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Era of flexibility

Flexible and capped drawdown usher in a new business era for advisers

The age of 75 has loomed large over the retirement planning world in recent years as the point in life when anyone using income drawdown suddenly found more limited options.

Although most retirees have lost the urge to splurge on fripperies by that stage of life, the age rule forced people into a rethink and to make decisions that were sometimes difficult and arguably unnecessary.

There were two main choices. One was to sell the pension asset and buy a lifetime annuity. But with annuity rates plumbing new lows and some torrid times in the property and equity markets, where was the logic in selling a depressed asset to buy an inferior income?

The other option was to retain the assets and to keep drawing an income using alternatively secured pension. Due to more stringent income limits, those taking the maximum would be subject to an immediate drop in income of nearly 25 per cent. These rules also made depletion of the fund far more difficult, with the result that those sticking with Asp were likely to die with sizable pension funds that could be subject to up to 82 per cent tax.

This explains some of the reasons why we are looking forward to the new era of capped and flexible drawdown.

Drawdown providers will have to offer capped as an option from day one although due to the complexities – and the fact we are yet to see the final legislation – flexible may take longer to become widely available. As an alternative to buying an annuity, all retirees will be able to take income directly from their pension using capped drawdown.

To prevent the fund being stripped out too quickly, the “cap” restricts the income that can be taken to between zero and 100 per cent of the basis amount calculated by reference to Government Actuary’s Department tables.

For those aged 55-75 currently in an unsecured pension, this is a tightening of the current limits of zero-120 per cent but for those in Asp, it will mark a loosening from the current 55-90 per cent.

Some of those in USP will be able to carry on being subject to the more generous USP limits beyond April and up until the time of their first drawdown review. In fact, anyone entering drawdown before April 6 will be able to secure the current limits for up to five years, even if they take no income, although there are potential “death tax” implications when benefits are crystallised.

From April 6, Asp is being abolished so anyone now reaching 75 or already in Asp can benefit from the new rules from that date without needing to wait for a review and good providers won’t charge for varying the amount of income.

The GAD basis figures will also be calculated beyond age 75, removing an anomaly that prevented income from rising with greater age while in ASP.

GAD tables (based on a 4 per cent per cent gilt index yield) show the notional income that could be taken at age 85. A man with a £200,000 pension fund would be able to take £30,800 a year under capped compared with £17,460 under an Asp. A woman of 85 would be able to take £27,800 compared with £15,300 under an Asp.

Clearly, there will be much more scope to use more of the fund to provide income during the retiree’s lifetime although it still might be the case that the third option of scheme pension will offer even more income and control particularly as health fades.

Flexible drawdown becomes an option for any retiree who can meet a minimum income requirement of £20,000 of secured pension income, from state or occupational arrangements through scheme pension or by buying an annuity. Once secured, the retiree will be able to take as much income as they like from the remaining fund although for tax efficiency, they are likely to take income up to their marginal income tax rates.

It is worth noting that people will not be able to select flexible drawdown in a tax year during which any contribution has been made to the pension.

Once flexible drawdown has been selected, no further tax relief on contributions will be paid. Flexible drawdown is likely to be used by those aged 65 and over who have stopped work and who can set the state pension against the MIR.

’Clearly, there will be much more scope to use more of the fund to provide income during the retiree’s lifetime although it still might be the case that the third option of scheme pension will offer even more income and control particularly as health fades’

There are a couple of restrictions that do still apply at age 75. First, it marks the maximum age on which tax relief can be claimed on contributions. The second is linked to the tax on drawdown funds left at death (unless providing an income to dependents or left to charity) which will be at a flat rate of 55 per cent regardless of age for all pension segments from which benefits have been taken.

If no benefits are being taken it remains at zero until age 75 at which point it rises to 55 per cent. This is likely to increased use of phased retirement where segments are unlocked as they are needed up to age 75.

Capped and flexible drawdown open up new possibilities but most important is the loud and clear signal that there is now no obligation – perceived or otherwise – to buy a lifetime annuity. The retirement income market is not only set to grow as the baby boomers reach retirement but to get far more sophisticated, offering huge scope for financial advisers to help clients achieve better outcomes. These are exciting times.

Mary Stewart is director of Hornbuckle Mitchell

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