Compulsory Annuity Purchase
The Treasury is to bring to an end rules forcing retirees to buy an annuity at age 75.
New annuity rules
The main changes to the pensions system are that alternatively secured pensions will be scrapped and replaced by lifetime capped income drawdown.
Capped income drawdown will allow yearly withdrawals between £0 and 100% of the basis amount of the pension fund, which was broadly in line with the amount that an annuity would actually pay. The current limits are 120% for under 75′s and 90% if over 75.
The current requirement to take an income of 55% of the basis amount after age 75 will be removed. The capped drawdown limit will be reviewed every 3 years rather than the current 5 years before age 75 and every year thereafter.
A new flexible drawdown option will be introduced, which will allow withdrawals above the capped drawdown limit as long as a minimum guaranteed lifetime income of £20,000 per year can be verified.
Sources of income which count towards the guaranteed lifetime income required are state pensions, defined benefit pension schemes, scheme pensions and lifetime annuities.
Currently individuals get around £5,000 per year from their state pension, although this is set to increase as part of the upcoming state pension reforms, and this will count towards the £20,000 minimum income limit.
Tax on death benefits from benefits already utilised will be charged at a rate of 55%, but the lump sum paid on death will not form part of the individual’s overall estate for inheritance tax purposes.
Lastly, tax-free lump sums can be withdrawn from the pension fund after age 75.
Overview of annuity rule changes
Retirees will get new freedoms over how they spend their hard earned pension fund, under these new pension laws. The Treasury will let people cash in their pension fund and use their money however they want to.
A spokesman for the Treasury said that the existing rules which create a requirement to buy an annuity by age 75 will end from April, 2011, adding that this will give retirees more choice over the use of their pension fund savings to provide a retirement income for themselves.
Limited appeal
However, this change will only apply to retirees who can demonstrate they have a separate source of income – a minimum of £20,000 per year. Only in these circumstances will they be allowed to cash in their entire pension fund.
Buying an annuity
The current system can force retirees to buy an annuity even when prevailing market conditions mean they could generate more income from other sources. Many people would argue that annuities do not currently provide good value for money.
Pension savers have been limited to taking a maximum tax free cash lump sum of 25% of the value of their pension fund at retirement and must use the rest to provide themselves with an income.
Changes at death
By avoiding having to buy an annuity, pension savers will also be able to keep their pension fund for longer and increase their chance of passing their pension fund money on to the next generation after their death.
Under these new rules, a saver’s pension fund will be able to be passed onto a beneficiary on death tax free if no cash has been withdrawn from the fund.
If cash has been taken, then the remainder of the fund will be able to be passed on but a tax charge will be applied. This tax charge will be 55%, a lot lower than the current 82% tax charge that can apply.
Not everyone wants to buy an annuity
It is fair to say that many people do not want to buy an annuity when they come to retire because that means their capital is gone for ever. The idea of buying an annuity and then dying days, weeks, or months afterwards and having an insurance company end up with the pension savings that’s been built up over many years doesn’t really appeal.
It could therefore be said that this change is good news and might well encourage people to save more in their pensions.
The general picture
The latest age at which annuity purchase can be postponed was raised to 75 four years ago. However, only about 4,000 retirees have taken advantage of this option.
However, looking at the overall picture, 450,000 people entering retirement last year invested a total of £11 billion into annuities. And, as more and more final salary pension schemes close down in the private sector, more people will reach their retirement in future with money purchase pensions, and they will need to arrange their own income in retirement somehow. The market for retirement planning is growing at a tremendous rate and will continue to do so.
Maggie Craig, a director of the Association of British Insurers (ABI), said that for the vast majority of people at retirement, buying an annuity is the right choice, as it provides a guaranteed regular income for the rest of their lives.
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