Saving for retirement – the biggest changes to pensions in 100 years (for now!)

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This is my third and last blog of this series.

In my first blog I looked at the three phases of retirement most of us are likely to experience. The amount of income required at each stage will depend on our age and activity levels. In my second blog I noted that given the new freedom and choice agenda the likelihood of being able to match the required pattern of cash flows during the three phases of retirement has increased.

In this blog I will look at the actual changes that have come into effect this week and what these mean for you as a DC saver. Or for those of you who are Trustees of a DC scheme, what the reforms mean for the members of your scheme.

So what’s changed?

Once you reach the minimum retirement age of 55, you can now take as much as you want from your pension savings whenever you want
This means that there is no longer a requirement to secure an income in retirement, for example, through the purchase of an annuity. The income limits on capped drawdowni will no longer apply and the minimum income requirement for flexible drawdownii will no longer be relevant.

You will still be able to take the first 25% of your pension fund as a tax-free lump sum. However, you will also be able to take the remainder of your pension fund as a cash payment, although this will be taxed as income at your highest marginal rate in the tax year in which you take it.

The tax treatment of pensions on death will now be far more generous
Up until this week, it was normally only possible to pass a pension on as a tax-free lump sum if you had not made any withdrawals and you died before age 75. If you were age 75 or over or if you had made any withdrawals from your pension savings, then a 55% tax charge would have been applied.

The new rules however make it much more tax efficient to pass on pension benefits to family members. The reforms allow a pension, in some cases, to be used to mitigate
inheritance tax:

  • If you die before 75, your beneficiaries can take your whole pension fund as a tax-free lump sum or as tax-free income through drawdown.
  • If you die at or after age 75, your beneficiaries can inherit the pension and they will only pay income tax at their highest marginal rate as and when they start to draw money. If a beneficiary opts to take a lump sum payment, a 45% tax charge will be made.
  • Pensions passed on can be further inherited on the death of the successor. Where this death occurs before age 75, the payment will be tax free in the hands of the new successor. If death occurs after age 75, the payment will be taxable.

This change to the taxation of pension pots potentially makes annuity purchases less appealing. This is because annuities normally die with you (they usually do not form part of your estate on death). However, annuities do offer other benefits such as a guaranteed income for life.

Pension pot size slashed again
The UK Government announced a reduction in the amount someone can pay into their pension over a lifetime, without incurring more onerous tax charges, from £1.25 million to £1 million.

As of this week, anyone who pays more than £1 million into their retirement pot will be taxed at up to 55 per cent on the excess. This is the third cut to the lifetime pension saving limit since the coalition government came to power in 2010 (the previous limit of £1.8 million was reduced to £1.5million) after the Labour Government introduced a limit of £1.4 million when last in office.

The Guidance Guarantee
The Chancellor has stated that free face-to-face impartial guidance (not personalised advice) will be offered to anyone retiring with a defined contribution pension from April 2015. This service will be provided by The Citizens Advice Bureau, called Pension Wise and The Pensions Advisory Service.

New restrictions on pension contributions
Now, if you make any withdrawals from your pension in addition to the tax-free lump sum, your future contributions to a defined contribution pension could be restricted to a lower limit of £10,000, (as opposed to the normal annual allowance which is currently £40,000).

The minimum retirement age will increase from age 55 to 57 in 2028
The government’s plan is that the minimum retirement age will always be 10 years prior to the state retirement age. This means that, in the future, as the state retirement age increases so will the minimum retirement age.

These changes have been hailed by some as the most radical pension reforms in a hundred years. Others would describe them as the most political. On that basis, look out for more changes before long!

Sital Cheema-Associate Director, Client Strategy & Research EMEA

Sital-Cheema

i Capped Drawdown Prior to 6th April 2015, entering into a ‘capped’ income drawdown arrangement allowed you to take an income directly from your pension fund without having to buy an annuity. The level of income could be varied to suit your needs, although you could not take more than 150% of the amount you could receive from a standard annuity. This 150% limit is no longer relevant as everyone can now enter into flexible drawdown now that the minimum income requirement for this has been removed. See ii below. 
ii Flexible Drawdown Prior to 6th April 2015, if you had a secured income of £12,000 per annum from state pensions, annuities and occupational pensions, you were able to enter into a flexible income drawdown arrangement. This requirement was removed as of this week. You can withdraw as much or as little income as you like from your pension pot – you can now withdraw the whole amount or nothing at all if you so choose.
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