A member, dependant, nominee or successor may use funds held in their drawdown pension to purchase a short-term annuity.

The income paid from a short-term annuity is taxed as the recipient’s income via PAYE.

It is possible to transfer to another provider only if the annuity was set up pre 6^th April 2015

In order for HMRC to consider an annuity a short-term annuity the following conditions must be met:

• it must be purchased using funds held in a drawdown pension;
• be payable by an insurance company; and
• for a term not exceeding five years.

The only ‘death benefit’ that can be included with a short-term annuity is a guarantee period of no longer than five years. If no guarantee period is set and the member dies within the term, the payments cease and the money used to purchase the annuity are lost.

A dependant’s, nominee’s or successor’s short-term annuity cannot include any guarantee period

If the short-term annuity is purchased from funds held in flexi-access drawdown there is no upper limit on the amount of income that can be paid.

If the short-term annuity is purchased from funds in capped drawdown there is an upper limit of 150% of the basis amount less any income being taken directly from the capped drawdown arrangement

EG – When Sophie, aged 55, designated £500,000 into capped drawdown pension on 1 June 2014 her scheme administrator calculated her basis amount as £20,000. Thus the maximum drawdown pension she can receive each year is £30,000.

At the start of her first pension year Sophie used funds from her capped drawdown pension and purchased a level short-term annuity of £10,000, payable for five years. Therefore, for the three year reference period she can take an additional:

• £30,000 – £10,000 = £20,000 each year from her capped drawdown

At her review in 2017, Sophie is informed that her basis amount has reduced to £16,000. As a result, from 1 June 2017 the maximum income she can take each pension year from her capped drawdown pension will be £24,000. This means that the maximum income she can draw from her capped drawdown pension for the next two years (i.e. the remaining term of the short-term annuity) is:

• £24,000 – £10,000 = £14,000

Once the short-term annuity ends, Sophie will be able to draw up to £24,000 per scheme year directly from her capped drawdown pension. This will apply until her basis amount is reset at the start of her next reference period on 1 June 2020.

What would have happened at the start of her new reference period in 2017 if Sophie had secured the maximum income of £30,000 via a short-term annuity in year one?

Well, she would have had a maximum income of £24,000 but would have been receiving

£30,000 (i.e. £4,000 above the maximum). As a result Sophie’s scheme administrator would have changed Sophie’s capped drawdown pension to a flexi-access drawdown pension and she would immediately become subject to the MPAA rules.