View more on these topics

A waiting game

Does a pension client need to act before A-Day to get the best deal for his retirement fund?

Hamish Brown, who is 65 and married, visits his IFA to talk about his pension fund, which is worth around 1m. He has significant assets elsewhere and is due to retire in the next few months. He would like to access some of the funds but is very opposed to buying an annuity and is not really dependant on pension income. He is concerned that A-Day could affect the options open to him. He has an adventurous attitude to risk.

A decision needs to be made quickly. Possible routes open to the client are income drawdown or an open annuity.

Income drawdown will still be available after A-Day but there will be some changes and their effect on the client needs to be established. Open annuities will only be available until April 4, 2006.

Hamish is reticent to buy an annuity because he wishes the fund to be available for his wife, Maggie, who is 10 years younger than him. Future income is also a factor.

Income drawdown and open annuities have similarities. Both avoid the immediate obligation to buy a conventional annuity and allow the individual to retain control of the investment profile of the pension fund. Both also allow a degree of control over the timing of income for tax planning purposes. These factors suit Hamish’s objectives and also his attitude to risk.

A pre-A-Day income drawdown arrangement is quickly disregarded. There are no advantages in acting quickly and the contract available after A-Day, if chosen, will give more flexibility for Hamish in respect of income. In fact, he need take none at all. However, it is the treatment of the pension fund on death which may provide the crucial answer about which avenue he should go down.

After A-Day, income drawdown will work as follows. The fund remains invested and Hamish can take no income at all or can take the maximum allowed on an annual basis, based on the rate set by the Government Actuary’s Department. If he dies before reaching 75, Maggie can continue to receive an income based on her own GAD rate or she can opt to take the remainder of the fund as a lump sum minus a 35 per cent tax charge. If Hamish dies after reaching 75, the lump-sum option will no longer be available. The income provided will still be based on Maggie’s GAD rate but reduced by 30 per cent.

An open annuity would provide different results. Income levels are flexible but there is a minimum level. GAD rates are not used and income to be taken will be roughly equivalent to that which would be paid via a conventional annuity. The maximum income is at the annuity provider’s discretion, taking into account the yield currently being earned from the underlying investments. Both these figures will be reviewed periodically. While not disastrous, the obligation to have income is, perhaps, less suitable for Hamish’s needs.

However, the remaining fund remains invested and on death, at whatever age, the full value will be passed to Maggie as a lump sum. This is a clear advantage over the income drawdown arrangement.

Hamish wants to consider an open annuity but he is less familiar with this arrangement than income drawdown. His IFA explains exactly how it works.

First, it is explained that an open annuity includes a segregated cell arrangement, whereby each individual’s pension fund capital is treated as an entirely separate fund. This differs from a conventional annuity where pension funds are pooled into a general fund.

He is then reassured that the open annuity concept has been discussed with HM Revenue & Customs and is classified as an annuity suitable for use with approved pension arrangements.

At the outset of the plan, a redeemable preference share representing an interest in the Gibraltar-based company providing the open annuity arrangement (which is a single-purpose insurance company) is bought at a cost of 1,000. This 1,000 must be derived from outside the pension fund capital.

On death, his preference share, the value of which will mirror the value of the segregated fund, will fall into his estate. It can then be redeemed against any monies left in the segregated cell, enabling Maggie to access any remaining pension fund capital, plus the initial 1,000 preference share value. The cell structure ensures that the residual value of the segregated fund is preserved for the benefit of the estate. As, in this case, the estate will pass to Hamish’s spouse, inheritance tax is not an issue.

Hamish needs to weigh up his objective of passing the fund to his wife (better under the open annuity) against the fact that he does not require income (better under income drawdown). The best solution may well be a bit of both.

Hamish is in the privileged position of being able to hedge his bets by putting half of his fund in each arrangement. It seems he is in a position to get the best of both worlds.


Wrap charges in

Paul McMillan asses the prospects for Ascentric

Capital punishment

A-Day reviews have highlighted exorbitant transfer penalties faced by clients

Anxiety attack

Financial advisers must take some responsibility for the lack of desire to close the pension and protection gaps

Investors confused about Tessa-only Isas, warns Pima

Consumers’ investment options are being limited bec- ause they are confused by marketing literature from providers about Tessa-only Isas, warns Pima. Technical adviser David Beaston says the marketing material from some firms does not make it clear that Tessa-only Isas no longer formally exist and should be treated simply as cash Isas. Beaston says the […]

Certification guide

Guide: how to… certify your pension scheme

Certification is highly complex and surrounded by a minefield of information and auto-enrolment jargon, which can make it very difficult to understand. However, for many employers it is a necessary process that must be executed successfully.


News and expert analysis straight to your inbox

Sign up


    Leave a comment


    Why register with Money Marketing ?

    Providing trusted insight for professional advisers. Since 1985 Money Marketing has helped promote and analyse the financial adviser community in the UK and continues to be the trusted industry brand for independent insight and advice.

    News & analysis delivered directly to your inbox
    Register today to receive our range of news alerts including daily and weekly briefings

    Money Marketing Events
    Be the first to hear about our industry leading conferences, awards, roundtables and more.

    Research and insight
    Take part in and see the results of Money Marketing's flagship investigations into industry trends.

    Have your say
    Only registered users can post comments. As the voice of the adviser community, our content generates robust debate. Sign up today and make your voice heard.

    Register now

    Having problems?

    Contact us on +44 (0)20 7292 3712

    Lines are open Monday to Friday 9:00am -5.00pm