Scheme pensions are becoming an established way of taking regular income from a registered pension scheme. Some pension providers are seeing it as the preferred alternative to buying an annuity for members over age 75.
The concept of scheme pensions is not new. It has a long history as a way of taking income from group schemes prior to A-Day. In the SSAS market, prior to buying an annuity, a pension was paid from the scheme funds based on the advice of the actuary.
The Finance Act 2004 established the concept of scheme pensions in primary legislation and allowed it to be used by all registered pension schemes, including Sipps. However, for many pension advi- sers, whose experience has been mainly in the personal pension market, the concept is new.
What are the facts?
A scheme pension is a secured pension payable at least annually for the member’s lifetime. The level is set by the actuary using standard actuarial pricing principles.
The actuary will take account of the likely long-term fund return and the actual age of the individual concerned and the resulting income can be at least 10 per cent more than that of an Asp.
The pension is based on the advice of the actuary, who will need to account for many factors when calculating scheme pension income such as the health of a member. For serious health conditions which will shorten a member’s life expectancy, a higher level of pension may be payable. This would be subject to medical reports and standard under- writing procedures.
With scheme pensions, there can be a guarantee period of up to 10 years. The level of pension paid to the member will be subject to there being adequate resour-ces remaining in the member’s share of the fund.
The guaranteed pension can be paid to any named beneficiary and would be taxable in the hands of the beneficiary. At the end of the guarantee period, any remaining funds can be used to provide dependants’ benefits.
There is no limit set in legislation as to how often the level of scheme pension should be reviewed. However, prior to A-Day, pensions paid from SSASs were reviewed at least every three years at the triennial actuarial valuation review and this would seem to be a reasonable benchmark.
Scheme pension can be paid from protected rights funds but there are restrictions on the options available and the pension that can be paid may be lower than that payable from non-protected rights funds. For example, there must be a 50 per cent dependant’s pension and the pension must be based on unisex rates.
If there is more than one member on scheme pension, the reduction in one scheme pension affects all on scheme pension. Either all members need to reduce by the same percentage or by the same nominal amount.
This needs to be clearly understood in schemes where two unconnected members in the same scheme are going on scheme pension.
The scheme pension can be transferred to another provider but the pension needs to continue.
The member cannot return to unsecured or alternatively secured pension and cannot purchase an annuity with their fund but the trustees can secure the scheme pension with an insurance company. If the scheme is being wound up, then the scheme pension would need to be secured with an insurance company.
In the event of death, the balance of the pension may be paid out to anyone nominated by the member as a lump sum.
If the member dies prior to age 75, an “annuity protection lump sum death benefit” is payable. This is calculated as the fund at the date of entering scheme pension, less any pensions paid up to the date of death.
The lump sum is taxed at 35 per cent and any fund remaining can be used to provide dependants’ benefits. If there are no dependants, the remaining funds can be allocated to other members.
If allocated to unconnected persons, then there is no inheritance tax or other tax charges. However, if allocated to connected persons, there are inheritance tax and other tax charges which can be up to 82 per cent of the fund, as with Asp.
The benefits that can be provided after the death of a member on scheme pension are dependant’s scheme pension, dependant’s USP/Asp or dependant’s annuity.
As with drawdown products, the costs and benefits of scheme pensions need to be weighed up against alternative income options and the client must be involved in all decisions. But the scheme pension is a force to be reckoned with.