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Nothing Simple About Feeling Secure For A-Day
Murray Waddell, Edinburghnews.com
United Kingdom
August 16, 2005
After April 6, 2006 (A-Day), the requirement to buy an annuity at age 75 with your pension fund will be removed, with the option to take Alternatively Secured Pension (ASP) being introduced.
The term "alternatively secured" is something of a misnomer, as the income will not be secured at all.
The amount which you can take from your fund each year after age 75 will be less than 60 percent of what you could have taken before then, but while this means there is less chance that the fund will run out, it could hardly be described as secure.
And people who thought decisions on income drawdown were going to become simpler will be sorely disappointed.
There will be three key questions to consider:
. Just because I don't have to buy an annuity will it be best for me not to do so?
. If I decide to defer buying an annuity what will be an appropriate investment strategy?
. What inheritance tax (IHT) implications will there be in respect of funds remaining after my death?
There is a feeling, fostered to some extent by the press, that buying an annuity is always a bad thing. Everyone knows of someone who bought an annuity and then died shortly afterwards, "losing all of their money". There is rather less publicity for the person who outlives their life expectancy and continues to receive an income for 30 or even 40 years.
Annuities provide guaranteed income which is payable throughout the lifetime of the annuitant and can also continue to be paid to a beneficiary after the annuitant's death.
Apart from those who are terminally ill, it is difficult to see any justification for not buying an annuity at, or even before, 75.
For someone in normal health at age 75 a single life annuity currently secures an index-linked income of around eight percent per annum, while a joint life annuity generates more than six percent a year, rising with inflation for life thereafter.
Competing against such high and rising yields is simply not realistic, however good the investment strategy is. Much lower levels of income will therefore be available under ASP.
For those for whom reduced income is not a concern, what might be an appropriate investment strategy? Typically this would depend on the attitude to risk, the dependency ratio (how much you depend on the pension compared to other sources of income), and the investment term.
But how long is the investment term? ASP can continue until death, or an annuity can be bought at any time.
And what might the IHT implications be? The Inland Revenue has recently published a discussion document in which it indicates that, in most cases, the ASP election will be considered as an arrangement which is intended to confer "gratuitous benefit" on the investor's beneficiaries.
Accordingly, on death the estate will be treated as having made a chargeable transfer based on what benefit could have been secured had an annuity been bought the day before death with a ten-year guarantee at "best market" rates.
The ASP option will need to be very carefully considered in the light of the potential IHT implications.
The possibility of adverse consequences is very real, particularly in cases where an alternative approach would have been to buy the annuity and thereby facilitate gifting away other capital under the PET provisions.
So, whereas at present you know that if you have not bought an annuity with your pension fund before age 75, you must do so at 75, you will soon have a decision to make at 75. And if you do not decide to buy an annuity at 75 you will need to review that decision at 76 and every year thereafter.
And if you are in drawdown before age 75, you will need to decide whether your investment strategy should be geared towards annuity purchase at 75 or some other age.
If only "simplification" could be really simple.
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