WEIGHING UP YOU RETIREMENT OPTIONS

When it comes to taking income from a pension plan at retirement, most people's default option is to buy an annuity. The main advantage of an annuity is that it will not run out until you die; the principal drawback is that annuities are not flexible, so you cannot vary the income from them year by year to meet your changing needs.

Fortunately there is now a growing range of new alternatives when it comes to your retirement options.

Before age 75...
The main alternative to annuities before age 75 is pension fund withdrawal, which raditionally has involved drawing income from your pension fund investments. The maximum permitted income initially is about 120% of what an annuity could provide and the minimum is nil. This structure of income drawdown offers considerable flexibility and means that if you die before age 75, the value of your pension fund (less a flat 35% tax charge) can normally pass to your chosen dependants as a lump sum, free of inheritance tax (IHT).

However, the fact that your pension funds remain invested means that there are risks: if market conditions are poor, your income could fall and perhaps never recover. This has been the fate of some of the first investors to opt for income withdrawal when it became available in 1995. With hindsight, many of them would have been better off with the guaranteed income provided by an annuity.

The obvious solution would be to build some form of guarantee into the income withdrawal process. At the time of writing, three companies had developed drawdown plans that incorporate income guarantees.

Two of these plans allow you to invest in a range of funds, without the risk of stock market fluctuations potentially forcing a reduction in your income. The third plan can give you a guaranteed income and a guaranteed lump sum after a fixed term of five or more years (but before age 75). That lump sum must be used to provide further retirement income.

From age 75...
Until last year, if you chose income drawdown you had to buy an annuity by the time you reached age 75. This changed from April 2006, with the introduction of alternatively secured pensions (ASPs). These allow a restricted form of income drawdown to continue after age 75 and the remaining fund can be passed on subject to IHT. In the March Budget, the Chancellor confirmed that such transfers would also be subject to income tax charges of up to 70%.

These tax charges make transferring the ASP fund very unattractive as a means of estate planning. However, ASP may still be preferable to an annuity in some circumstances, for example, if you need income flexibility, have a much younger spouse and/or wish to leave your pension fund to charity on death.

As with pension fund withdrawals, for ASPs your starting point is to take advice. If you want to build your pension into your estate planning after age 75, there are still opportunities to do so.

Please Note: This newsletter is for general information only and is not intended to be advice to any specific person. You are recommended to seek competent professional advice before taking or refraining from taking any action on the basis of the contents of this publication. The newsletter represents our understanding of law and HM Revenue & Customs practice as at May 2007.