The first year of alternatively secured pensions has been eventful, but how did income withdrawal survive, what is its future and is it of any use in retirement planning?
One of the cornerstones of A-Day last April was the removal of the requirement to buy an annuity at age 75 and the introduction of income withdrawal post age 75 (referred to as alternatively secured pensions or ASP).
The first year of ASP has been eventful to say the least but it does appear to have survived - just.
The real question now is whether ASP has a future and is of any use in the retirement planning process.
Post A-Day, there appeared to be no real issue other than how inheritance tax would be applied to the residual ASP funds.
ASP was never likely to be a mass market product as very few people would have had a fund of sufficient size to be able not to draw an income.
For some reason, HM Treasury seemed to think otherwise and decided to backtrack under the argument that ASP had only been designed for those with a principled religious objection to annuity purchase - in its view, the Plymouth Brethren.
This was somewhat ridiculous and would have been impossible to police even if it was legal.
The Pre-Budget Report in December 2006 was expected to include the Treasury's up to date thinking on the subject and indeed it did. Rather than not needing to draw any income, a minimum income of between 65% and 90% of GAD rates was introduced.
Any residue on second death or first death without any dependants (the transfer lump sum death benefit) would then become an unauthorised payment and subject to a whole raft of potential tax charges, namely:
l Unauthorised Payment Charge of 40%.
l Unauthorised Payment Surcharge of 15%.
l Scheme Sanction Charge of 15%.
l IHT of 40% could also still apply.
There could also be a scheme deregistration charge of 40%.
Between the Pre-Budget Report and the Budget on 21 March 2007, there was a lot of lobbying to change the Treasury's view and it did appear from some reports that there was some hope of change.
The Budget brought very little change other than a reduction in the amount of minimum income to 55% of the GAD rate and some clarification of how inheritance tax would be levied against the fund. The key point is that the legislation is very firmly structured to dissuade any attempt to pass on money to beneficiaries' pension schemes after death by keeping the transfer lump sum death benefit as an unauthorised payment.
There are lots of arguments as to why this is a retrograde step but that is a subject for a different article.
In my opinion, the key point is that we have not reverted to compulsory annuity purchase at age 75.
In the last year from a planning perspective the role of ASP seems to have changed drastically. Originally the theory was that well off clients would draw nil income from their ASP fund post age 75, potentially pay their inheritance tax and then pay the rest to the pension schemes of their beneficiaries.
This may not be the case under the new regime where the potential tax charge would appear to be something like 82%, and that is without the discretionary deregistration charge.
In such circumstances it would also appear to be logical to attempt to minimise the amount of the fund that is likely to be left and subject to the tax charge. In order to achieve this specific planning might be required.
Obviously one option might be to just spend the pension fund as quickly as possible but it is probably possible to add a little more subtlety to this.
It might be possible to draw more income than is specifically needed and then this excess income could either be invested for the direct benefit of the drawdown client or it could be passed to a third-party pension contribution to perhaps a spouse or children.
So for a third-party contribution, the original client may suffer tax at say 40% on drawing the income but if paid on behalf of a third party, will enjoy tax relief at their highest rate. So if a child is a basic rate tax payer any contribution paid on behalf of that child will enjoy basic rate relief. This means a net cost (the difference behind the higher rate paid and the basic rate relief recouped) of 18% - highly preferable to say 82%.
Any such third party contributions would need to be justified by the individual paying them as gifts through normal expenditure so that they are not caught for inheritance tax in the future. In such circumstances the donor must demonstrate that the money is paid out of normal expenditure over an annual basis, that such payments do not disrupt the donor's normal standard of living. Such payments will need to be reported to HMRC after the donor's death for them to confirm the exemption.
As an alternative the extra contribution could be invested into another investment vehicle which has a more beneficial inheritance tax regime than ASP. This could be into an investment bond in a trust, a whole of life policy or even into a portfolio of AIM stocks which would not be subject to IHT on death.
The key thing is to make sure that the money is moved into an investment where the potential tax charge is less than it could be.
It is also important to realise that the ASP tax charges are only chargeable in the absence of a dependant. So for a situation say where there is a husband with a younger wife, it is likely that she could live longer than him and therefore the period of time that ASP could continue could be considerable.
It may be that an annuity is chosen as the ideal form of providing an ongoing stream of income, but that the annuity is perhaps not purchased until the client is in their eighties when an enhanced rate might be available. It might even be possible to buy an annuity with a guarantee period which could guarantee a stream of income back to the deceased's estate. This might even be at an advantageous rate depending on how HMRC calculate the IHT value of the guaranteed income payments.
From the perspective of financial planning, all of this gives the financial adviser the opportunity to get involved with the client with a view to using the pension fund in the most efficient way possible and with a view to minimising the effect of the ASP tax charges. It is dynamic management which be charged to the client.
Is ASP dead? I do not think so. If anything we must change our thinking so that ASP is perhaps not an end in itself but merely a means to an end.