In March 2014 the Chancellor, George Osborne, announced that he would introduce significant new defined contributions pension flexibility. Announcements made this week give further detail to these flexibilities, and what we presently know is highlighted below.
It should be noted that this is subject to final law, and therefore potentially will change, but given the obvious political time frame of a general election in May 2015, we would not expect significant deviation from what is below:
- Defined contribution flexibility will proceed in April 2015
- Once the flexibility is accessed an individual will not be allowed to contribute more than £10,000 to pension in any given year (with equivalent consideration to other means of pension saving)
- Pension choice guidance will be delivered by independent providers including the Money Advice Service and the Pension Advisory Service
- A pension commencement lump sum of 25% will continue to be available
- Defined benefit transfers will be allowed, with professional advice and only from private pension scheme
- The death benefit on pensions which have been crystallised, or where individuals are over the age of 75 will reduce from the current level of 55% to a new lower rate to be confirmed in the Autumn statement
- The minimum pension age will increase to 57 from 2028
DC Income Flexibility from 2015
Once a client has reached their pension age they will be able to take what they want from their defined pension contribution fund whenever they want, subject to relevant taxation. From a planning perspective we see this as a significant opportunity for individuals to meet their financial requirements in a tax efficient manner.
If restrictions exist in transferring out of a defined contribution pot, changes will be made to legislation to allow clients to move to more flexible pots to allow them to withdraw their pension funds as they wish.
We welcome these flexibilities and believe that a reduction in restrictions will increase positivity to long-term savings.
Mitigating Risk of Abuse
There is a clear potential risk that individuals could use pensions to avoid income tax, corporate tax, national insurance and also capital gains. Accordingly, once an individual has accessed their pension in the new flexible way their pension savings allowance will drop from the present level of £40,000 to £10,000 reducing the potential for tax savings.
Purchasing a secure income source, solely taking tax free sums, or accessing small pots (less than £10,000) will not trigger the annual allowance reduction. Provision will also be made for those who are in “capped drawdown” to continue to have the flexibility.
Under current rules those that have “flexible drawdown” can make no additional pension contributions, and these individuals will actually receive an increase to their allowance which is currently zero to a new higher allowance of £10,000.
We have no particular issue of these anti avoidance rules, which seem proportionate in their nature as the Exchequer have prepared pragmatic figures which suggest up to £24 billion of tax can be avoided if these rules were not in place. In addition the Government estimates only 2% of pension savers will be affected, so we feel that the increased flexibility and opportunities for planning will not be significantly impacted by these controls.
For those who require simplified guidance, we embrace the introduction of a not for profit organisation who will help individuals to understand their options. Presently the raft of retirement options is complicated and we feel that this has allowed some interested third parties (often insurance companies) to benefit from individual confusion.
A majority of individuals should be able to make their own decisions; as they may have smaller pots which can be accessed in total without more than 20% income tax, and others may simply be best with a secure source of income. We will continue to focus our efforts on those who have more complex requirements and have the wish and the means to pay for personalised advice, rather than ‘guidance’.
Tax free cash
For many people the principal benefit of a pension is that 25% of the value will be tax free. Indeed as the residual pension income is taxed under PAYE at marginal rates, the tax free cash element maybe the only benefit for those who are paying 20% in tax working life and anticipate being 20% tax payers in their retirement life (when compared with, for example, ISAs).
We welcome the commitment to maintaining this benefit, particularly given the significant number of changes to pensions that have occurred in the last ten years.
For most individuals transfer from a DB Scheme will continue to be poor value. DB pensions receive valuable protection in law and are underwritten by both assets outside the employer held on Trust; and also rules exist to ensure a employer cannot cut loose their liabilities.
Notwithstanding this, we had significant concerns that the abolition of DB transfers could have a converse effect, seeing a run on private DB schemes. This might happen if individuals sought to exercise a right for fear of losing this right in the longer term. Many pension schemes may not be able to survive a ‘run on the bank’ scenario.
We do believe that the ability to transfer without advice for small pots (less than £30,000) is a sensible concession.
Death Benefit Tax to come down from 55%
The attachment to the 55% taxation on death benefits seems a curious legacy given the proposed increase in flexibility. In practice most individuals would be able to strip their pension fund dry, with no more than 45% income tax to pay.
It is our anticipation that the 55% rate will fall (probably to 45%, if not the pension holder’s marginal rate if lower).
From an advice perspective our current preference is to use a combination of flexible or capped drawdown, in a phased approach, where a client has no need for tax free cash. This maximises the death benefit which is totally free of tax, before the age of 75. Therefore the potential improvement to the death benefit is a small concession, and one that we embrace, but not significantly so.
Pension age going up
The pension age will increase to 57 in 2028, which essentially means that anyone born after March 1973 will have their earliest possible retirement date deferred by up to two years. The intention is to ensure that there is always ten years between the State Pension Age and the minimum pension age from private pots, which highlights the need for planning outside of a pension fund where an individual thinks they, for example, may retire early through downsizing, selling a business or other capital event.
For most individuals this will not be a viable option but given these increased flexibilities we understand why the Government wants to defer the period for which an individual has access to their retirement funds.
Like many of these changes, individual advice will be required, and we should be clear that these proposals are not final law yet. We think that the anti-avoidance measures are proportionate, and fair and think that the overall “gain” of increased flexibility, massively outweigh the down sides of the restrictions which have been put in place.
If you would like to discuss anything raised above, then please do not hesitate to contact us using the details above.