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Alternative thinking

Alternatively secured pensions are high on the list for change but do they have a place in retirement planning?

With a general election next year, we are at a point where manifestos are being drafted on a daily basis and lobbying is high on the agenda.

One of the pension subjects high on the list for change is alternatively secured pension and whether or not it is possible to develop a more flexible option.

The real question now is whether ASP has a future and is of any use in the retirement planning process.

After A-Day, ASP was never likely to be a mass-market product as very few people would have had a fund of sufficient size to be able not to draw an income. There appeared to be no real issue other than how inheritance tax would be applied to the residual ASP funds.

For some reason, HM Treasury seemed to think otherwise and decided to backtrack under the argument that ASP had only been designed for those with a principled religious objection to annuity purchase – in their view, the Plymouth Brethren. This was somewhat ridiculous as it would have been impossible to police, even if it was legal.

The pre-Budget report in December 2006 was expected to include the Treasury’s up-to-date thinking on the subject and indeed it did. Rather than not needing to draw any income, a minimum income of between 65 per cent and 90 per cent of the Government Actuary’s Department rates was introduced.

Any residue on second death or first death without any dependants (the transfer lump-sum death benefit) would then become an unauthorised payment and subject to a variety of potential tax charges, including:

  • Unauthorised payment charge of 40 per cent.
  • Unauthorised payment surcharge of 15 per cent.
  • Scheme sanction charge of 15 per cent.
  • Inheritance tax of 40 per cent could also still apply.

So, in total, a charge of 82 per cent.

The final rules (and the ones that currently apply) require a minimum income of 55 per cent of the GAD for a 75-year-old and a maximum of 90 per cent.

The key point is that the legislation is very firmly structured to dissuade any attempt to pass on money to beneficiaries’ pension schemes after death by keeping the transfer lump-sum death benefit as an unauthorised payment.

It is a positive thing that we have not reverted to compulsory annuity purchase at age 75 but at the price of quite a complex and unattractive option.

The balance of retirement planning has changed. With a tax charge of 82 per cent,it would appear to be logical to attempt to minimise the amount of the fund that is likely to be left and subject to the tax charge. In order to achieve this, specific planning might be required.

Obviously, one option might be to just spend the pension fund as quickly as possible but it is possible to add a little more subtlety to this.
It might be possible to draw more income than is specifically needed and then this excess income could either be invested for the direct benefit of the drawdown client or it could be passed on as a third-party pension contribution or perhaps a spouse or children.

So, for a third-party contribution, the original client may suffer tax at, say, 40 per cent on drawing the income but if paid on behalf of a third party, will enjoy tax relief at their highest rate. If a child is a basic- rate taxpayer, any contribution paid on behalf of that child will enjoy basic-rate relief. This means a net cost (the difference behind the higher rate paid and the basic rate relief recouped) of 20 per cent – highly preferable to 82 per cent.

Any such third-party contributions would need to be justified by the individual paying them as gifts through normal expenditure so that they are not caught for inheritance tax in the future. In such circumstances, the donor must demonstrate that the money is paid out of normal expenditure over an annual basis, that such payments do not disrupt the donor’s normal standard of living. Such payments will need to be reported to HM Revenue & Customs after the donor’s death for them to confirm the exemption.

As an alternative, the extra contribution could be invested into another investment vehicle which has a more beneficial inheritance tax regime than ASP. The key thing is to make sure that the money is moved into an investment where the potential tax charge is less than 82 per cent.

Mike Morrison
Head of pensions development
Axa Wealth

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