Pension income options

Defined benefit arrangements cannot offer lifetime annuities. All defined contribution  schemes must offer members the option of a lifetime annuity from the insurance company of their choice. This is known as an ‘open market option’ and means that the fund need not be used to purchase an annuity from the plan provider but can instead be used to purchase an annuity from another provider offering a better rate or a more suitable type of annuity.

The benefits received from a lifetime annuity depend on the size of the fund at retirement, the annuity rates available and the type of pension benefits selected. Until 6 April 2012, it also depended on whether the fund was comprised of protected or non-protected rights. However, from that date, protected rights ceased to exist as a separately designated type of pension and all monies held within a defined contribution scheme are now treated the same way, provided the scheme rules...

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Lifetime annuity rules bought before 6/4/2015

Must be paid at least annually for life

Conventional lifetime annuities must normally be guaranteed not to reduce (other than in the specified circumstances detailed below)

Can include ancillary death benefits such as dependants’ pensions, guarantee periods of up to ten years and/or annuity protection

Must not be capable of being assigned or surrendered except in the event of a pension sharing order

Can be transferred to another registered pension scheme if the form of the pension does not change

Conventional lifetime annuities can only be reduced in certain prescribed circumstances, i.e. if the reduction is the result of:

A change in RPI/CPI

A change in the market value of freely marketable assets

A change in an index reflecting the value of freely marketable assets

A change in the bonuses attached to a with profits annuity

Under what circumstances can conventional lifetime annuities be reduced?

Answer : Purchase course for answer

All pensions paid from defined benefit arrangements are scheme pensions

Defined contribution schemes can provide scheme pensions but the member must first be given the opportunity to select a lifetime annuity from their choice of insurance company. In practice, because of the practical difficulties in guaranteeing a scheme pension from a defined contribution scheme without purchasing an annuity, it is unlikely that many schemes will offer this option, with large occupational defined cont...

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Can be transferred to another registered pension scheme if the form of the pension does not change

Scheme pensions can only be reduced if the reduction is the result of:

A pension share or other court order (e.g. on bankruptcy) reducing the scheme pension payable

An ill-health pension stopping because the member has recovered

A bridging pension ceasing or reducing at State pension age

A global reduction to all pensions under the scheme (for example, on wind-up)

A requirement of public sector pension regulations, e.g. where a pensioner is re-employed

The scheme administrator paying an annual allowance charge in relation to the member

What three factors determine the level of pension available from a defined benefit scheme?

Answer : Purchase course for answer

Fixed rate annuities – these are also known as conventional annuities and prior to 6 April 2015 were the most widely used annuity products. They provide a guaranteed level of pension income, on a basis agreed when they are set up.

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Impaired-life annuities – these annuities offer higher pensions for people with more serious medical conditions such as cancer or heart disease. They are generally fully underwritten, and therefore more expensive.

For a scheme pension payable from either a defined benefit scheme or a (large) occupational defined contribution scheme, there are three main death benefit options:

Dependants’ pensions

Pension guarantees

Value protection

A non-scheme pension can also be paid out to a nominee (an individual who is not a dependant who has been nominated by either the member or the scheme administrator) or to a successor, who is an individual nominated by a dependant, nominee or earlier successor.

Dependants’ pensions

Secured pensions can be set up to provide a continuing pension to one or more of the member’s dependants on their death. A dependant is defined as: Shortened demo course. See details at foot of page.

Value protection

A feature introduced by the simplified regime is the facility for lump sum death benefits to be paid from secured pensions to a wide range of beneficiaries (not just dependants). This is intended to address the traditional concern that annuities offered poor value for money on death.

The facility is also known as annuity protection (or, where scheme pensions are involved, pension protection). The maximum annuity (or pension) protection lump sum death benefit that can be paid is the original crystallised value of the pension minus the total pension payments received to the date of death, and taxed on the recipient as pension income under PAYE if death occurs on or after attaining age 75. If death occurs before age 75 and the lump sum death benefit is paid out within the two-year window following the member’s death then there is no tax charge.

What is the required term for which dependants’ pensions must be payable?

Answer : Purchase course for answer

Pension increases

Many benefits built up under defined benefit schemes must include a mandatory level of minimum pension increases during payment. The level of increase required depends on the type of benefit and when it...

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GMP built up between 6 April 1988 and 5 April 1997 must include a 50% pension for any surviving widow, widower or civil partner

GMP built up between 6 April 1978 and 5 April 1988 must include a 50% pension for any surviving widow

Longevity

Longevity or life expectancy has improved substantially over the past century, mainly due to better social conditions and advances in medicine. This means that people are living longer and each generation spends more time in retirement. The issue that this creates for insurers is that the annuities they commit to pay will be payable for longer than was the case in the past. As a direct consequence of this, annuity rates have fallen markedly in the last twenty years.

Fixed interest securities

Investing in long-term gilt...

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- An impaired life annuity offers higher rates for individuals with certain medical conditions that are likely to be life-shortening, such as cancer or heart disease. Impaired life annuities are likely to be fully underwritten and the annuity provider will make a detailed investigation of the applicant’s medical history

What are the two main factors that affect annuity rates?

Answer : Purchase course for answer

Investment-linked annuities provide a pension income which depends on the performance of the underlying investments. They are normally linked to unit-linked funds or with-profit funds chosen by the annuitant. As such, the pension income paid can go up or down, depending on how the investments perform.

Unit-linked annuit...

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New base annuity: £980.29 + £19.60 = £999.89

If the applicant selected a realistic ABR there is the potential for a rising income. If the applicant selected a higher ABR the initial income would be higher but there is a high risk that the income could fall due to low bonus rates.

The provider may offer the option to switch to a conventional annuity.

If a with-profit annuity had an ABR of 5% and an initial income of £10,000, calculate the new base annuity if a bonus of 3% was declared.

Answer : Purchase course for answer

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Lack o...

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