GMP and lump sums
Many people only realise they have GMP when they want to take benefits. Often they’re disappointed to hear that they either can’t retire early, or that there is little or no tax-free cash. This can be disappointing if you have other pensions and have taken them flexibly or invested them in something like flexi-access drawdown.
Sometimes it is possible to give up the GMP and transfer current scheme to the another pension, and then take benefits in a different way.
No tax-free cash
It is very common for existing schemes with GMP to tell their customers or members that there is no tax-free cash available. This is because the GMP has to be paid before any other benefits can be paid. Some examples might help explain how this happens.
Section 32s and no tax-free cash
If you have a section 32 with GMP then a tax-free lump sum might not be available, or it might be limited.
Remember, if you have GMP it is a guaranteed income that has to be paid at age 65 for a man and 60 for a woman.
You would normally be allowed to get 25% of the pot as a tax-free lump sum. However, the GMP would have to be secured (paid for) first. For example:
Mr Smith, 65, has a Section 32, and it must pay out an income of £1,000 of GMP. This is pre 88 GMP, so it does not increase, but it must pay £500 per year for a wife if he dies. He has a GMP pot of £25,000. In other words this is a level annuity (not increasing) on a joint life 50% basis.
Before he can take a lump sum, he has to ensure his pension will be at least £1,000, and will pay £500 per year to his wife if he dies.
So, what he needs to do is buy an annuity (guaranteed lifetime income) with the fund to provide this income. Suppose the cost of buying the £1,000 per year income is £25,000 (please note this is not an accurate annuity rate). This would mean that there would not be anything left to take as tax-free cash. In this instance he can only take an income.
Suppose however, his pot is £28,000. He could use £25,000 to buy an annuity, securing his £1,000 per year income. He would then have £3,000 left. This £3,000 can be paid as a tax-free lump sum.
It would be advisable in these circumstances to shop around for the best annuity. Suppose he can find a more competitive annuity provider, and it only costs £23,000 to secure the income, then he could take £5,000 as a tax-free lump sum if his pot were £28,000. See annuity purchase and GMP for more details.
Often with a Section 32 even the pot itself is not big enough to buy the income, in which case the Section 32 company would have to pay the income. If for example his pot was only £10,000. The Section 32 company would be responsible for paying an income of £1,000 at age 65 even though his fund could not buy such an income on the open market.
Early Retirement
If you have a Section 32 with GMP then it is less likely that you can take a lump sum if you retire early.
There are two reasons for this. The GMP income it must pay is based on the income at age 65, and that does not change even if you take the pension at say 55.
The cost of buying income is greater the younger you are, as the income would have to be paid for longer.
Additionally, the pension pot has not had as long to grow so it is likely to be smaller.
In this instance you can wait, and hope the fund grows, and/or the cost of buying the income becomes cheaper. The other option is to look to take a transfer.
Continuing the example above. Suppose Mr Smith had a pot of £25,000, and transferred this to a personal pension. This would break the requirement to secure the £1,000 per year income. This would let him take £6,250 as a tax-free lump sum, and then buy an annuity with the remaining pot. It would also be possible to take the entire £25,000 out too under flexible rules.
However, sometimes this is not possible, as there are rules that can prevent this.
Find out more about Section 32 transfers or contact us for a free initial discussion.
Final Salary Scheme - no lump sum
Mr Jones is a member of a final salary scheme, and is 55. He wants to take benefits now. He has a pension that will at age 65 give him £2,000 of GMP and £2,000 of non-GMP income (which we call “excess” in the industry). So an income of £4,000 in total. Remember – normally tax-free cash from such a scheme is taken by giving up some of the non-GMP income.
However, his scheme reduce pensions if you take them early. If the scheme reduce the pension by 5% per year, his £4,000 per year promised income would drop to just £2,000, because it has a 50% reduction (in other words it pays half of the promised income for taking it 10 years early). But, the scheme has to pay GMP of £2,000 per year. So, they can pay him the income of £2,000, but there is no other pension income left to swap for a lump sum.
So, in this example Mr Jones can retire early, but he cannot take a lump sum. (If the income was below £2,000 then he might not be able to retire early at all).
The only way he can get a lump sum from this scheme is to either wait, or give up all the guarantees and transfer out and lose the valuable guarantees. If he waits say five years, then his £4,000 income would be reduced by just 25%. So, he would have an income of £3,000 per year. £2,000 is GMP still and £1,000 is what we call “excess” – the amount over and above the GMP income. So, he can swap up to £1,000 (the excess) of the income for a lump sum. The amount of lump sum would depend on other scheme rules and its commutation factor.
His other option, but with the loss of a guaranteed income, would be to transfer the final salary scheme. It might be possible to just transfer part of this pension too. Upon transfer the promised income is converted into a cash pot, and the GMP requirements no longer apply. He can do what he wants with the fund value, either buy an annuity or leave it invested, or take it as cash. BUT this would mean giving up a guaranteed income. This is usually not suitable for most people but could be if you if for example you have serious health issues. To find out more see GMP and Final Salary Transfers.
If you have a pension with GMP and want advice, or have a question, or just want to have a chat about it with a UK Qualified Independent Financial Adviser, then phone now on 01793 686393 or contact us online.