The risk of pensions INflexibility from April 2015

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New flexibility of withdrawals comes with inflexibility of contributions <i>credit</i><a href="https://www.flickr.com/photos/jessicamullen/3672695368/in/photolist-6AxwnW-gLmDMe-ad771p-c7B22d-Dc7vg-gLnC5n-7n5QCz-nEsbgq-oa5o1N-v1rGj-gLmEpX-JqnrZ-9xMc8K-7P4zZL-7aRgrb-D7agV-d5He1U-9mS78F-gLnBnF-gLmERt-gLmAum-4bCN5V-4GpURA-jDkoYs-9rMNXw-aD2L7r-eR9vE4-oQHdST-ecrha8-a7pQxs-ecwXEw-ecwX8o-ecwWWQ-ecwWxq-ecwWem-mWNrP2-9j9Ji8-drWXx-m7v3wV-jxSG5o-iYGeFv-ecrm8K-cnR3ff-cnR3d1-ecrjKP-ecwUcd-ecwUbG-ecwUa9-ecrh8R-ecrh8c">Jessica Mullen</a>
New flexibility of withdrawals comes with inflexibility of contributions. Credit: Jessica Mullen

From 6th April 2015 accessing a pension flexibly can cause an individual’s pension contribution allowances to fall from £180,000 to £10,000; we believe this will reduce choice for many. Action now can retain the higher limit and still allow flexibility when required; in many cases the ‘old’ rules will be more tax efficient than the new.

The pension freedom rules from April 2015 have been broadly welcomed, but for those who are looking to take an income flexibly from their pension the changes mean action may need to be taken before April 2015 to maximise their future planning opportunities.

Currently and up until 5th April 2015 individuals can select a retirement option known as ‘Capped Drawdown’. These facilities allow flexible withdrawals from a pension fund subject to a maximum cap which is broadly equivalent to the highest annuity level they could achieve. Specifically the rules currently prohibit the limits ever being lower than:

  • At age 55: 6% of the fund after tax-free cash
  • At age 60: 7% of the fund after tax-free cash
  • At age 65: 8% of the fund after tax-free cash
  • At age 70: 9% of the fund after tax-free cash
  • At age 75 (and thereafter): 11½% of the fund after tax-free cash

These are significant withdrawals, and may not be met by long-term investment growth. An individual taking the maximum may expect their fund to reduce, and therefore their income levels to fall in the future.

However, Capped Drawdown also allows individuals to continue making contributions up to the standard annual contribution allowance of £40,000 per annum, and retain the ability to “carry forward” unused contribution allowances which could be as much as £180,000 in the 2015/16 tax year.

From 6th April 2015, if an individual doesn’t have a Capped Drawdown contract, as soon as they withdraw more than their 25% tax-free cash sum their annual pension contribution allowance (to money purchase pensions) reduces from £40,000 to £10,000 per annum contribution. This could have serious implications for individuals who wish to access their pension fund but who also plan to continue contributions either personally or from their employer.

Capped Drawdown suits many individuals who wish to enjoy a phased approach to retirement. By withdrawing income from their pension fund, at the same time as taking some of their tax-free lump sum allowances, an individual can reduce the income tax they pay, whilst retaining a lifestyle they are used to.

For those able to control their remuneration (business owners, senior executives and those whose employer offers ‘salary sacrifice’) a pension contribution, with simultaneous Capped Drawdown withdrawals can be very efficient. However if an individual doesn’t have a Capped Drawdown facility set up pre 6th April 2015 the reduction in the contribution allowance mentioned previously will significantly reduce this very efficient option.

We feel that Capped Drawdown will continue to suit many people post 6th April as the maximum income cap is more than enough for those wishing to avoid early erosion of their pension fund. Importantly a Capped Drawdown can convert to the new post 6th April 2015 unrestricted withdrawal environment but the reverse will never be true.

The ability to continue making pension contributions, receiving income tax relief at the highest possible rates and potentially saving National Insurance (via a salary exchange arrangement), whilst withdrawing an income that is, at commonly taxed an effective rate of 15% is compelling.

In summary, individuals born before 6th April 1960 who are considering gradually moving into retirement and whom may for tax planning or employer contractual arrangement reasons wish to make contributions to their pension of in excess of £10,000 retirement need to consider seeking advice now.

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24 Nov 2021

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