Alternatively secured pensions, an alternative to annuities?

Alternatively secured pensions enjoyed a brief period of popularity as a different option to annuities, before the government limited the way they can be used by imposing high tax charges, says Nick Golding

UK employees slogging away to build up their pension pots through an occupational scheme raised a small smile in April last year when alternatively secured pensions (ASPs) were introduced under pensions simplification laws allowing them for the first time to leave retirement savings, normally lost on death, to the next generation. However, the government has now clamped down on the way they can be used by imposing high tax charge on payments.

ASPs were introduced following pressure from religious groups such as the Plymouth Brethren to remove the obligation to buy an annuity on the grounds that they are prevented from doing so due to their beliefs. They consider that annuities allow people to benefit from, and gamble on, the death of others, as mortality risks are pooled so that people dying prematurely keep annuity rates high.

When ASPs were first introduced, they provided investors an alternative to purchasing an annuity at age 75 years. Unlike annuities, ASPs enable employees to maintain investment control of their pension assets until their death, while drawing a monthly income directly from their pension.

Prior to pensions simplification, it was impossible to pass on a lump sum from a pension fund to employees’ dependants and not a route open with annuities. When ASPs were first introduced they enabled members to make a lump sum payment on their death to any other member of their scheme, which could be set up to include family. Such a move incurred a 40% inheritance tax charge if the deceased’s remaining fund contributed to an estate of £300,000 or above.

Paul Macro, head of defined contribution (DC) at Aon Consulting, explains that this feature was of interest to the wealthy. “Advisers had plenty of wealthy non-religious clients who [wanted] to go for this simply because it could be used as a way of passing on money to your family on death.”

However, ASPs were never intended to be used in this way and, in the pre-Budget report in December 2006, the government stamped on this.

“Pensions are not about passing on money to the next generation, they are about saving for retirement,” adds Macro.

From April 2007, individuals who wish to use an ASP instead of buying an annuity will now be subject to certain limitations, some of which will make the deal far less attractive than before.

However, individuals who took on an ASP after they were introduced in April last year and who died before April 2007 will qualify for the product’s original terms. All others who have taken on an ASP or are planning to purchase one at age 75 years, will be subject to the new set of rules.

This is blow for many individuals, some of whom were planning to live on the smallest amount possible through their ASP, in order to be able to pass on a larger sum to their dependants upon their death.

A minimum as well as a maximum amount that people must draw each year from an ASP has now been written into the legislation. John Lawson, head of pensions policy at Standard Life, says: “Now the government is forcing individuals to take a minimum income of an equivalent annuity income.”

From April this year, at least 55% of the value of an equivalent annuity that could be bought with an individual’s funds and assets must be drawn annually from an ASP. The most that can be drawn, meanwhile, now stands at 90% of the value of an equivalent annuity.

Furthermore, the remaining funds in an ASP can no longer be passed on as a lump sum as an authorised payment for tax purposes upon a member’s death. While such payments can still be made, they are now treated as unauthorised payments for tax purposes, and incur high charges as a result.

Andy Wale, consulting director at Premier Pensions Services, says: “Lump-sum death payments will not be illegal. They will still be accepted, but a possible four extra tax charges come into play.”

These include a 40% charge for making an unauthorised payment, a 15% charge for an unauthorised surcharge, and then a further 15% scheme sanction charge. The remaining 30% of the pension fund also remains liable for an inheritance tax charge.”Effectively, what you have is a tax that is above 80%, so it becomes unattractive. Why on earth would you do anything like this when it would throw so much money at the tax man?” asks Macro.

If you read nothing else read this…

  • Alternatively secured pension (ASP) arrangements were introduced to satisfy religious groups that objected to buying annuities on moral grounds.
  • From April this year, individuals who want to transfer lump-sum death benefits from ASPs to their dependants could incur tax charges of above 80% on the amount.
  • The government has also introduced a minimum and maximum amount that can be withdrawn through an ASP as income each year.