Section 32s
It is very common to find GMP as part of a Section 32 contract. Section 32s, or buyout bonds as they are also known were introduced in the mid 80s. At that time they could only accept transfers in, and typically this was from a final salary scheme.
Many insurance companies offered them and the idea was simple. Rather than just having a final salary scheme that gave guaranteed increases on the income, you transfer the money and would have investment growth that was far greater. That was the theory at least.
At that time, investment returns were much higher, as was inflation, and annuity rates much better too (so the cost of securing the income was much lower). So, for many people it seemed a reasonable bet.
However, as time progressed investment returns dropped, and annuity rates got worse. But the guaranteed income stayed the same as was promised. Potentially for GMP this could be increasing by as much as 8.5% per year. And many Section 32 contract were invested in poor with-profit funds too.
This has created problems for many Section 32 holders.
Section 32 Problems
No Tax-Free Cash
One of the most common problems with this type of contract is that sometimes there is no tax-free cash.
Don’t forget that a Section 32 with GMP has to guarantee a certain level at age 65 for a man, and 60 for a woman. The invested pot has to buy the income first, before any tax-free cash can be paid.
For example, if you are a 65 year old man, with a GMP income requirement of say £2,000 per year, you cannot take any tax-free cash until you have first secured that income.
If this is Pre 88 GMP, which does not increase, then you would need a pot of around £40,000 to £50,000 to buy an annuity (guaranteed income) to pay £2,000 per year level income at age 65. If you were 55, you would need even more.
If this was Post 88 GMP, which is income that has some inflation protection (it increases – see GMP Rules for more details) once it starts to be paid, then you would need a pension pot in excess of £70,000. So, it can be disappointing to realise you have a fund of say £70,000, but it will only give you £2,000 per year income and no tax-free cash at all.
Sometimes it is possible to transfer a Section 32. In the above example, this would, if it were allowed, give you a pot of £70,000. This could provide:
GMP Basis
£70,000 Total Pot
£0 Tax-free cash
£0 Remaining fund
£2,000 Yearly increasing income
The income would increase by inflation with a yearly maximum increase of 3%. Inflation increases over 3% would be met by the Government.
Transfer to a Personal Pension
£70,000 Total Pot
£17,500 Tax-free cash
£51,250 Remaining fund
£2,250 Yearly level income
In this example, it would be possible to to use the £51,250 to buy any type of annuity. The one above assumes the income would not increase.
The above rates are based on approximate annuity rates (at July 2021). As you can see in the above example, taking the transfer can provide more tax-free cash, and a larger, but not increasing income. Giving up increases means that you would have £17,500 of tax-free cash and a slightly higher, but not increasing income. But, even if the £2,000 per year pension increased by 3%, then it would only go up to £2,060 after the first year. This is still below the level of a non-increasing income, and this income could be taxed too. And you would have had £17,500 of tax-free cash.
Pension flexibility
If it is possible to take a transfer, then it would also be possible to enter a flexible pension. This would mean that you would have options of taking the entire pension out. This could be done in one go (with a large tax charge), or could be done bit by bit to perhaps lessen the tax.
It would be possible to use what is called flexi-access drawdown. This means having the money invested, and taking money out of the pot to use as income. This can be done to replace an annuity with the hope that the fund grows sufficiently to give you a lifetime income.
Click here to find out more about Section 32 transfers.
No Early Retirement
One other common problem is that it is sometimes possible to have a Section 32 and be unable to retire early.
If we continue with the above example of a £70,000 pot and a £2,000 per year post 88 GMP income. Suppose you’re only 55 and want to retire early. The cost of securing the income would be greater than £70,000. This is because as a younger person the cost of securing the income would be more, as it would probably be paid out longer.
If the cost was £80,000 then you would not be able to retire, as you could not be able to guarantee £2,000 per year from age 65. You would ordinarily have to wait until the pot grew big enough to pay for the income, or until age 65 when the company would have to guarantee this level of income. So, you would not be able to take any tax-free cash or any income. The only ways to take immediate benefits would be to transfer the Section 32 to a personal pension, or see if you could find a provider who could provide the income for less than £70,000. Neither of these options is always possible. See Section 32 transfers or GMP and annuities for more details.
Section 32 Guarantees
Regardless of these problems you have to remember that the contract still has valuable guarantees.
Regardless of the value of the fund, and the cost of securing the income, the provider is still responsible to ensure that at your normal retirement the GMP income is paid.
So, even if the pot was worth £50,000, the insurance company would, at age 65 have to guarantee to provide the income. This is one of the key advantages of GMP. See GMP Advantages for more details.
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.