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UK government proposals to end “compulsory” annuities

By BILL BLEVINS [email protected]

Bill Blevins is the Managing Director of Blevins Franks. He has specialised in expatriate investment and tax planning for over 35 years. He has written books and gives lectures on this subject in Southern Europe and the UK.

Prior to the UK General Elections, both the Conservatives and Liberal Democrats had pledged to end compulsory annuitisation. In the June Budget, the age by which a pension holder needs to buy an annuity was increased from 75 to 77.

A Treasury consultation paper on July 15 goes even further by saying that from April 2011 there should no longer be a deadline by which people “effectively have to annuitise”.

The purpose of consultation process is to enable the government to thrash out the finer detail of the new regulations. The two year window until age 77 is to allow the consultation and agreement to be finalised.

Currently, if you do not buy an annuity by age 77 you are automatically transferred into an Alternatively Secured Pension (ASP). When you buy an annuity you usually cannot pass the balance on to your heirs (other than a spouse’s or dependent’s pension) and the rates are currently low.

ASPs offer lower levels of income to drawdown and a higher tax charge on death – up to 82 per cent compared to the 35 per cent applied to income drawdown.

You cannot defer your pension income or tax free lump sum after age 75 or delay buying an annuity till after age 77.   

Under the proposals in the consultation document, from April 6, 2011 UK pension holders will be able to buy an annuity at any age they like. 

If they choose not to buy one at all they will no longer be transferred into an ASP. The same drawdown system that currently exists pre age 77 will apply post 77, with name “capped drawdown”.  There will be a second choice of a new “flexible drawdown” system.

Capped drawdown

Under this regime, income can be withdrawn subject to annual Government Actuarial Departments (GAD) limits. Those in drawdown can currently take income of up to 120 per cent of GAD limits, but this limit will be reviewed. It is expected to be conservative to ensure that people do not take too much income and end up falling back on the state for support.

Flexible drawdown

Under this regime, pension holders will be able to take more than one lump sum and as much as they like, provided they can show that they have already secured “minimum income requirements” (MIR).  The definition of MIR will be determined after the consultation.  It may vary according to age and/or marital status.

Only pension income will be used to determine your MIR – any income generated from your other savings and investments will not count.  It can include state pensions and other pensions already in payment provided they are guaranteed for life and take inflation into account. Annuity income will be considered provided it increases by the same level of inflation or by 2.5 per cent each year and is guaranteed and immediate in payment. 

Besides the level of MIR, the government needs to establish what constitutes secure income; the age at which the MIR has to be determined and how it should be assessed.

Tax charges on death

The good news is that those who do not want to buy an annuity will no longer be faced with a tax charge of up to 82 per cent on the residual fund left on death. Instead it will be subject to a recovery charge of 55 per cent. The bad news is that for those who die aged 77 or younger, the tax charge increases from 35 per cent to 55 per cent.

This is obviously an improvement on 82 per cent, but while you can leave the balance of the fund to your heirs (which you cannot do with an annuity), the taxman will still take over half of your fund.

The current 82 per cent charged on ASP includes inheritance tax. Under the consultation IHT will no longer “ordinarily” apply on death after 75.

However the government will monitor the situation and clamp down on any signs of abuse.  If IHT were applied, the total tax rate would be 73 per cent.

This 55 per cent tax is “designed to recover past tax relief”, but considering that most people only receive 40 per cent or 20 per cent tax relief, it seems unfair that they will be taxed 55 per cent on death.

The consultation document also proposes that the tax free lump sum can be taken after age 75. The consultation period ends on September 10. 

While we welcome the demise of the ‘annuity trap’, we still need to find out exactly what the new regime will entail.

It appears that the MIR rules to be applied on flexible drawdown could be very complex.  55 per cent is also a rather punitive tax charge for the balance of the fund.

QROPS (Qualifying Recognised Overseas Pension Schemes) continue to look attractive for expatriates who have pension funds totalling more than 100,000 Pounds Sterling. 

Provided you have been non-UK resident for five complete and consecutive UK tax years at the time of your death, your fund will escape all UK charges on death, whether it is 35 per cent, 55 per cent, 82 per cent or IHT.

For expatriates in countries like Portugal, a QROPS also provides tax savings during your lifetime.

No UK PAYE is payable on income from a QROPS; your pension can roll-up tax free and taxation of withdrawals is usually beneficial. 

You can also set up the fund and income in Euros to avoid exchange rate risks and costs, and QROPS provide increased investment and income flexibility.

Seek advice from a wealth management professional like Blevins Franks to establish if a move into QROPS would be appropriate for you.

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