Retirement: Scheme Pension, an alternative to an Annuity or Income Drawdown?

Most would-be retirees are aware of how an Annuity works and other options such as Enhanced Annuities, Income Drawdown are becoming more popular.

However, as falling gilt yields push Annuity rates ever lower and reducing the maximum available income from Income Drawdown plans, one retirement option is passing most people by completely unnoticed.

We asked Oliver Bowler, of Talbot & Muir, to explain more about Scheme Pension, what it is, and how it works, this is what he had to say:

People are living a lot longer than ever before: a good thing, right?  The probability of living to 100 is better than it’s ever been, and nearly 1 in 10 men and 1 in 7 women now aged 60 are projected to live another 40 years, as this table (by DWP August 2011) shows:

	Age 55 now	Age 60 now	Age 65
Males	10.3%	9.5%	8.7%
Females	15.7%	14.5%	13.4%

So, what does this mean for retirement options?

Annuities definitely have their place, but with Annuity rates at historically low levels  is it a good idea to lock in to an Annuity now? On the other hand, Annuity rates may yet fall even further: what impact will Solvency II and gender neutral pricing have? Experts have predicted a 10 – 20% decrease in Annuity rates once the effects of both of these have bedded in.

Whilst the flexibility of Income Drawdown remains a benefit, this option has been made increasingly unattractive in recent years, with the maximum level of income reducing from 120% to 100% of GAD, Gilt Yields that have ‘bottomed out’ at 2%, and the re-pricing of GAD Tables in 2011.

Some people have seen drops in maximum drawdown allowances of over 50% after their most recent income review.

As always, there are alternative choices: different varieties of insurance company sponsored Annuities, and the increasingly popular option of money purchase Scheme Pension.

What is Scheme Pension?

Unlike a Capped Drawdown arrangement, the level of income payable under a Scheme Pension is established by actuarial calculations, and is individually tailored to the SIPP (Self Invested Personal Pension) or SSAS (Small Self Administered Scheme) member.  Consequently, a Scheme Pension calculation may produce a higher income than a Capped Drawdown pension or an Annuity.

With the gilt yield for Capped Drawdown dropping to 2% in September, a Scheme Pension may provide a solution for some members, given that the level of income payable is determined on a bespoke basis, and it can therefore take into consideration other factors such as the health of the member and the projected investment performance of their pension fund.

The table below illustrates the comparative annual income payable to a male crystallising £100,000 of his pension fund:

	55	65	75
Capped Drawdown*	£4, 100	£5, 300	£7, 700
Annuity**	£4, 794	£6, 053	£8, 038
Scheme Pension***	£6, 149	£7, 603	£10, 097

* Based on GAD rate for 1st September 2012, and the 2011 GAD tables.
** For illustration purposes only, based on rates for a male in good health. Source: Money Advice Service 01/09/2012
*** For illustration purposes only, based on rates for a male in good health. Source: Talbot & Muir 01/09/2012

As you can see, for those aiming to maximise their income, a Scheme Pension should be considered as an alternative to Capped Drawdown and Annuity purchase for many clients when looking at retirement options.

Ill Health

As mentioned, the key benefit of Scheme Pension is that the provider can also factor in the client’s health, which may increase income levels over time, a clear differential from Income Drawdown where ‘one size fits all’. This income can be reviewed as and when a member’s health worsens (or improves).

A further option is to build in a guarantee period of up to 10 years. This may be particularly appropriate for those clients with a reduced life expectancy, as it provides their beneficiaries with an alternative to a lump sum death benefit subject to the 55% Tax Relief Recovery Charge. This will be taxed as a dependant’s pension, but can be paid to any eligible beneficiary whether or not they are financially dependent on the member at the time of their death.

The price to pay is a lack of flexibility. A Scheme Pension is a secured income and cannot be increased or decreased at the request of the member, as a Capped Drawdown pension can. Furthermore, unlike a conventional Annuity, the income may fluctuate with investment performance.  Finally once someone elects for Scheme Pension there is no going back to Drawdown, but they can move to an Annuity at any time.

As the statistics on longevity continue to improve, conventional retirement options start to look more and more outdated.  Although perhaps not for everyone, a Scheme Pension can be the most suitable choice, specifically if a would-be retiree wants an income that is free from the shackles of GAD and flexible enough to cope with variations in the fund value, economic climate and health.

Next steps

If you would like to learn more about Scheme Pension and whether it’s a viable alternative to an Annuity or Income Drawdown for your own specific circumstances contact one of our advisers.

Our team of Independent Financial Advisers are experienced in developing retirement income strategies for clients the length and breadth of the UK. If you are approaching retirement and would like advice on your options call one of our IFAs today on 0115 933 8433, alternatively enquire online or email info@investmentsense.co.uk