An advantageous scheme

By Leonora Walters, 31 May 2011

Low annuity rates are leading increasing numbers of retirees to consider drawing an income directly from their pension pots via income drawdown. But, unless you can secure pension income of £20,000 a year from other sources, you will have to use 'capped drawdown', which limits the amount you can draw each year to ensure you do not run out of capital.

These limits are calculated by the Government Actuaries Department (GAD), and in June this year, the GAD rate used to calculate the level of income that people can draw down will fall from 4 per cent to 3.75 per cent. This will reduce the level of income that can be drawn from a pension pot. If you want to draw a higher level of income, a credible alternative to capped drawdown could be a scheme pension.

With a scheme pension, you get regular payments until your death or the end of a guarantee period. But the level of payments is not based on GAD rates, which are a one-size-fits-all calculation derived from government bond yields, but by the pension provider's actuary, who individually assesses you.

"Scheme pension could provide at least 10 to 15 per cent more income than capped drawdown," says Mel Kenny, chartered financial planner at independent financial planner Radcliffe & Newlands. "This is because income from a scheme pension is set by actuaries who look at age, health and investment profile, rather than GAD rates."

The level of scheme pension is also reviewed every three years so, for example, if you become ill or your life expectancy falls, you could draw down greater amounts following your review. Capped drawdown rates are also recalculated every three years, but with reference to GAD rates rather than your own circumstances.

Suitable investors

A scheme pension is a good option if you want to take out as much of your pension as you can every year, but do not qualify for flexible drawdown, for which you must have a minimum income of £20,000 a year in addition to what you take from flexible drawdown.

It could be useful if you are in poor health, and it could also be a more tax-efficient option for those wanting to make gifts to beneficiaries. If you die while in drawdown, although the remainder of your pension pot does not go back to an insurance company as it does with an annuity, your beneficiaries will face a 55 per cent death charge. That's less than the 82 per cent it used to be, but it's still more than the standard 40 per cent inheritance tax charge and you don't get the benefit of a £325,000 allowance.

With a scheme pension, there are a number of outcomes for the fund after you die. They vary between the four main providers: Rowanmoor, Axa, James Hay and Hornbuckle Mitchell.

If the scheme pension is in a guarantee period, it can continue to pay out to your beneficiary until the guarantee period ends, if there are sufficient funds. At the end of this period, there are a number of options for taking the rest of the fund, including:

■ Taking a cash lump sum based on the original fund, less any pension payments already paid and 55 per cent tax.

■ Using the remainder of the scheme pension to buy an annuity.

■ Continuing with the scheme pension.

■ Moving to capped or flexible income drawdown.

Until 5 April 2012, if you have a spouse or civil partner when the scheme pension commences, you must make provision for 50 per cent of the pension from the protected rights funds to be paid to them.

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