Home > News > 2001 > May 2001 > Setting up your own income drawdown arrangement
Setting up your own income drawdown arrangement
Adam Walker from Barnett Waddingham's London office considers one way that money purchase schemes affected by the new maximum transfer value regulations can continue to offer useful choices to members.
When the PSO gave notice in the summer of 1999 of new flexible arrangements which allowed UK occupational schemes to offer an "income drawdown" facility to members, the move was generally welcomed. In practice, however, it seems that the take-up rate for the new option was not particularly high, due to the additional costs and complications of running such a facility. In particular, the ability of members to switch to a personal pension, run by a personal pension provider with sufficient drawdown applicants to reach critical mass and justify the setup fees, gave occupational scheme trustees comfort that their members could still draw on a full range of options.
However, the Revenue's new rules on maximum transfers to personal pensions have again limited the options available to members. This has created a further disadvantage of occupational money purchase provision, especially for small employers, and seems certain to drive more and more scheme sponsors into the arms of GPP providers. While occupational schemes suffer, the relative attractiveness of the UK Government's flagship "stakeholder" concept is being advantaged.
Some money purchase schemes are revisiting the possibility of operating a drawdown facility in response to the new restrictions. This article sets out some of the issues that need to be addressed by trustees who are considering this option.
What is income drawdown?
The drawdown facility allows members to defer purchase of an annuity, at least until age 75. Instead of buying an annuity, retirees make regular withdrawals of cash from an individual fund, rather like a deposit account at the bank. The deposit account analogy also applies in that the member's individual fund accumulates interest in line with the actual investment performance of the fund. Until an annuity is purchased, therefore, the member retains the investment risk which would have been passed to the annuity provider on purchasing a non-profit annuity.
Withdrawals from the member's individual fund are taxed as earned income, in the same way as pension payments under an annuity contract. After the member's death, spouses and other eligible dependants may also make use of the drawdown facility.
There are specific minimum and maximum limits on the amount that an individual may draw down each year. These limits need to be calculated and certified by an actuary at least once every three years.
What issues are there for trustees?
The basic idea behind drawdown is fairly simple, but some complications may arise, such as:
- Member communications and setup. Ideally the trustees should formalise the offering of a drawdown facility by means of an amending deed shortly after announcing the new facility. Then they need to make members aware of the new option. The Inland Revenue emphasises that the objective of drawdown is not simply to provide extra flexibility in determining how much pension a member gets each year, but rather to allow members to time their annuity purchase to their advantage. This implies that members should monitor the annuity market constantly with an eye to buying their annuity at a propitious time. The complication here is that while the Revenue specifically refers to the trustees' duty to appraise members of this fact (which presumably means referring to the point of drawdown, and practical ways for members to keep an eye on the annuity market during the drawdown period in initial communications), the final decision obviously remains with the member, and the trustees qua trustees are not authorised to advise the member on when or when not to go.
- Segregation of individual member funds. Because each member using drawdown usually has an individual account, it is necessary to identify his or her assets separately. For schemes with a unitised investment portfolio where each member has an allocated number of units, this is relatively uncomplicated. However, for "traditional" money purchase schemes, where "units" of the fund are not earmarked for individual members, it might be most practical to ring-fence part of the fund for each individuals, or even remove it from the fund altogether. There are alternatives to this, but this may involve reassessment of individual members' shares of the overall fund, which may be complicated.
- Investment restrictions. If individual members' funds are segregated, there may be practical restrictions on how the money may be invested - both in terms of the options actually available (some investment products may be unsuitable for monthly withdrawals) and the overall fees (as any fixed cost charges are spread more thickly than across the whole scheme, or penalties applied due to the regular withdrawals).
- Payroll function. Many money purchase schemes buy compulsory purchase annuities when members retire rather than paying the pensions themselves. This can mean that the scheme has no payroll system to pay over the member's drawn-down funds and deal with the tax. Getting the employer onside may be an option. Barnett Waddingham operates payroll facilities for a number of our SSAS and SIPP clients, and we would be very happy to provide services in this area if required.
- A continuing obligation to provide drawdown facilities. If the trustees choose to make a drawdown facility available, and a member begins to make use of drawdown, it appears that the member effectively becomes the arbiter of his or her own destiny, in that he or she alone may decide when to retire. The trustees no longer have a say in the matter. This may have repercussions if, for example, the trustees wish to wind up the scheme, as the chosen method for securing liabilities in respect of drawdown members will have to accommodate drawdown on an ongoing basis.
- Additional fees. The extra complication of drawdown necessarily entails fees, although drawdown is designed to create the potential for higher long-term benefits than an annuity. The trustees need to decide on the extent, if any, to which the scheme (and hence ultimately the sponsoring employer) subsidises the costs of administering a drawdown facility. The costs will often be passed on in full to the member, who will still benefit so long as these costs are less than the annuity providers' loadings for administrations and profit.
- Annual limits on drawdown. Limits have been imposed by the Inland Revenue, mainly to ensure that the drawdown benefit continues to resemble a pension, rather than letting members have access to a large amount of cash in one go, hence stopping drawdown from being used as a subtle tax-efficient savings policy yielding a lump sum. Policing these limits entails further costs. An actuary is required to certify the maximum a member can draw down in a given year, which is broadly the equivalent annual payment from an annuity, but calculated on a basis set by the Government Actuary's Department rather than by seeing what the annuity market is offering. Annual drawdown can be between 35% and 100% of this maximum, which must be re-calculated and certified at least every three years.
Taking things further
Members stand to benefit from an increased choice if trustees offer a drawdown facility, but the circumstances of the scheme may make things more or less difficult depending on how the issues above affect the scheme. In particular, the size of the scheme is likely to determine whether running a drawdown facility will be cost-effective for the scheme and the members.
Barnett Waddingham would be happy to carry out a feasibility study and provide a quotation for any services required to run drawdown. For further information, please contact Adam Walker at Barnett Waddingham.
Adam Walker, May 2001.