What is a typical query?
A member of a DB scheme contacts you to ask if it’s a good idea to take the maximum cash allowed when he retires.
What could you do?
Recommend the member gets independent financial advice?
Discuss the situation with the member?
Some options you can discuss are .....Lump Sum
Purchased Life Annuity
Income and Expenditure
The member could do a simple comparison like the one in this table to see if they would be better off taking the Pension Commencement Lump Sum (PCLS) or not.
| If PCLS is taken £ | If PCLS is NOT taken £ | |
| PCLS | 12,500 | 0 |
| Pension p.a. | 2,742 | 3,647 |
| Total received after 5 years | 26,210 | 18,235 |
| - After 10 years | 39,920 | 36,470 |
| - After 15 years | 53,630 | 54,705 |
| To age 82 (average life expectancy) | 59,114 | 61,999 |
Note that life expectancy is important in this decision.
Now what do you do?
It was a simple question but the answer is not always easy!
You have given the member some things to think about to help him make an informed decision.
Now you can suggest that he/she talks to an independent financial adviser.
Purchased Life Annuity (PLA)
A PLA works on the same basis as a standard annuity by converting a lump sum into guaranteed income however the money can’t come directly from a pension. A PLA can be purchased using any other capital including a PCLS and any other savings.
A PLA is paid with basic rate tax deducted, those who are not liable to basic rate tax can reclaim it and those who are subject to higher rate tax will pay that through their tax return.
Continuing employment
Employees have the right to ask their employer if they can continue working past retirement age.
Currently 10% of the UK working population are over SPA.The member may want to work on a part-time basis and only receive part of their pension.
State Pension
The member needs to find out what they may be entitled to and decide whether to claim it or defer until a later date.
Pension Scheme
The pension scheme rules will state if:
If employment continues after taking pension, automatic enrolment may still apply so pension contributions may have to continue.
Tax Implications
If the income from the State pension, earnings and other sources total more than the allowance permitted by HMRC then they will be taxed through their employer’s PAYE system.
If the member has income from the State pension and other sources these may affect their tax coding which in turn, affects the amount the employer deducts from their earnings under PAYE. If the member has income which is not "earned”, this may also affect their tax coding.
Flexible Access Drawdown
This is an alternative to an immediate annuity purchase and is available to members with Defined Contribution benefits.The member can take up to 25% of the fund as a tax free lump sum with the remaining fund being used as income drawdown or to purchase an annuity.
Trustees need to agree to offer this option and if they chose not to, the member would have to transfer to another pension arrangement that does have the flexibility options.
The member should always seek regulated financial advice to ensure that this type of arrangement is suitable for their future income needs.
Advantages and Disadvantages of Income Drawdown
The main advantage is that the member can access a pot of money when needed and is not forced into purchasing a pension with the money – they could buy a new car or go holiday with it.
They can also draw out multiple lump sums (taking into account any scheme restrictions) over a period of time. However, this could mean that the member leaves themselves with no pension income when reaching retirement.
The importance of planning ahead
When planning for retirement or other decisions involving finance the member also needs to think about the financial impact on their dependants should they predecease them.
Guaranteed Pension
If the member’s pension has a guarantee period and they die before it expires then any balance paid as a lump sum can normally be paid tax free if the member dies before age 75.
Any balance paid as pension will be subject to income tax.State Pension.
If the member is not married then their partner will not be able to rely on the member’s NI record to claim extra State Pension (subject to satisfying the relevnt conditions).
State Benefits
Examples of State benefits that may be payable are:
Inheritance Tax
By planning ahead the member can maximise any inheritance tax reliefs and exemptions that may be available.
The member should make a will to ensure that their assets go to those they want to receive their benefits. If they don’t leave a will the member dies "intestate” and any assets will be shared out amongst their next of kin in a strict priority order – a partner the member is not legally married to may get nothing.
Inheritance tax is paid on death if the value of the member’s estate is above the Inheritance Tax Threshold.
The excess amount above the Inheritance Tax Threshold is taxed at 40%. It must be paid from the estate within 6 months of death and before a grant of probate is issued.
Probate
This is the means by which the will is provided so that a person’s executors can deal with their estate and distribute their property in accordance with it.
If a member leaves a will, the executor applies for a grant of probate.
If the member does not leave a will, then the next of kin normally applies for a grant of representation.
If the member is not legally married or in a civil partnership, their surviving partner cannot apply and are not automatically entitled to benefit from the estate.
If the member is separated but not yet divorced then the spouse will inherit some of the estate and can apply for the grant.
