The scheme of things
Rule changes have made scheme pensions a potent new retirement force
In the next few years, thousands of drawdown clients are going to face major cuts in their incomes as they reach their next drawdown review.
Those who had been taking the maximum from their drawdown pots 120 per cent of the basis figure published by the Government Actuary’s Department will find that from their next review, they are restricted to the basis figure alone. There is also the fact that gilt yields have fallen and the new GAD tables are a bit less generous.
Some clients will be able to sidestep the tighter restrictions using flexible drawdown which basically removes the GAD basis figure as a restriction.
But for those who either cannot or choose not to meet the £20,000 a year minimum income requirement, there is a third option scheme pension.
Once seen as a niche offering, April’s rule changes have made it a potent new force in the retirement income market.
The issue dates back to A-Day in 2006 when pension rule changes brought in an influx of new drawdown clients, attracted by the ability to take 20 per cent more income than they could generate from a level lifetime annuity.
A 60-year-old man could, for example, have taken a maximum annual income of £7,680 per £100,000 of pension fund. This is based on the gilt index yield figure for June and July 2006 of 4.5 per cent although over the next year, many would have locked in income based on gilt index yields that rose as high as 5.25 per cent.
Moving forward to 2011, that same client is now 65 and approaching a five-yearly review, the last before reviews move to every three years.
Using the 2011 GAD tables and June’s gilt index yield figure of 3.75 per cent, the maximum income he can take is now £6,400. For someone in this position, that represents an income cut of £1,280 a year or nearly 17 per cent at a time when prices of goods and services are rising sharply.
The maximum income under scheme pension is calculated not by GAD tables but by an actuary based on the individual client’s own life expectancy and fund size. In our example, the same 65-year-old could take £7,835 income assuming good health 22 per cent more than available through capped drawdown. If the member is in poor health, that could increase to £9,917 or 55 per cent more income than capped.
As with other drawdown arrangements, the income is generated by a portfolio of assets. In our case, we give the member identical control and choice of assets as they have in a full Sipp so it can include funds, shares, bond, gilts and commercial property as well as more esoteric investments.
Will taking more income increase the risk of fund depletion? The actuary takes a cautious approach, for example, assuming the 65-year-old in good health will live nearly 30 more years and 17 years if in very poor health.
The income from scheme pension is also subject to actuarial reviews every three years, at which time the income level can be reset.
The objective of the actuary is to intelligently manage the rate of income withdrawal, taking into account the fund size and the life expectancy of the member. The goal is to maximise the benefits paid out during the member’s lifetime. There is the option of a pre-determined term which will continue to pay income, even if the member dies during the term.
This is taxed at the recipient’s marginal rate, not the 55 per cent that applies to lump-sum death benefits.
Scheme pension is a long-established way of paying pension income to multiple-member schemes.
Recognising the huge potential for it to become a “bespoke” drawdown arrangement for those suffering fading health, we had the technical and administrative knowhow to pioneer its use for individual members back in 2008.
The new pension rules have expanded its potential to include almost everyone aged 55 upwards who is considering drawdown.
Adviser interest has been running at significantly higher levels, most obviously to help clients heading towards an income cliff edge. But many have also recognised that higher income potential not only may keep the client happy but also vastly increased opportunities to show their expertise in estate and inheritance tax planning.