Retirement annuity contracts (section 226): check for a guaranteed annuity rate

A retirement annuity contract (RAC), often called a section 226 pension, is an older type of personal pension for the self-employed and for employees who weren't in an employer's pension scheme. No new RACs could be taken out from 1 July 1988. Many still carry valuable features, especially a guaranteed annuity rate, so check yours carefully before you move it.

What is a retirement annuity contract?

Before personal pensions arrived in 1988, people who had no employer's pension scheme could save for retirement through a retirement annuity contract. They were taken out with insurance companies, and contributions qualified for tax relief.

The name "section 226" comes from the law that set them up: section 226 of the Income and Corporation Taxes Act 1970. The rules were later carried into Chapter III of Part XIV of the Income and Corporation Taxes Act 1988, so you may also see them described as section 620 contracts.

Under those rules, RACs were for people with "relevant earnings", which meant earnings from self-employment or from a job that wasn't pensionable. The 1988 Act says the chapter does not apply to any contract made on or after 1 July 1988. That is the date personal pensions replaced RACs for new savers. Anyone who already had an RAC could keep it, and many people still have one today, sometimes still paying in.

Since 6 April 2006, RACs have been treated as registered pension schemes under the Finance Act 2004, so the modern pension tax rules generally apply to them. Some features of the original contract, though, live on in the policy terms.

Features that can make an RAC valuable

Every RAC is different, and many are plain savings policies with no special terms. But because they were written decades ago, some include features that are hard or impossible to get today.

Guaranteed annuity rates

The most important is a guaranteed annuity rate (GAR). This is a promise to turn your pot into a lifetime income at a fixed rate set when the policy began. RACs are among the most common homes of GARs. Because the rates were set when interest rates were generally higher and people weren't expected to live as long, many are more generous than the rates generally available for a new annuity today.

A GAR usually comes with conditions. It may only apply at a set age, it is often for your life only with no partner's pension, and the income is often level rather than rising each year. Our guide to guaranteed annuity rates explains these conditions in detail.

Retirement ages

Under the old rules, an RAC annuity normally couldn't start before age 60, but section 620 of the 1988 Act allowed earlier ages in some cases, including ill health and occupations where people customarily retired earlier.

Today, the normal minimum pension age is 55, rising to 57 on 6 April 2028. Some people have a protected pension age that lets them take benefits earlier. HMRC explains that for RACs and personal pensions, the pre-2006 protection only applies to someone who, on 5 April 2006, had a right to take benefits before age 50 (HMRC Pensions Tax Manual, PTM062205). There is also separate protection linked to the rise to 57, which depends on the scheme rules. HMRC notes that a protected pension age can be lost if you transfer, except in limited cases such as a block transfer. Your provider can tell you whether any protected pension age applies to your policy.

Tax-free cash

Under the original rules, an RAC could allow a lump sum of up to three times the annual amount of the remaining annuity (section 620(3) of the 1988 Act). Since 6 April 2006, the modern rules apply. Tax-free cash is generally 25% of the pot, up to the Lump Sum Allowance of £268,275 for most people (gov.uk).

Where an RAC has a GAR, the way the provider works out tax-free cash matters. Taking a lump sum usually reduces the part of the pot that buys income at the guaranteed rate. Ask your provider for figures with and without tax-free cash.

With-profits terms

Many RACs were written as with-profits policies. These can include guaranteed bonuses, a final bonus that isn't guaranteed, and a possible market value reduction if you leave at certain times. Some only pay their full value on a set date, often the same date as the GAR.

How to check for a GAR

Your annual statement may not mention a guarantee at all, so the safest approach is to ask the provider in writing. You could ask:

1. Is this a retirement annuity contract, and does it have a guaranteed annuity rate or any other guarantee?
2. What is the guaranteed rate, and does it apply to the whole fund or only part of it?
3. At what age or on what date can I use it? What happens if I take benefits earlier or later?
4. Does the guaranteed income include a pension for a spouse or partner, and does it increase each year?
5. How is tax-free cash calculated, and how does taking it affect the guaranteed income?
6. What are the current fund value and transfer value? Is there a market value reduction or exit charge?
7. Do I have a protected pension age under this policy?
8. What would be paid if I died before taking benefits?

If you can't find your provider because the company has merged or changed its name, the government's Pension Tracing Service can help you find contact details.

Why you shouldn't transfer an RAC without checking the guarantees

It is often easy to move an RAC. Transfers to modern personal pensions or drawdown can look attractive because they offer more flexibility and investment choice. But if your RAC has a GAR, moving it normally means losing the guarantee for good. The GAR usually only applies if you take the annuity from your existing provider.

A GAR is a safeguarded benefit under section 48 of the Pension Schemes Act 2015, and the FCA states that a pension policy with a GAR has a safeguarded benefit (PERG 12.6). That has two consequences:

• The FCA starting assumption. The FCA's rules (COBS 19.1.6G) say an adviser should start by assuming that a transfer or conversion of safeguarded benefits will not be suitable for most people, and should only recommend it if they can clearly show it is in your best interests.
• Advice is required over £30,000. If the safeguarded benefits are worth more than £30,000, your provider must check that you have taken regulated advice before you can transfer or convert them. Since 6 April 2018 the value for this test has been the transfer value.

Before you can give up a GAR, your provider must also send you a personalised risk warning. It must say that your benefits include a potentially valuable guarantee that will be lost, explain how the guarantee works and include illustrations based on your own policy. Read it carefully before you decide anything.

Other things you might give up include a protected pension age, with-profits bonuses and any special terms in the original contract. Our guide to safeguarded benefits explains the wider rules.

Be wary of anyone who contacts you unexpectedly about moving an old pension, or who promises better returns elsewhere. Check the FCA ScamSmart site before dealing with any firm.

What are your options with an RAC?

Depending on your policy, you may be able to:

• take the guaranteed annuity at the GAR date, with or without tax-free cash
• use the guarantee on part of the fund, if the policy allows it, and take the rest another way
• leave the policy where it is for now and draw on other savings first, taking care not to miss the GAR date
• buy an annuity on the open market, for example an enhanced annuity if your health qualifies
• transfer to another pension, such as drawdown, giving up any guarantees, after regulated advice where it is required

Which option suits you depends on your health, whether a partner relies on you, your other income and how much flexibility you need. A guaranteed single-life, level income is good value for some people and a poor fit for others.

How Arthur Browns can advise on GAR pensions

GARs are the one area where I can advise directly. Through Arthur Browns Wealth Management Ltd, I can advise on pensions with guaranteed annuity rates, including retirement annuity contracts, subject to suitability; advice is chargeable. Charges are explained in writing before you agree to go ahead.

I will look at the guarantee itself, your other income and savings, your health and family situation, and what matters to you, before recommending the option I believe is most suitable.

For free, impartial guidance on your options, contact MoneyHelper. If you're 50 or over, you can book a free Pension Wise appointment about your defined contribution pensions, including RACs.

You may also want to read about section 32 buy-out plans, which can carry similar guarantees, and how the free chat works.

Frequently asked questions

What is a section 226 pension?

It is another name for a retirement annuity contract, an older personal pension for the self-employed and for people in non-pensionable jobs. The name comes from section 226 of the Income and Corporation Taxes Act 1970. No new contracts could be taken out from 1 July 1988.

Does every retirement annuity contract have a guaranteed annuity rate?

No. Many RACs have a GAR, but plenty don't. Some have a guarantee on only part of the fund. The only way to know is to check the policy documents and ask the provider in writing.

Can I still pay into my RAC?

Some RACs still accept contributions, but not all. Ask your provider. Paying in can add to the part of the fund covered by any guarantee, depending on the policy terms.

Can I take tax-free cash from an RAC?

Generally yes, under today's rules: usually 25% of the pot, up to the Lump Sum Allowance. If your RAC has a GAR, taking tax-free cash usually reduces the guaranteed income, so ask for figures both ways.

Do I need advice to transfer my RAC?

If it has safeguarded benefits, such as a GAR, worth more than £30,000, the law requires you to take regulated advice before you can transfer or convert them. If it has no guarantees, advice isn't legally required, but it is still worth checking what you would give up.

What happens if I miss my GAR date?

It depends on the policy. Some guarantees apply only on a set date or at a set age, and may be lost if you take benefits earlier or later. Ask your provider well before the date so you have time to think.

If you think you have a retirement annuity contract with a guaranteed annuity rate, or you're not sure, get in touch for a free, no-advice chat about how GARs and the advice process work.