FAQ: the New Pension Annuity Rules

At present, pensioners must exchange their pension fund for an annuity by the time they reach 75. An annuity is an insurance policy that provides regular income for life in exchange for a pension or a lump sum. Everyone at present with a personal pension must buy an annuity before the age of 75. An annuity can be bought between the ages of 50 and 75. The larger the pension the larger the income for life will be. Many people do buy annuities from their pension insurance company when in fact better deals can be found elsewhere.

In basic terms the new pension annuity rules gives greater choice to pension savers. The existing annuity rules are to be scrapped, and in theory this means retirees can dip into their pension funds as desired. The new pension annuity rules are designed to give retirees more choice on how they convert their pension funds into income. One quarter of the pension fund can be taken as a lump some but the rest of the fund can be used as a taxed income.

Unlike the present rules, those with a pension arrangement no longer have to take any income from their pension before or after the age of 75. The pension commencement lump sum will be available to be taken whether an income is taken, at any age. Pensioners will have the choice of taking an annuity or using an income drawdown. An income drawdown can be either a capped drawdown or a flexible drawdown.

A capped drawdown is where money will stay invested in shares, property funds, etc, and pension savers take income from the fund. Retirees will be able to decide on their level of income depending on the capped limit. The current income level permitted is 120% but this will be reduced to 100%. This is comparable to the income available from an annuity.

Individuals who choose flexible drawdown who meet the Minimum Income Requirement of pre-tax £20,000 per year income can choose flexible drawdown. This means they are free to dip into their funds as desired. Flexible drawdown mean the savers can take as much or as little as they wish in income but income tax must be paid on withdrawals. The 25% lump sum will not be subject to tax.

The downside to a drawdown contract, is that as you take income from your policy, the value of it is reducing and will provide you with less of an income in later life.

The Minimum Income Requirement (MIR) has been set in place to ensure retirees do not take all of their income and then rely on state benefits. The MIR is a £20,000 lifetime income, which would mean a pension fund investment of at least £250,000. The state pension, annuities and personal pensions will count when assessing the £20,000 lifetime income. An individual will be required to show proof that they do have this amount of secured lifetime pension before they will be permitted to use flexible drawdown.

Not too many retires will be eligible to use flexible drawdown. Most pensioners do not have enough in a pension fund to meet the £20,000 Minimum Income Requirement. Just under half a million people annually buy annuities, and of these, just under 1% would have enough to be eligible for flexible drawdown. But some annuity buyers have private pensions as well as work pensions and in some cases this may be enough to meet the MIR.

Taking a varying income is one of the major benefits of drawdown instead of buying an annuity. Many pensioners are also less than pleased when having to hand over a big lump sum in exchange for a not too substantial income. Annuities also mean savers are locked into the present annuity rates; inflation can decrease the amount of income.

Running a pension drawdown can come with some drawbacks including the expense factor. Investing money is a tricky business and expert help may be needed on investment decisions. This means paying someone to make these investment decisions as well as paying admin charges that could be over £500 per year. There can also be fees charged every time a saver decides to make a withdrawal. This could amount to a hefty chunk of money throughout the running of the drawdown.