All change

Penny Cogher scrutinises the government's wide ranging changes
to pensions and offers guidance on what they mean

In the world of pensions, this year's budget was seen as the most radical for a generation. Broadly, the government aims to relax the pension rules which currently stipulate that benefits payable from a defined contribution (money purchase) scheme, like a group personal pension or a SIPP, must be provided in the form of a pension, a lifetime annuity, or a restrictive drawdown arrangement, with 25 per cent of the overall pot being paid out as tax-free cash. The legislative changes that will be put in place by the budget announcements are, perhaps inevitably, somewhat piecemeal.
Some interim measures have been made by the Pensions Act 2014, and other changes are in the Taxation of Pensions Bill 2014-15. But what do these seismic shifts in the law mean for individuals and their pensions?

Mandatory annuity purchase

 The Chancellor of the Exchequer, George Osborne, announced in March 2014 that, from April 2015, those aged 55 and over will no longer be required to buy annuities, and the existing drawdown rules will be relaxed. So, individuals coming up to retirement are given this greater freedom and so have rather more decisions to make than they had pre-budget. Options, and combinations of these options, range from:

• taking all their pension pot as cash in one go to be used to provide an alternative form of income through investment, or just to be spent;

• drawing the pot down in instalments through retirement;

• buying an annuity later into retirement when a stable, regular income is required; and

• opting for the traditional route and navigating the complexities of the annuities market to get the best deal on offer at retirement.

However, being able to take 25 per cent of the pot tax-free continues to be an option, at least for the time being.

The jury is still out on quite what impact this new freedom will have.
While statistics show a decline in annuities uptake post-budget, some individuals will always prefer having the guaranteed income for life that only an annuity provides.

Capped drawdown

The rules around income drawdown (accessing money purchase pension savings as income) have been significantly relaxed, enabling individuals to take proportionately more from their pension pots through drawdown than ever before. For all drawdown years starting on or after 27 March 2014, the annual withdrawal cap limiting the amount drawn down from an individual's pension fund has been increased from 120 per cent to 150 per cent of the value of a comparable annuity, as calculated by the Government Actuary's Department. This effectively raises the limit on the amount of funds that can be taken as drawdown annually, thereby increasing flexibility for individuals.

Although flexible drawdown will cease to be relevant from 6 April 2015 owing to the new freedoms, the rules have been relaxed in the interim. If an individual of pensionable age meets a minimum income requirement of £12,000 (reduced from £20,000 under the current reforms ) and is a member of a money purchase scheme (MPD), that individual can use flexible drawdown to access their pension savings.

Taxation of Pensions Bill

The Taxation of Pensions Bill is currently working its way through parliament and is still subject to change. However, it will extend the pension changes introduced in the Pensions Act 2014 by:

• allowing all the funds in a MPD to be taken as an authorised taxed lump sum, so removing the higher unauthorised payment tax changes;

• increasing the flexibility of the income drawdown rules by removing the maximum cap on withdrawal, and the minimum income requirements for all new drawdown funds from 6 April 2015;

• enabling those currently with capped drawdown to convert to a new flexible drawdown fund (arranged with the individual's scheme);

• enabling schemes to make payments to individuals directly from their pension savings with 25 per cent taken tax-free (instead of just one tax-free lump sum at the outset);

• increasing the maximum value and scope of trivial commutation lump sum death benefits; and

• restricting or reducing certain tax charges that apply to death benefits.

Trivial commutation

It is not uncommon for individuals to have many pension pots from different jobs, some larger than others. These smaller pots of pension savings (whether in a MPD or defined benefit/final salary schemes) can be withdrawn as a lump sum, known as trivial commutation.
The minimum age for an individual to withdraw a trivial commutation lump sum is to be reduced from 60 to 55.

From 27 March 2014, the trivial commutation limit has been increased from £18,000 to £30,000. The following must be met for schemes to commute trivial benefits of up to £30,000:

• there is a one-off 12-month window available for a member to take advantage of trivial commutation - although more than one payment can be made in this time;

• the individual's pension rights under all registered pension schemes must not exceed £30,000 on the 'nominated date' - a date within three months of the first trivial commutation lump sum payment;

• the individual must have some of his or her lifetime allowance available;

• the payment must extinguish the individual's entitlement to benefits under the scheme; and

• the individual must have reached 60.

Under the scheme-specific commutation regime, up to three personal or stakeholder pensions of less than £10,000 as cash payments can also be taken, no matter how much is received from other pensions.

Lump sums - instant access

The budget paved the way for what has been coined 'instant access' to money purchase pensions. There is some hyperbole here, and over 55s won't really be permitted to use their pension funds as glorified cashpoints. From
6 April 2015, an individual aged 55 or over with money purchase pension savings will be able to access their fund in full, provided the rules of the scheme permit this. Individuals can choose
to take an annuity or pension, enter flexi-access drawdown, or withdraw their funds as cash. If they opt to withdraw as cash, 75 per cent of each withdrawal will be taxed as income at the marginal rate, while 25 per cent will be paid tax-free.

The sting in the tail

The lifetime allowance of pensions has been reduced to £1.25m for the tax year 2014/15, and the annual allowance reduced to £40,000.

Because of concerns that people could game the system (drawing funds from their pension pots and using them to fund new tax relief contributions) those in flexi-drawdown will have their annual allowance cut from £40,000 to £10,000 in any tax year. This only applies to money purchase arrangements and does not apply for individuals in capped drawdown.

Death and taxes

The chancellor recently announced less punitive taxes on defined contribution pension funds following an individual's death. From April 2015, if an individual dies aged over 75, beneficiaries will benefit from the funds being free of tax if they keep them in the pension fund. If the beneficiaries draw a pension from the fund, this is then subject to their marginal rate of tax. If the individual dies before age 75, no tax will be payable. The definition of 'beneficiaries' has been broadened so it doesn't just mean dependants. This again is expected to boost demand for income drawdown in retirement, over annuities.

Where benefits are paid as a lump sum, no tax will be due if the member dies before age 75, and the tax charge on death after age 75 is dropping from 55 per cent to 45 per cent.

Pension change is always political

These changes aim to 'sex-up' all pension saving and defined contribution pension saving in particular. They go hand in hand with the introduction of auto enrolment - enforced defined contribution pension saving for the masses. It was a clever marketing ploy, now perhaps regretted, for the Pensions Minister, Steve Webb, to say when the budget changes were announced: "If people get a Lamborghini and end up on the state pension, the state is much less concerned about that, and that is their choice".

How long these flexibilities last is another matter altogether. Already the Fabian Society, Labour's left wing think tank, is encouraging their abolition as they 'stop pensions being pensions' and Australia is trying to move away from these types of freedoms for much the same reasons.

 

Penny Cogher is a partner at Charles Russell Speechlys