Standard annuity
An annuity is an insurance contract purchased by the member or the pension scheme to guarantee the member an income for life.
There are also other options that can be added to give the annuity useful attributes, such as increases in payment, a guarantee that the annuity will be paid for a certain time even if the member dies, or an income for a nominated individual after the member’s death. All these options will come at a cost, so the value of each needs to be determined in respect of each individual.
Annuities were all treated the same until the introduction of the pension freedoms in 2015. A standard annuity will be a level or increasing annuity, although the rises could be determined by indices such as the consumer price index or the retail price index.
Flexible annuity
The main difference between a standard annuity and a flexible annuity is that the flexible version will have the scope to decrease. This is most likely to be because it is linked to investments. The fact that it can decrease will mean the purchase of a flexible annuity will trigger the money purchase annual allowance.
Flexi-access drawdown
Flexi-access drawdown gives the greatest flexibility of all the pension retirement options, although with that comes risk. FAD allows a member to choose any level of income they want from their pension fund. How long the fund lasts will depend on the amount of income taken, the investment growth on the amounts that remain, as well as charges.
The product will usually pay out 25 per cent of each amount crystallised, tax-free (the PCLS). This could either be the whole fund or just some of it. But if the client wants the PCLS from the amount they are crystallising, then that decision needs to be made at the outset. The rest of the crystallised funds can be paid out at any time subject to income tax, in the same way a salary would have been under PAYE rules.
On death the funds can be paid out to any nominated individuals, either by a lump sum or income under beneficiaries FAD. Alternatively it could be paid out to a trust if that is more appropriate.
The taxation of these benefits is dependent on the individual’s age at the point of their death. The funds will be free from income tax prior to the age of 75, and at 75-plus the funds will be taxed as income on the beneficiary or subject to a 45 per cent tax charge if paid to a trust – with a tax credit when benefits are then paid out.
