The concept behind phased retirement is simple - a pension fund is split into a number of policies (...
The concept behind phased retirement is simple - a pension fund is split into a number of policies (often 1,000) and the member can take benefits from each policy separately.
This enables a member to stagger or phase the purchase of annuities over a period of up to 25 years (between ages 50 and 75). Although each policy can be treated separately, pension providers' illustration systems allow the benefit package to be considered as a whole.
The benefit of phasing annuity purchase is that a member need vest only the number of policies necessary to produce a particular income level. The income required is generated through a combination of tax-free cash and annuity. The example in tables 1 and 2 shows how this works.
Where funds have been transferred from an occupational scheme, tax-free cash from each policy would be restricted to the lower of a) 25% of the fund value, and b) the amount certified on transfer; apportioned between the number of policies originally set-up (for example, 1,000), increased in line with the RPI from the date of transfer.
Income flexibility is restricted to the extent that the annuity, once in payment, cannot be reduced. However, income can decrease from one year to the next since tax-free cash may be treated as a part of the Income.
The policyholder can choose the point at which to lock-in to an annuity, leaving policies non-vested if (s)he believes annuity rates are low or; conversely, purchasing if (s)he believes annuity rates are high.
The type of pension purchased can be different for different policies. For example, the annuity payable from some policies may increase each year; others may be at a flat rate. A dependant's pension could be included from certain policies.
Death benefits - any of the policies not vested remain within pension funds with tax-efficient investment growth.
In respect of these policies, the fund value can be paid as a lump sum (where funds have been transferred in from an occupational scheme and there is a surviving spouse/dependant, this is restricted to 25%, with any balance being used to purchase a survivor's annuity). Normally there will be no liability to inheritance tax (IHT) if the benefits are payable at the discretion of the scheme administrator or trustee, or are written under an individual trust.
For any policies that have been vested, the return is restricted to the continuation of instalments remaining within a guaranteed period plus any entitlement to a dependant's pension (if such a pension were selected at vesting).
From April 2001 it will no longer be necessary to split the pension fund into a number of policies. Partial surrender of a single fund will be allowed to provide the income required.
Pension providers use different terms when referring to this option (the PIA object to the expression 'deferred annuity' since annuity implies guarantees which are not possible with 'income withdrawal'). Income withdrawal or drawdown are the current vogue and throughout the rest of this article is referred to as income withdrawal.
Income withdrawal works in an entirely different manner from phased retirement. There is no need to split the fund down into multiple policies.
Instead of purchasing an annuity, a policyholder can withdraw amounts from his/her pension fund broadly equivalent to the annuity which the fund could have provided.
Once started, income must continue, but may be varied, until an annuity is purchased (by age 75 at the latest), or until the policyholder dies, if this is sooner.
During the period of withdrawal of income prior to purchasing an annuity (known as the deferral period), any growth in the fund is free from income and capital gains tax.
No further contributions can be made to a contract being used for income withdrawal once withdrawal has started, nor may transfers be made (in or out). An open market option is available however, at the point of annuity purchase.
Greater flexibility is being introduced to allow people with personal pensions to choose a different investment manager by switching their funds under income withdrawal to a different personal pension scheme.
With non-protected rights benefits income withdrawal can start from age 50, or earlier in the case of ill-health or where the policyholder's occupation allows an earlier retirement date.
Tax-free cash can be taken only at the point when the income withdrawal commences.
Maximum and minimum annual withdrawal limits are set, but within these parameters, the income can fluctuate.
The maximum income is determined by applying a Government Actuary's Department (GAD) annuity rate to the fund (net of any tax-free cash taken). The minimum income withdrawal is 35% of the maximum. The maximum and, by default, minimum levels are reset every three years.
The first review of the level of income is due on the third anniversary of the policyholder selecting income withdrawal.
Currently, where income withdrawal is phased, each arrangement has to have a separate three yearly review date. From 1 October 2000 a single review date will be permitted for all arrangements under income withdrawal.
Maximum annual withdrawal = Fund after cash x GAD annuity rate
Minimum annual withdrawal = 35% x maximum
The GAD annuity rate is for a single-life, non-escalating annuity and is dependent on age attained (whole years) and gender. The rates also vary with current gilt yields.
The relevant gilt yield is the gross redemption yield on UK gilts (15 years) on the fifteenth day of the month (or previous working day if the fifteenth is not a working day) preceding the reference date (the date the income withdrawal is selected). The rate is rounded down to the nearest 0.25%. GAD provides a table of rates at 0.25% intervals.
Similar basic rules apply for protected rights benefits as for excess benefits although income withdrawal cannot start until age 60; there is no tax
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