RPSM09103580 - Technical pages: member benefits: drawdown pension: capped drawdown pension: using drawdown funds to provide other forms of pension

This guidance has been written from the members’ perspective.

What happens if I use funds from my drawdown pension fund to buy a lifetime annuity?
What happens if I use funds from my drawdown pension fund to pay a scheme pension?
How much capped drawdown pension can I have if I buy a short-term annuity using funds from my drawdown pension fund?

What happens if I use funds from my drawdown pension fund to buy a lifetime annuity?

[Paragraph 10 Schedule 28]

If you are under 75 and use part, or all, of your drawdown pension fund to buy a lifetime annuity,

  • there will be a recalculation of your maximum drawdown pension, and
  • there will be a lifetime allowance test on the purchase of the lifetime annuity.

RPSM11104540 explains how the lifetime allowance test will work for the purchase of a lifetime annuity from a drawdown pension fund.

The new maximum drawdown pension will take effect from the start of your next pension year. Your maximum drawdown pension for the current pension year remains unchanged. Your scheme administrator must calculate your new maximum drawdown pension as at the date of lifetime annuity purchase. They cannot choose to use another date.

Example

Asif is being paid a drawdown pension. His current reference period started on 1 May 2012 and is due to end on 30 April 2015. The basis amount for the reference period is £8,500. The maximum drawdown pension Asif can take each pension year is £8,500 (100 per cent of the basis amount) for the first year and £10,200 (120 per cent of the basis amount) for the next two years.

On 1 February 2013 Asif uses £50,000 of his drawdown pension fund to buy a lifetime annuity. After the lifetime annuity purchase Asif has £75,000 left in his drawdown pension fund. Asif is 66. The purchase of the lifetime annuity triggers a recalculation of Asif’s maximum drawdown pension.

The calculation must be carried out as at 1 February 2013, the date the lifetime annuity was bought. The scheme administrator cannot choose to use another day. Asif’s scheme administrator used the GAD tables to work out the new maximum drawdown pension using the following information

  • the fund value after the annuity purchase (£75,000),
  • Asif’s age on 1 February 2013 (66), and
  • the 15 year UK gilt yield percentage for 15 January 2013 (4.5 per cent).

The revised basis amount is £5,325. This applies from the start of the next pension year. That is 1 May 2013. So until 30 April 2013 Asif can still be paid a drawdown pension based on the old maximum amount of £8,500. For the year beginning 1 May 2013, as it begins after 25 March 2013, for that and the following pension year, Asif’s maximum drawdown pension is 120 per cent of the £5,325 basis amount i.e. £6,390.

The reference period remains the same; it will end on 30 April 2015. At the start of the new reference period Asif’s scheme administrator will calculate a new maximum drawdown pension for Asif.

Asif is 66 on 1 February 2013 when he buys the lifetime annuity. As he is under 75 the purchase of the lifetime annuity triggers a test against the lifetime allowance. As the lifetime annuity is purchased using funds already tested against the lifetime allowance Asif is given a credit for the amount previously tested against the lifetime allowance. Asif used 40 per cent of his drawdown pension fund to buy the lifetime annuity, so he is given a credit of 40 per cent of the amount originally designated into his drawdown pension fund. Asif originally designated £140,000 into his drawdown pension fund. The calculation for the lifetime allowance test is

Annuity purchase price - 40 per cent amount designated to provide drawdown pension

£50,000 - £56,000 (40 per cent@ £140,000)

The amount used to buy the lifetime annuity is less than 40 per cent of the amount designated to provide drawdown pension. So the amount tested against the lifetime allowance is £nil.

Example 2

The scenario is exactly the same as in Example 1 except that Asif originally designated £100,000 into his drawdown pension fund. So this time the calculation for the lifetime allowance test is as follows:

Annuity purchase price - 40 per cent amount designated to provide drawdown pension

£50,000 - £40,000 (40 per cent@ £100,000)

The amount used to buy the lifetime annuity is £10,000 more than 40 per cent of the amount designated to provide drawdown pension. So the amount tested against the lifetime allowance is £10,000.

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What happens if I use funds from my drawdown pension fund to pay a scheme pension?

[Paragraph 9 Schedule 28]

If you use part, or all, of your drawdown pension fund to buy a scheme pension, and you are under 75

  • there will be a recalculation of your maximum drawdown pension, and
  • there will be a lifetime allowance test on the provision of a scheme pension.

RPSM11104270 explains how the lifetime allowance test works where a scheme pension is provided from a drawdown pension fund.

The new maximum drawdown pension will take effect from the start of your next pension year. Your maximum drawdown pension for the current pension year remains unchanged. Your scheme administrator must calculate your new maximum drawdown pension as at the date the scheme pension is provided if you are under 75. They cannot choose to use another date.

Example

On 5 January 2012 Tony puts all his funds in his money purchase arrangement into payment. He designates £562,500 to provide a drawdown pension. The scheme rules allow Tony to opt for a scheme pension at a later date.

Tony’s reference period runs from 5 January 2012 to 4 January 2015. His scheme administrator calculates the basis amount as being £30,937.50. This is also Tony’s maximum drawdown pension for the pension years beginning 5 January 2012 and 5 January 2013. For the year beginning 5 January 2014, as it begins after 25 March 2013, for that year, Tony’s maximum drawdown pension is £37,125 (120 per cent of £30,975.50).

On 7 July 2013 Tony decides to take up the scheme pension option and use half his fund to provide a scheme pension. Tony has drawn no pension from his drawdown pension fund and so, because of investment growth, his drawdown pension fund is now worth £650,000. The scheme will provide Tony with a £17,500 a year scheme pension in exchange for £325,000.

The provision of the scheme pension triggers a recalculation of Tony’s maximum drawdown pension. The calculation must be carried out as at 7 July 2013, the date the scheme pension was provided. The scheme administrator cannot chose to use another day. Tony’s scheme administrator uses the GAD tables to work out the new maximum drawdown pension using the following information

  • the fund value after the scheme pension has been provided (£325,000),
  • Tony’s age on 7 July 2013 (57), and
  • the 15 year UK gilt yield percentage for 15 June 2013 (3.75 per cent).

The revised basis amount is £17,875. The new maximum drawdown pension is 120 per cent of the £17,875 basis amount i.e. £21,450 and will apply from the start of the next pension year. That is 5 January 2014. So until 4 January 2014 Tony can still be paid a drawdown pension based on the old maximum amount of £30,973.50.

The reference period remains the same; it will end on 4 January 2015. At the start of the new reference period Tony’s scheme administrator will calculate a new maximum drawdown pension.

As Tony is less than 75 the provision of a scheme pension triggers a lifetime allowance test. As the scheme pension is provided from funds already tested against the lifetime allowance, credit is given for the amount previously tested against the lifetime allowance. Tony has used 50 per cent of his drawdown pension fund to provide a scheme pension so he is given credit for 50 per cent of the amount originally designated to provide drawdown pension. So the amount tested against the lifetime allowance is:

20 x the scheme pension - 50 per cent of the amount designated to provide drawdown pension

(20 X £17,500) - £281,250 (50 per cent @ £562,500)1 = £68,750

£68,750 will be tested against Tony’s lifetime allowance.

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How much capped drawdown pension can I have if I buy a short-term annuity using funds from my drawdown pension fund?

[Paragraph 9 Schedule 28] 

You can use part of your drawdown pension fund to buy a short-term annuity contract.

The amount of capped drawdown pension you can get will be reduced by the annuity payments made from a short-term annuity contract that has been bought using funds from the same drawdown pension fund. The annuity payments will be deducted from the maximum drawdown pension you can take.

Example

Heather has designated funds into drawdown pension. Her scheme administrator has calculated her maximum drawdown pension as £5,000.

Heather has used part of her drawdown pension fund to buy a short-term annuity. This gives Heather an annuity of £3,000 per year.

Heather wants to draw some income from her drawdown pension fund. Her maximum drawdown pension is £5,000 and Heather is getting £3,000 of that maximum amount paid as a short-term annuity. This leaves £2,000 that Heather can take as income withdrawal each pension year


  Glossary (RPSM20000000)