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Benefit match

Clerical Medical retirement planning manager Steve Meredith looks at the changes for taking pension benefits.

The Pensions Act has introduced a wide variety of changes which come into effect on three different dates – April 6, 2005, September 6, 2005 and April 6, 2006. I will address the changes specifically relating to how benefits can be taken with effect from April 6, 2005.

Changes for final-salary schemesFor final-salary schemes, an additional benefit type is created – namely, post-April 2005 benefits. Pensions accrued in respect of service from April 6, 1997 to April 5, 2005 must continue to increase in payment in line with LPI but pensions in respect of service after April 2005 need only increase in line with RPI capped at 2.5 per cent. (See table 1).

Changes for money-purchase schemes and personal pensionsRemoval of LPI requirementsThe Pensions Act 2004 removed the LPI obligation altogether from money-purchase benefits coming into payment from April 6, 2005.

The act only covered rights accrued on or after April 6, 1997 but draft regulations were issued to remove the indexation requirement for pensions derived from protected rights (RPI up to 3 per cent) accrued before April 6, 1997. The consultation closed on January 31 and these regulations are due to come into force on April 6, 2005, the same date as the relevant part of the Act.

From April 6, 2005, there will be no requirement to buy an LPI annuity with the proceeds of the protected rights fund and the individual will be able to have a much wider annuity choice (the requirement to buy a 50 per cent spouse’s pension remains). Access will still be available only from age 60.

However, from A-Day, it will not only be possible to access protected rights benefits from age 50 (rising to 55 in 2010) but it is also likely to be possible to take 25 per cent tax-free cash from protected rights funds.

It is important to bear in mind that the above rules for final-salary schemes, money-purchase schemes and personal pensions will not apply automatically to all schemes. The schemes will need to amend their rules to take advantage of the changes.

Advice issuesClearly, any individual who intends to take benefits from a money-purchase scheme between now and April 2005 needs to be aware of these changes. An individual taking benefits before April 2005 may be upset to find out, after buying an index-linked pension, that if they had waited a few days, they could have had more choice and possibly purchased a much higher level pension. For example, Peter is 65 (on March 31, 2005) and his wife Jane is three years younger. Peter has a fund of 100,000.

Using current annuity rates, it can be seen from the example in table 2 that if Peter is happy with a level pension, then he could get nearly 2,000 a year more by waiting a few days, until after April 2005. There would be a similar difference if we looked at protected rights funds.

Of course, Peter may be even more annoyed to find out that if he had delayed taking benefits for a year, he could even have had a quarter of the protected rights’ fund as tax-free cash (although he forgoes the annuity payments he would have had in the meantime).

Research shows that 80 per cent of annuities, when clients have a choice, are bought without any escalation. The main drawback with level annuities is that they are eroded with inflation and lose their purchasing power. This would only be a problem if annuitants live a long time or inflation is high. It is worth bearing in mind that it could take over 20 years for an indexed annuity at 3 per cent to catch up on payments from a level annuity.

Clearly, words of warning will need to be made about the possibility of a big reduction to annuity rates which could arguably mean a smaller level pension in the future. Nevertheless, it is important that individuals are made aware of these changes when giving advice about taking benefits from money-purchase schemes and contracted-out personal pensions.

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