in your entire pension fund if the following conditions are met:

1. You are between 60 and 75;
2. The value of all your pension funds added together must not exceed 1% of the lifetime allowance (i.e. not more than £16,500 in the 2008/09 tax year);
3. If you wish to cash-in more than one pension, assuming you meet this qualifying conditions above, you must do so within 12-months of cashing-in the first one. You will not be able to cash-in any other pensions after that 12-month period has expired.

You may may wish to consider the following when making a decision about cashing in your pension fund on the grounds of triviality:

1. A quarter of the cash paid is tax-free with the remainder treated as taxable income in the year it is received.
2. All rights to benefits from your plan end on receipt of the lump sum.
3. Will the lump sum impact on any means-tested benefits you may be entitled to (i.e. pension credit, income support, housing and council tax benefit).

There are different ways of valuing existing pension rights to test against this threshold. Click here to visit our website and the different ways of valuing existing pension rights.

What is an alternatively secured pension (ASP)?

• An ASP is a plan available to over-75s that allows you to continue investing your pension fund whilst drawing a regular income.
• The minimum that must be drawn as an income from the fund is 55% of an amount calculated by applying the funds available to a table produced by the Government Actuaries Department (GAD).
• The maximum is 90%.
• The GAD table is based on the level of single-life lifetime annuity rates for a person of the same sex and aged 75. No allowance is made in the annuity rate used for any level of annual pension increases.
• The pension year for an ASP is the 12 months from your 75th birthday and every subsequent 12 month period.  The maximum and minimum amounts must be recalculated every new pension year, based on the level of the fund held at that time. The reassessment continues to be made by reference to an annuity at age 75, irrespective of what actual age you have reached.
• On death, any funds remaining in the ASP must be used to provide a pension for a surviving spouse, civil-partner or dependant.  This could be in the form of a lifetime annuity or unsecured pension (if the dependant is under 75) or another ASP (if the dependant is over 75).
• On death, or the death of the spouse, civil-partner or dependant, the remaining funds can be transferred to other members of the scheme.  This will attract an effective tax charge of 70% on the remaining fund.
• If there are no dependants, your remaining fund can be paid to a registered charity of your choice.  This will not attract a tax charge.
• Inheritance Tax (IHT) is charged on your death as if the value of any remaining funds were part of your IHT chargeable estate. Funds paid to charity are excluded. If your residual funds are used to provide pension benefits for your spouse, civil-partner or dependant, the tax charge will not arise until entitlement to such benefits ceases.

What is an impaired life annuity?

• An impaired life annuity pays an income for life in the same way as a lifetime annuity.  However, it pays a higher income to those suffering with certain medical conditions on the basis that they have a reduced life expectancy.  Medical conditions include, but are not limited to, high blood pressure, diabetes, heart conditions, kidney failure, certain types of cancer, multiple sclerosis and chronic asthma. This is not a comprehensive list.
• An annuity provider will normally ask for a report from your doctor.  They do this to make sure that the details in your application form are correct.
• If you are accepted for an impaired life annuity, your income will be higher than from a conventional annuity because the annuity provider expects to pay your income for a shorter period of time.  This can make a substantial difference.

What is an enhanced annuity?

• An enhanced annuity is normally available for regular smokers, but can also benefit people who are overweight. An enhanced annuity may also be available if you have spent a good proportion of your working life in a hazardous occupation, such as mining.
• An annuity provider will normally ask for a report from your doctor.  They do this to make sure that the details in your application form are correct.
• If you are accepted for an enhanced annuity, your income will be higher than from a conventional annuity because the annuity provider expects to pay your income for a shorter period of time.  This can make a substantial difference.

What is serious ill heath?

• Only if you have a life expectancy of less than 12 months does HM Revenue & Customs consider you to meet their definition of serious ill health.  In that situation their rules allow you to take your entire pension plan fund as a tax-free lump sum.
• To qualify, all of the following conditions must be met.
1. Before making the payment the plan provider has received written evidence from a registered medical practitioner confirming that you are expected to live less than one year;
2. You have not used up all of your lifetime allowance when payment is made;
3. All your rights must be given up as a lump sum under the arrangement;
4. Any payment is made before you reach your 75th birthday; and
5. You have not already taken your benefits from the plan.

What is an MVR?

• A Market Value Reductions (MVR) is where the value of your pension savings is reduced to allow for the fact that the underlying value of the assets is less than the face value of the plan.
• An MVR is normally only applied where the pension saving has been made in a with-profit fund. It can only be applied when you are taking benefits from your pension plan at a date other than the Selected Retirement Date (SRD) of the plan.
• Its application is designed to protect policyholders who are not taking their money out and its intention is to give you a fair share of the with-profit fund but no more. A MVR could be as high as 30%.

What is a GAR?

• A Guaranteed Annuity Rate (GAR) provides a fixed rate for converting a fund into an income at retirement.
• It is written into the policy conditions and does not alter with changing investment conditions.
• The rates are usually more generous than those available on the open market.
• They may, however, have conditions that limit the way your annuity is paid, e.g. often there is no provision for annual pension increases or for a pension payable to your spouse upon your death.

Should I merge plans?

• If you have more than one plan, you can merge them together at retirement and purchase one lifetime annuity, instead of having income from a number of different sources.
• A larger fund made up of a number of merged plans can give increased purchasing power, giving a higher income in retirement.
• Having fewer lifetime annuities could also reduce administration cost, again giving a higher income in retirement.
• Some plans may penalise you if draw your retirement benefits at a time other that your Selected Retirement Date (SRD).  So, if your plans have different SRDs, check what impact merging will have on your funds.  There could be hefty penalties or Market Value Reductions (MVRs). 

Tax Free Lump Sum

It is likely you will be able to take part of your fund as a tax-free lump sum. The value of the lump sum could be as much as 25% of the value of your fund. The remaining fund must be used to provide a Lifetime Annuity or transferred to a permitted alternative arrangement.  Note that you only have one chance to take your lump sum - once you have set up an annuity, you cannot take a lump sum at a later date.

Taking a lump sum can be very attractive:

• It is paid tax-free – unlike income, which is taxable
• It is money here and now
• You can choose how to use it – you could:
  • Pay off a debt
  • Save or invest it
  • Spend it
• Any money you have left from the lump sum when you die can be passed on to your family in a straightforward way - unlike taking an income, which means you have to make specific choices to provide for someone else, otherwise the income stops when you die.

However, there could be a disadvantage to taking the lump sum:

• It comes from your pension pot, so there will be less left to provide you with an income
• If you want to provide an income for your spouse after you die, the more money there is in your pot, the higher your spouse’s income could be.

Make sure you take into account your other savings and sources of income when you make this choice.  If you are likely to depend on Pension Credit, be aware that both your level of income and any lump sum savings can affect whether you qualify or not.

What is the lifetime allowance?

The Inland Revenue places a ceiling on the value of benefits that can be taken from pension schemes before an special tax charge becomes payable.

Benefits valued in excess of the lifetime allowance will be subject to a tax charge of 25%. If the excess benefits are taken as a pension (i.e. a regular income), it will be taxed as income. However, any excess benefits taken as a lump sum which will be taxed at 40%. This will make the overall tax charge to be 55%.

The lifetime allowance rates for 2008/09 to 2010/11 are:
2008/09 - £1.65m
2009/10 - £1.75m
2010/11 - £1.80m

What is a short-term annuity?

• A short-term annuity is an agreement with an insurance company of your choice to pay over a portion of your fund (i.e. the remainder of your fund will remain invested) and in return they will pay you an income for a fixed period of no more than 5 years.  In the meantime, the remaining fund will continue to be invested.
• Payments cannot continue after your 75th birthday.
• The maximum amount that can be paid from a short-term annuity is currently 120% of a single life pension using tables drawn up by the Government Actuaries Department (GAD). There is no minimum amount. The annuity can be level or it can be arranged to increase each year at a fixed rate or in line with inflation.
• Your fund will reduce by the cost of buying the short-term annuity.
• It is not an alternative to buying a lifetime-annuity.
• This type of annuity may be attractive to someone who wishes to defer buying a lifetime annuity but wishes to purchase a temporary annuity with part of their fund.

What is an investment-linked annuity?

• Investment-linked annuities put your pension fund into investments, such as stocks and shares. This means that you could continue to benefit from stock market investments after retirement, but there is also the risk that the value of your investments could fall.
• Investment-linked annuities can be either:
  • with profits annuities; or
  • unit-linked annuities.
• With an investment-linked annuity you will be linking your income in retirement to the ups and downs of the stock market instead of receiving a pre-set income, as you would with a lifetime annuity.

What is a with-profits annuity?

• Your pension fund is invested in an insurance company’s with-profits fund. Your income is linked directly to the performance of this fund. Your income is usually made up of two parts:
  • a starting income - this is set at a low level, but, unless investment conditions are very bad, you’ll usually get at least this much income. Many providers guarantee a minimum level of income.
  • bonuses - the insurance company usually announces bonus rates once a year. Bonuses can be both reversionary (usually paid each year for the duration of your annuity) and special (paid for a year or so) until the next bonus announcement. The amount of any bonuses depends on many factors, such as:
    • how well investments are doing - for example stock market performance;
    • business risk - the financial strength of the fund; and
    • the insurance company’s assessment of what it can afford to pay out in bonuses.
• You will select the level of income by choosing an anticipated bonus rate (ABR). This is the expectation of future bonuses paid and is normally between 0% and 5%. If the bonuses added for that year are greater than the ABR, your income will increase. If they are less, your income will fall.
• Bonuses are not guaranteed. Whether or not you get a bonus depends on the financial strength of the firm.

What is a unit-linked annuity?

• Your pension fund is invested in units in investment funds. Your income is linked directly to the funds you have invested in. You can usually choose the types of fund, for example:
  • medium-risk managed fund - a fund manager selects a broad range of different shares and other investments. Spreading your money in this way may reduce risk, although investment risk cannot entirely be removed.
  • higher-risk fund - a fund manager selects shares and other investments in a particular country or sector, such as smaller companies. Because your money is less widely spread the risk is higher.
  • tracker fund - which closely follows the performance of a particular stock market index and reflects the level of risk within that index.
• Usually, these have lower charges than managed funds.
• The more risky the underlying fund you choose, the more your retirement income may vary - both up and down.

What is income withdrawal?

• With income withdrawal (or Unsecured Pension as it is formally known) you can continue to keep your retirement savings invested and take an income each year directly from your fund rather than buy a lifetime annuity. This facility can only be continued to age 75, at which time a lifetime annuity has to be bought or the money transferred into an alternatively secured pension (ASP) where you can continue to take income withdrawal.
• The income you can take from an income withdrawal arrangement can be varied each year between a minimum and a maximum amount. The minimum is 0% and the maximum is 120% of a single life pension calculated according to tables produced by the Government Actuaries Department (GAD). These tables are based on the amount an individual's fund would buy as an annuity based on their life only and with no allowance for any future increases. The maximum amount needs to be recalculated every 5 years.
• If you die before the age of 75, any surviving spouse or dependant may have the option of claiming a lump sum subject to 35% tax, continue with the income withdrawal arrangement if under 75 or an alternative secured pension (ASP) if over 75 or purchase a lifetime annuity.
• You should be aware that if your fund investments perform poorly, the level of income payable may reduce. Therefore, your level of income should be reviewed every year. There is no guarantee that the pension ultimately purchased will be higher than the amount that could have been purchased at outset.
• The administrator of the unsecured pension arrangement will charge fees, often on a time cost basis, and there may also be investment management fees, and thus the costs of these arrangements can be high.

What is phased retirement?

• Phased retirement uses a portion (or a number of portions) of your fund to buy a lifetime annuity. The rest of your fund remains invested. You can later use other portions of your fund to buy further lifetime annuities. In this way you can provide a flexible income.
• Each time you convert a portion of your fund to a lifetime annuity, you can first take some tax-free cash (limited to 25% of the value of each portion).
• Converting portions of your fund regularly - for example, once a year - means you can effectively use the tax-free cash, as well as the lifetime annuity, to provide your income.
• Plan providers often set a minimum fund size for lifetime annuity purchases so you must convert enough of your fund each time to enable you to buy an annuity.
• Phased retirement can be a useful financial planning tool, for example if you want to ease back gradually on work and start to replace your earnings with pension income.
• It also provides more flexible help for your survivors if you die. The part of the fund you haven’t converted to lifetime annuities can pay a pension or a lump sum for your surviving dependants, depending on the terms of the pension plan.

What is your selected retirement date (SRD)?

Your SRD is the retirement date you chose when you set the plan up or the date chosen for you by your employer. You can find it on your plan documents or by calling your plan provider.

Should you provide an income for your spouse, civil-partner or dependants on your death?

• If you choose to build in protection for your spouse, civil-partner or specified dependants, they will receive a continuing income on your death (if you die before them).
• If you choose not to build in protection for your spouse, civil-partner or dependants, the income from the annuity will stop on your death.
• Your decisions are not reversible once your lifetime annuity is set up.  You should consider very carefully how your spouse, civil-partner or dependants will survive financially after your death before making a final decision.
• You will not have a choice about providing protection for your spouse or civil-partner for any part of your fund that is made up of Protected Rights. Protected Rights is the part of your fund that was built up if you were ever contracted out of the State Earnings Related Pension Scheme (SERPS) or the State Second Pension (S2P). Current rules make it compulsory for your spouse or civil-partner to receive 50% of your income from the Protected Rights on your death.
• A dependant is:
• a child under the age of 23;
• a child over 23 who, in the opinion of the pension provider, is dependent on you because of physical or mental impairment; or
• anyone who is financially dependent on you.
• If you choose to build in protection for your spouse, civil-partner or dependants, you must decide the level of income that will continue to be paid on your death.  This is normally expressed as a percentage of your own income and can range from 0% to 100%.  Many annuity providers will only allow you to choose a specific percentage, such as 50%, 66.66% or 100%.
• The level of income you have selected will be paid for the rest of the life of your spouse, civil-partner or dependant. In the case of a child, the income will cease when the child reaches their 23rd birthday unless they are dependent on you due to mental or physical impairment.
• The level of income will rise in line with whatever, if any, inflation protection you have built into your own income. These increases will be added on from the date you start drawing your annuity.
• In making your decision, you will need to take account of the income and other assets that will be available to your spouse, civil-partner or dependants when you die.
• The higher the continuing income you choose, the lower your own starting income will be.

Should you protect your income against inflation and rises in your standard-of-living?

• If you choose to protect your income against inflation, your income will increase each year.
• If you choose not to protect your income against inflation, your income will remain the same throughout your lifetime. In effect, the purchasing power of your pension will decrease each year because of the increase in inflation.
• Your decisions are not reversible once your lifetime annuity is set up.  You should consider very carefully how your income will be affected before making a final decision.
• If you choose to protect your income against inflation, there are two options on how much your income increases during payment. It could be either:

• in line with the Retail Price Index (RPI); or
• a fixed rate - usually 3% or 5% each year. You choose the level.  The annuity provider will be able to tell you the minimum and maximum rates they are prepared to offer.

• The income payable to your spouse, civil-partner or dependants on your death (if application) will also increase at the rate chosen.
• The higher the rate of protection you choose, the lower your starting income will be.

Should you guarantee a minimum period of payment in case of death in the early years?

• If you choose a guarantee, your income will be paid for a minimum period of time.
• If you do not choose a guarantee, your income will cease on your death (unless you have built in protection for your spouse, civil-partner or dependant).
• Your decisions are not reversible once your lifetime annuity is set up.  You should consider very carefully how your spouse, civil-partner or dependants will survive financially after your death before making a final decision.
• You can choose an income which has a guarantee period of up to 10 years.
• If you die within the guarantee period, the installments will continue to be paid until the end of the guarantee period.
• For example, if you choose an income with a five year guarantee period and die after receiving three years payments, the annuity provider will continue to pay the installments for the remaining two years.
• An alternative to receiving future installments is instead to have a lump sum equal in value to the installments The lump sum will be taxed at 35%.
• The continuing installments can be paid to one or more of your dependants or your Estate.
• If you die after the end of the guarantee period, your income will cease immediately on death.
• The cost of providing a ten year guarantee period is going to be more expensive than a five year guarantee period.
• If the annuity provider offers Capital Protection, this means that on death, the plan provider will pay a lump sum equal to the original fund value used to buy the annuity less any gross payments you have received. Any lump sum is subject to a tax charge of 35%.
• The plan provider will let you know what protection they are prepared to offer in the event of death.
• The higher the protection, the lower your starting income will be.

What is the Retail Price Index (RPI)?

The RPI is the most familiar measure of inflation in the United Kingdom. The Government uses it for uprating of pensions, benefits and index-linked gilts. It is commonly used in private contracts for uprating of maintenance payments and housing rents. It is also used for wage bargaining.

Finding an independent financial adviser

The following organisations can help you find a suitably qualified independent financial adviser in your local area.

IFA Promotion - 0800 085 3250

www.unbiased.co.uk

Institute of Financial Planning - 0117 945 2470

www.financialplanning.org.uk

The Personal Finance Society - 020 8530 0852

www.thepfs.org/findanadviser

You should look for an independent adviser that is qualified in retirement planning.

Always use an authorised independent financial adviser, one that is authorised by the Financial Services Authority (FSA). The FSA regulates the advice given by these advisers.

Advisers will give you a document explaining what type they are and what services they offer. This document should also tell you how the adviser expects to be paid - either by a fee or by commission from the product provider.

After discussing your personal needs and circumstances with you, the adviser will recommend a product from the range on offer. The adviser will explain why they have suggested that product.

Make sure you come away from your meeting with the financial adviser with a full understanding of what you are putting your money into. Remember, there is no such thing as a stupid question about pensions. Pensions can be immensely complicated and people sometimes feel inadequate when faced with one. You should not worry about this. You have a right to have things properly explained to you in language you can understand; you should not feel inhibited about asking the most basic questions.

Specialist Occupations

Before 6 April 2006, some professional people, mainly sports persons and individuals in hazardous occupations, had normal retirement ages below 50. For these rights to be protected from tax charges:

• the member must have had the right on 5 April 2006 to take a pension and/or lump sum before the age of 50;
  the right must be unqualified in that no other party need consent to the individual’s request before it becomes binding upon the scheme or contract holder;
• the provision to take benefits before age 50 must have been set out in the governing documentation of the retirement benefits scheme or deferred annuity contract (section 32 policy) on 10 December 2003 (the date of the second Inland Revenue "consultation document"); and
• the member must have
  • had the right under the scheme or contract on 10 December 2003, or
  • acquired the right in accordance with the provisions as it was on 10 December 2003, upon joining the scheme after that date.
    

The age at which the member has the right to take a pension on 5 April 2006 will be their protected pension age, and they will not incur a tax charge when benefits are paid between that age and normal minimum pension age.