Pensions – Freedom & Choice
“The most radical changes in a century” – What do the new rules mean for you?
In his March 2014 Budget, Chancellor George Osborne introduced “the most radical changes to pensions in almost a century”. The new measures come with extensive implications for an estimated 18 million people in the UK who have pension plans.
It has been estimated that as many as ‘one in eight’ pensioners may seek to withdraw all the funds in their pension. In his speech, George Osborne clearly underlined the need for expert advice whatever your stage of life in order to benefit from the changes and ultimately enjoy a comfortable retirement. It should be noted that as the median pension pot is around £12,500, the advice which will be freely available to the average person will be necessarily limited.
Traditionally, those retiring with their own pension funds purchased annuities. However, annuity rates have fallen dramatically over the last few years. This is due partly to a rise in life expectancy but more recently because of the lowering of interest rates during the recession, which contributed to a reduction in gilt yields upon which annuity rates are based. Those with larger pension funds had more options, such as flexible drawdown, but restrictions still applied.
The common belief was that change was overdue.
Some things have not changed in that there are still restrictions on how much you can save both in each year and over your lifetime – this rule must never be forgotten!
Some changes have already come into effect. The limits on how much people can draw from their pension each year have been relaxed since March 2014. To access flexible drawdown, you need to have a secured annual income of £12,000 (previously £20,000). This requirement will be abolished altogether from April 2015.
From April 2015, the following changes will come into effect…
Flexible access from age 55
Pension investors aged at least 55 (rising to 57 from 2028) will be able to access their pension fund as a lump sum if they wish. The first 25% will be tax free and the rest will be treated as taxable income and will be subject to income tax at their marginal income tax rate. Basic-rate tax payers need to be aware that any income drawn from their pension will be added to any other income received, which could result in them paying tax at 40% or even 45%.
You can also choose to take your pension in smaller lump sums, spread over time, to help manage your tax liability.
ACTION POINT: If you are in a Defined Contribution scheme (“DC” or Money Purchase), you should consider your options now.
Income drawdown restrictions to be relaxed
Those with larger pension pots have the ability to draw an income directly from their fund. Using income drawdown means you can choose how much income to take and when, which, leaves your options open. The rest of the fund remains invested and gives your money the opportunity for further growth.
From April 2015, some current restrictions will be removed. Fully flexible drawdown will offer considerable freedom but also a high degree of risk which highlights the need for expert planning advice. Capped drawdown arrangements will continue, though are currently limited to 150% of a benchmark annuity rate. It should be noted that adopting these new flexibilities will restrict your future ability to invest more into your pension scheme – care is necessary!
ACTION POINT: If you are already in capped drawdown prior to 6 April 2015, you can move to the new unlimited regime and draw more income than the current maximum. This may have implications for any future contributions and you should seek professional advice.
Transferring from a Defined Benefit Scheme
If you have a final salary (e.g. Defined Benefit (“DB”)) pension fund, you may still be able to take advantage of the new rules to make unlimited withdrawals. However to do so, you would have to transfer some or all of your pension into a DC pension, such as a Self-Invested Personal Pension (SIPP). We agree with the FCA that this is unlikely to be beneficial for most clients. You should seek financial advice before considering transferring benefits out of a Defined Benefit scheme, as you could lose valuable benefits which need to be weighed against the new flexiblities.
Unfortunately, members of unfunded public sector Defined Benefit schemes, such as the NHS Superannuation scheme won’t be able to transfer to Defined Contribution schemes.
ACTION POINT: Speaking to an adviser before transferring benefits out of a Defined Benefit scheme will ensure you are aware of the full implications. From April 2015 this will be a legal requirement where the transfer value is greater than £30,000.
Reviewing your retirement plans
The new rules give considerable freedom of choice. Under the new rules, whilst nobody will be forced to buy an annuity at any age, those who wish to can do so at present and this may prove to remain the best solution for some people.
Clearly, it has never been more important to make the right choices about your pension fund, both how you should carry on saving and how you should take the benefits. These decisions will affect you for the rest of your life. It is essential, especially for those nearing retirement, to seek professional advice. Not only will an expert look at your pension fund, but they will consider your wider financial goals. They will also consider another aspect of the new freedoms outlined below.
Your Pension Pot – A tax efficient way of keeping it in the family
Important changes are taking place with regards to how pensions are treated in the event of your death. Retaining pension wealth within the pension fund and passing it to future generations is now an extremely tax efficient estate planning solution. Upon death the pension funds are free from IHT. This, combined with the fact that the underlying investments are free from Capital Gains and income taxes (over and above the 10% tax credit on dividends which cannot be reclaimed) and the potential for tax free withdrawals make pensions an extremely tax efficient planning option. Indeed it may even change the way we utilise our capital in retirement possibly leading us to spend other funds before our pensions.
From April 2015, you can nominate who inherits your pension fund – it can be anyone of any age and is no longer restricted to your ‘dependents’. If death occurs before age 75, the nominated beneficiary can access the funds at any time tax free. If the original policy holder dies after age 75, defined contribution pension funds can be taken in instalments and will be taxed at the beneficiary’s marginal rate as they draw income from it. Alternatively, they’ll be able to take it as a lump sum less a 45% tax charge (this will become their marginal rate from 2016/17).
Additionally, the nominated beneficiary can appoint their own beneficiary, allowing the accumulated pension wealth to cascade down generations, whilst continuing to enjoy the tax freedoms that the pension wrapper will provide.
Each time a pension fund is inherited, the new owner has control over the eventual destination of those funds.
From April 2015 the following changes will take effect:
- Flexible access to pensions from age 55 (57 from 2028)
- Pension drawdown restrictions removed
- Transfers from unfunded Defined Benefit schemes will no longer be allowed
- On death before the age of 75, death benefits from pensions will be payable to beneficiaries tax free
- Lump sum death benefits after death over 75 will be subject to 45% income tax charge in 2015-16 and beneficiary’s marginal rate thereafter
- The 25% tax-free amount does not have to be taken in one sum upon retirement. It is possible to take smaller amounts over time, each with 25% tax free