Duncan Wilson, Financial Planner at Price Bailey, writes:
George Osborne’s budget statements regarding pensions have once again made them not only interesting, but very likely the cornerstone of everyone’s saving strategy.
The following thoughts are structured to give the information I believe is likely to be of most interest (based on the questions I am most often asked), some thoughts about how this could impact upon you, and finally some areas where you might be able to enhance your planning for the future.
Pension scheme members will be free to access their pensions as they see fit
Once you reach age 55, you will have complete freedom over how you choose to use your pension fund.
In many ways, pensions will be as accessible as a bank account. The main options we expect most to utilise to draw their pension will be to:
- Take up to 25% as a tax free lump sum and use the residual fund to provide an income (either as an annuity or Flexible Access Pension, which is effectively replacing the drawdown concept you might have heard of). If you were to choose the Flexible Access Pension, there are no limits to the income you can draw apart from how much is in the fund, but any income would be taxable.
- Take a series of lump sums, with 25% of each withdrawal being tax-free and the remainder taxed as income (known as Uncrystallised Funds Pension Lump Sum).
- As an extension of the above, take the whole pension as a lump sum, with 25% of the withdrawal being tax-free and the remainder taxed as income.
NB: Members already in a drawdown environment will also be free to benefit from the reforms.
…However everyone should consider the taxation implications
This is one of the reasons why we don’t expect everyone (especially the well advised) to be emptying their pension funds.
If you draw funds in excess of the tax-free lump sum, paid as either income or a lump sum, this will be added to your other income, and subject to income tax at your highest marginal rates. Depending on the income drawn, this could mean that up to 45% income tax could be payable on withdrawals, and don’t forget that the effective marginal tax rate between £100,000 and £120,000 is 60% as your personal allowance is reduced.
George Osborne has forecast that the pension flexibilities will bring in an additional £4bn in tax by 2020 (in 5 years’ time), and £8bn by 2030 (Source HMRC). This is because some people will take action to access the pension flexibilities unaware of the consequences, and unaware of the ways to plan effectively to make sure this doesn’t happen.
Death benefits from pensions are much more beneficial
There was a welcome surprise in George Osborne’s 2014 Autumn Statement in terms of the above, and this is another reason why we don’t expect everyone to empty their pension funds.
Whilst a review of death benefits was announced in the March 2014 Budget, nobody was expecting the outcome to be as generous as it has been. Notwithstanding any charges that might apply if a deceased’s total pension holdings breach the lifetime allowance (currently £1.25million), the following applies:
- If a scheme member dies before age 75, the whole of the remaining fund can be paid to beneficiaries tax-free, as a lump sum or income. Currently this is only the case if benefits had not been drawn from the pension (the pension is classed as “uncrystallised”), with a tax of 55% currently applying to lump sum death benefits from schemes where pension benefits have been crystallised (or if the member dies over age 75).
- Where death occurs after age 75, lump sums paid before April 2016 will be taxed at a flat rate of 45%. Income and lump sums paid after April 2016, can be paid to beneficiaries subject to income tax at their marginal rate.
- Anybody can be nominated to be a beneficiary and receive pension death benefits. Currently, only dependents, usually a surviving spouse, are the primary beneficiary in most instances.
For many savers, this change should be as exciting as the income flexibilities from March. This opens a wide range of opportunity for planning for future generations, with pensions now being not only a tax efficient and flexible savings vehicle, but also an intergenerational wealth management vehicle. This, coupled with the fact that generally speaking pensions will not form part of the an inheritance tax calculation, means that for many, pensions could become the first thing saved into while accumulating wealth, and one of the last things that is accessed when drawing on wealth in the future.
Depending on how you draw income, future pension contributions could be limited to £10,000 per year
Where flexible benefits are taken from April 2015, future pension contributions will be limited to £10,000 per year.
This does not apply to:
- Those previously in capped income drawdown who remain within the cap that existed pre April 2015
- Those only taking tax free cash
- Those purchasing an annuity
- Those accessing pensions under the triviality or ‘small pots’ rules
With this in mind, care should be taken on how you draw benefits if there is a possibility you might wish to pay in larger contributions in the future.
Annuities are not dead
Perhaps a little controversial to say, as the press comment and public opinion is currently against annuities.
However, it is widely expected that this market will evolve over time. Indeed, many commentators are now predicting that annuities could be used by certain people as a type of insurance policy to provide their base line living expenses, and then flexibilities accessed when additional funds are required. This would mean that people’s standard of living would not be compromised in the future in the event that their pension funds are depleted (such as happened to a minority of people in the USA who run out of money).
The annuity market is likely to evolve greatly over the coming years, and it is important that these are considered (in whatever form they take) as a part of a retirement strategy, even if it is only to discount them.
Not all pensions will benefit from the Flexibility
The new freedoms apply to money purchase schemes only.
Members of final salary schemes will receive their tax-free cash and income as outlined in the scheme rules. Whilst some could elect to transfer to a money purchase pension, this is a difficult decision to make, and it is important that the implications of such a decision are understood. Such a decision only applies to private sector and local government final salary schemes, and only once professional advice has been received. Teachers, civil servants, police, NHS staff, the armed forces and fire fighters will not be allowed to transfer.
You also need to consider whether your existing pension scheme is able to accommodate the flexibilities. Providers are under no obligation to change their rules to allow the new freedoms, and it is important that you review your pensions to assess their continued suitability to accommodate your wishes.
In conclusion
The pension flexibilities offer a fantastic opportunity for all pension savers to plan not only for their future, but also for the future of generations to come. We expect your pensions to sit alongside a wide range of investment vehicles to provide for your retirement income, and it will be making all of these arrangements work together that will ensure you receive your future benefits in the most efficient way and ensure that your wealth is passed onto your beneficiaries with the minimal impact.
If you would like to discuss any of the above points, your pensions or any part of your wealth structuring, please contact us.