September 2007

Taxing times

Excitement about the launch of alternatively secured pensions (ASP) last year extended far beyond the small group of Christians originally targeted as the beneficiaries of the rule.

Although designed for a small minority with a religious objection to mortality pooling, the introduction of ASP was inevitably seized on as a new retirement opportunity by all those who believe forced annuitisation by age 75 is not in everybody's best interests.

The Government's belated imposition of sharply increased tax charges - up to 82% - and higher minimum income levels was designed to choke off interest from wealthy people who realised ASP rules allowed them to continue building up their pension fund with a view to passing some of it on through inheritance.

Despite the disappointment over high tax charges, now the dust has settled many advisers and clients are realising that ASP still has an important role to play for a whole range of people who at last have an opportunity to keep control of their pension pot instead of being forced into the irrevocable decision to buy a lifetime annuity by the time they celebrate their 75th birthday.

Who might be attracted to ASP?

One obvious group who remain attracted by the idea of rolling their cash over into ASP is anyone keen to leave money to charity. This is because on death the residue of the fund can be passed on to registered charities free of tax. Many people would prefer to see their left-over fund go to good causes they have personally chosen rather than have it swallowed up by an insurer.

However, ASP also remains an option for those keen to leave some of their accumulated pension fund as an inheritance. The current tax rules impose a 70% 'unauthorised payment charge' plus inheritance tax of 40% of the remainder on the death of the holder, giving a total tax grab of up to 82%. Although only the remaining 18% can be passed on at death, some people view this as a better alternative to losing the entire pot to an annuity company or taking on the expense and extra risk of opting for a guaranteed annuity that may never pay out.

They also know that moving into ASP effectively keeps their future options open to respond to changes in pension rules. These days, a 75 year old will on average survive at least another decade and many considerably longer - about one in 10 will reach age 100 - so they do have some time on their side.

Their belief that change will happen is likely to be strengthened by the widely held view that the 82% tax rate is inequitable. Is it really fair in these days of age equality that someone up to age 75 in income drawdown can pass on their remaining pension fund subject to only 35% tax, but on their 75th birthday the tax charge jumps to 82%?

Many see this as a politically driven attack on the wealthy and one that, like Labour's high tax rates of the 70s, will not survive the test of time. Possible scenarios for a revision could be if Labour bowed to consumer or industry pressure, if the Conservatives were elected to government, or if an appeal to Europe forced a change in UK laws.

There is even the possibility the age 75 rule itself could be pushed back or scrapped, perhaps in response to rising life expectancy. The truth is, much can change in the pension world over five to 10 year periods and those in ASP have nothing to lose and much to gain by sitting tight and keeping their options open.

Another factor in the decision to move into ASP comes from sharply falling annuity rates over the last decade due to falling investment returns and increased longevity.

The decline has been felt by those reaching retirement but has had a similarly profound impact on people forced to buy annuities later in life. Some may believe the rates they are quoted as they reach age 75 simply represent poor value at current levels compared to the fund they are giving up, and are prepared to wait for a pick up before taking the irrevocable decision to buy a lifetime annuity. We have seen annuity rates rebound off historic lows and those who believe this trend will continue may benefit from moving into ASP until better rates come along.

This is true particularly for the increasing number reaching age 75 in good health and who are therefore only eligible for standard annuity rates. It is a sad fact of life that as age increases, so do the chances of people suffering ill health.

Those who move into ASP when healthy but who subsequently suffer poor health or are diagnosed with a specific illness can still benefit from substantially higher enhanced or impaired life annuity rates. Someone in their 80s diagnosed with an illness that reduces their life expectancy to two or three years could perhaps secure annuity rates of 30-40%. Similarly, those going into long-term care often become eligible for high rates to reflect the high chances of their early deaths.

Spouse age

ASP also has a particular relevance to those couples where the age difference between the holder and his/her spouse can have a major impact on the retirement income available through an annuity. A 75 year old male could currently secure a single life lifetime annuity rate of around 10%. If he required a 100% spouse's pension and his wife was 10 years younger, the income level would fall to a far less appealing 6%. By using ASP to delay annuity purchase for 10 years, the income lift would be significant if they both remained healthy and even greater if either succumbed to an illness.

Linked to this is the key point that there are still no tax charges following the death of the ASP holder who leaves the residue of their fund to a dependant such as a spouse or civil partner. Some people with ASP funds have good reasons to remain invested but arrange that on their death, the spouse - who may be younger or older - then uses the whole fund to buy an annuity. This means a spouse can benefit from the full value of the ASP funds and potentially receive a higher annuity rate than if a lifetime annuity had been purchased at age 75.

One final point that we all should remember is that people approaching age 75 do not necessarily see this as a great age and certainly not a barrier for their continued interest in controlling their pension provision. This point seems entirely lost on a Government that seems determined to use an arbitrary age rule to wrest control of pension money away from wise investors and hand it to an annuity company regardless of whether this is in the pensioner's best interest.

Those keen to keep control of their fund should be applauded rather than treated like insolent children. Many will have self-invested successfully for many years and built up good pensions and will see no reason for the state to insist they are no longer capable of managing their own affairs. Quite reasonably, they want to retain the choice to annuitise at a time that is most suitable to them bearing in mind all of their circumstances, not at a time that suits the Government.

Financial advisers need to keep abreast of the ASP options because, although not suitable for everyone, there continue to be cases where it is clearly the best option for a client. A key point when setting up income drawdown arrangements is that many providers do not offer a facility for funds to be rolled over into ASP at age 75. In fact, many of the major insurers are not yet allowing ASP. Specialist SIPP providers are more likely to give this flexibility and where medium-large pension pots are involved, be more cost effective through the charging of fixed rather than percentage based fees that can work out much cheaper over the long-term.

Neil Marsh
Managing Director
Hornbuckle Mitchell