Jenny Lowe investigates a more flexible alternative to annuity purchase for retirement income.

Purchasing an annuity is the most common course of action for a retiree in order to secure an income, the main alternative being the appropriately named alternatively secured pension (ASP). But there is another option, the scheme pension.

While purchasing an annuity may be the standard course of action in order to secure an income during retirement, it is not always the best option. According to Rowanmoor Pensions, of those clients that decide not to buy an annuity, 69 per cent have opted for a scheme pension, compared with just 31 per cent who have gone for an ASP.

So what is the difference? Well, pension scheme trustees don’t have to purchase an annuity to provide retirement income. They can make a commitment to provide an income for the life of the pensioner out of scheme resources.

The option of a scheme pension offers the potential for taking higher levels of income, with rates calculated by an actuary. This will be particularly attractive now, as ASP and unsecured pension income rates, based on the Government Actuary’s Department (GAD) rate calculations, have hit an all-time low due to falling gilt yields.

Actuarial calculations
It is up to the scheme’s actuary to determine how much income can be paid out from a member’s share of the fund, based on assumptions such as the life expectancy of the individual, paying due regard to their state of health, potential investment growth and cost deductions.

The principle is that if the actuary’s calculations are right, the member’s fund will reach zero on the day they die. In other words, the member has had all of their fund paid to them. If, however, there are funds remaining on death and no dependants, those funds cannot be passed to, for example, charity.

This therefore makes it attractive when compared with an ASP, which works on the basis of never allowing the member to receive all of their fund. That is because the maximum income is restricted to 90 per cent of that of an annuity and it is reviewed every year but always based on the annuity rate for a 75-year-old (the age at which annuity purchase is compulsory under current rules). So, there will always be money left in the fund when the member dies.

Outliving your resources
So what happens if the member taking a scheme pension lives longer than was expected? According to Robert Graves, product development manager at Rowanmoor Pensions, there is an obligation to pay the scheme pension for life and, generally speaking, it would not be expected for the income to decrease.

However, the scheme’s actuary should review the assumptions from time to time and, if it is determined that the continued payment of the scheme pension at its current level would be detrimental to the scheme, there is the option to reduce the scheme pension to a supportable level.

Maximum flexibility
Graves argues, ‘After setting aside money from income in a pension scheme, on retirement investors want to be able to take their income how and when they want and as tax efficiently as possible.

‘When a client reaches the age of 75, can an adviser look that person in the eye and assure them that either a lifetime annuity or alternatively secured pension offers them the best chance of getting the majority of their pension savings returned to them,
or their beneficiaries, when compared with the scheme pension option?’

So perhaps it is time to take a stand against ‘compulsory annuities’ and investigate the alternatives.