David Seaton looks at why advisers should recommend scheme pension to clients.
There are three common questions I am asked when I meet IFAs: 'What is a scheme pension, why is it important and why don't I know about it?'
For those reaching age 75, the income options are either to buy an annuity, go into alternatively secured pension (ASP) or choose a scheme pension.
If an annuity is chosen, should it include a guarantee? The danger is that if the member lives past the guarantee date, then the cost of that guarantee is effectively wasted. Should the member buy a dependant's pension? There is the possibility that their spouse or civil partner dies before them, thus the member loses the potentially high cost of providing the contingent dependant's pension.
Alternatively secured pension (ASP) requires the pension to be set annually and it will fall each year unless the fund return is more than the pension drawn. The result is that on death (after paying any appropriate dependant's pension), there is likely to be a substantial fund remaining, to be taxed at 82%.
The alternative is the scheme pension. This is simply another way of drawing money from a pension scheme. The rules dictate that the pension, once fixed, cannot be reduced to less than 80% of the initial pension; it must be paid for life, and if reduced, must be on the advice of an actuary, with the reduction being made equally to all members of the scheme who are receiving scheme pensions.
Unlike an ASP, which cannot offer any guarantee, the scheme pension may offer a guarantee of up to 10 years. In the event of death, the balance of that pension may be paid out to anyone nominated by the member. The maximum ASP must be calculated annually in line with 90% of the Government Actuary's Department's tables for a 75-year-old and the current 15-year gilt yield. This gives an artificially low level of pension and ensures there will be a significant fund remaining on death. In a scheme pension, the actual pension drawn can be certified by an actuary, who will take account of the likely long term fund return and the actual age of the individual concerned. The result is likely to be an income at least 10% more than with an ASP, ensuring more of the fund is used for the purpose it was established.
Shortened life expectancy
The scheme pension can also be an important choice for people with shortened life expectancy. This can be taken into account by the actuary when setting the level of pension income, possibly enabling the scheme pension to provide a far larger pension for the client than an annuity purchase on an impaired life basis, ASP or even unsecured pension.
As with all alternatives there are drawbacks to scheme pensions. As with any drawdown product, the administration costs and ongoing advice will be a significant issue for all but those with large pension funds of, say, £500,000 or more. The client will need to continue to be involved in investment decisions and the level of pension actually drawn will depend on the return the fund achieves. If fund performance is not as predicted by the actuary, or the member lives longer than expected, the level of scheme pension will have to reduce, or the fund could run out.
Finance Act 2004 introduced the concept of scheme pensions as a way of paying benefits directly from a pension scheme. It was to apply to both defined benefit (DB) and defined contribution (DC) schemes with more than 50 members. The industry questioned the need for the 50-member rule and HMRC agreed that it was not necessary. They did identify a weakness in the calculation of the pension commencement lump sum in relation to the scheme pension, and in the Finance Act 2005, the 50-member rule was removed and anti-avoidance legislation relating to the pension commencement lump sum was introduced. Subsequent Finance Acts have amended the rules, firstly imposing additional taxes on death in ASP, and, in the Finance Act 2008, similar taxation was brought in for death in scheme pension.
Many providers did not welcome the scheme pension option. The industry tried to tell us that SSAS was dead and that SIPP was king, but a scheme pension cannot be offered inside a SIPP with a master trust because you cannot treat all scheme pensioners equally. Many in the industry tried, and still lead us to believe that scheme pension was an accident and not designed for small schemes. However, with the Government, HMRC and the Treasury reviewing the rules and legislation on scheme pensions being enacted, the inference is that they are here to stay and are a very valid option!
For the adviser in the know with clients approaching age 75, with significant funds and no wish to buy an annuity, the scheme pension is, to use the cliched term, a 'no brainer'.
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