For those who do not wish to buy an annuity, the government is proposing to allow capped drawdown, equivalent to unsecured pension (USP) extended beyond age 75, for the whole of an individual’s retirement.
USP currently allows individuals to take a tax-free lump sum at the beginning of their retirement, keeping funds invested in a tax-exempt environment while drawing down an income from their remaining pension pot in line with their needs, subject to a prudent drawdown limit. Capped drawdown will be applicable from the age of 55.
Tom McPhail, head of pensions research at Hargreaves Lansdown, said the capped drawdown proposal is both radical and unexpected. “The government deserves extra marks for style here. Even if you have a modest income, you are effectively able to access an income for life, and have the flexibility of choosing how much you drawn down annually, subject to a capped limit.” he said.
The government will also create additional flexibility for individuals who wish to draw down more than the capped annual limit. Under this model, drawdown of unlimited amounts will be allowed from the pension pot, provided people can demonstrate they have secured a sufficient minimum income to prevent them from exhausting their savings prematurely and falling back on the state.
An individual could choose to annuitise part of their pension pot and invest the remainder in a capped or flexible drawdown arrangement. Conversely, they could enter a capped drawdown arrangement upon retirement and could decide to purchase an annuity at a later date in order to secure a guaranteed income for life.
To access flexible drawdown, the consultation proposes individuals must satisfy a Minimum Income Requirement (MIR) to protect the Exchequer from the risk of people falling back on the state.
One option outlined in the consultation is to set the MIR at the level of income above which a person cannot claim means-tested benefits. However, this would not be straightforward as means-tested benefit entitlements are not based on income alone, but take into consideration other factors such as long-term care, disability and housing circumstances.
The level of the MIR should therefore be a reasonable proxy for an income level above which the likelihood of an individual prematurely exhausting their pension savings and falling back on the state is minimal, the consultation states.
Towers Watson said the MIR could end up being a big number relative to most pension savings if the government takes a cautious approach to ensure pensioners aren't entitled to taxpayer support, having spent their own money.
Paul Macro, senior consultant at the advisers, said: “If the government took a conservative approach, many people would have to use roughly the first £300,000 of their savings to provide a secure income before being able to access the rest of their money upfront.
“However, that number could fall if annuity rates improve, if means-tested benefits are pared back further in response to the fiscal crisis, or if the government decides there is only a small risk of people running down all their non-pension assets.”
Most people do not have pension pots of this size, but will still have more flexibility to invest their savings aggressively to accumulate a bigger income later in retirement, if they are prepared to risk outliving their money, Macro said.
Trevor Matthews, chief executive of Friends Provident, said it is important the industry sets a realistic minimum income requirement that excludes individuals from any means-tested benefits.
Tim Whiting, head of desk and web at the Annuity Bureau, said the overall impact of the proposals will be modest and only likely to benefit those with large funds. He added the vast majority of people will still need to access income as soon as they finish working, and so the option of deferring their annuity will not be viable.
“In addition, the average retirement fund in the UK is less than £30,000 and at that value flexibility really is not an option,” Whiting said.
Macro also pointed out most occupational DC schemes do not currently offer income drawdown, therefore will either have to offer this facility or require members wanting to use it to transfer out into a personal pension.
The closing date for responses is September 10, 2010.
