- The UK Government's 2014 Budget contains a radical shift in the overriding ethos behind the UK's pension rules – where previously individuals have been severely restricted in how they can spend a pension pot, Chancellor George Osborne's plan is for pension savers at retirement to have the freedom to liberate their savings when and how they choose from 2015.
- The increased flexibility should allow individuals to employ a more joined-up strategy across the entire spectrum of their savings (Individual Savings Accounts etc. as well as pensions), and ultimately make it easier to meet cash-flow requirements in retirement. It should also provide greater flexibility for transferring wealth to future generations.
- This freedom, however, comes with a responsibility to make sure that you plan your retirement income wisely. Pensioners will need to hold onto enough assets to sustain them and their dependants in the latter years of retirement and avoid any unnecessary tax liabilities. Financial planning advice is therefore essential.
The historic situation
The rules regarding pensions saving in the UK have traditionally been very restrictive in terms of how retirees can spend their money, with the Government's unstated aim being to make sure that savers don't unwisely spend too much in earlier years of retirement leaving them a burden on the state as they get older. Typically, an individual can withdraw up to 25% of their pension savings as a tax-free lump sum. The remainder is then either:
- Invested in an annuity (an insurance product that provides an annual income throughout life) – products which have in recent years faced criticism for providing poor value; or
- Invested by the pensioner in an earmarked savings vehicle, from which they can draw income at their chosen pace, subject to annual limits set by the Government depending on the retiree's age. At present this 'capped drawdown' gives an annual maximum income of 120% of what government actuarial tables predict an annuity would pay giving the person's age.
In 2011 the Government allowed increased flexibility for savers with significant guaranteed income, so-called flexible drawdown. Pensioners earning £20,000 or more a year (a level considered too high to be eligible for state support) were allowed to draw down their fund without restriction, albeit subject to income tax.
The Government has also been more flexible in some other restricted situations:
- Those with pension savings considered to be too small to provide a sustainable ongoing income also have greater flexibility. A saver with £18,000 or less in their pensions pot is allowed to spend the 75% outside their tax-free allowance as they wish.
- Provision is also made for individuals who may have collected several small pension plans – individuals are allowed unrestricted access (though again with only 25% tax-free) for up to two pension pots with £2,000 or less in each.
Where Osborne wants to go
From 2015, while maintaining the 25% tax-free lump sum allowance, the government plans to allow retirees (once they reach 55, or 57 from 2028 onwards) to withdraw and spend the 75% balance as they see fit, whether that be on property, a wider range of investment products or perhaps funding children or grandchildren in education. The key point is that this 75% is still taxable income – the more you draw down in any one year the higher your taxable income for that period. In other words, without the right planning, you may unintentionally give more to the taxman than you need to or would wish to.
The Chancellor also announced that the 55% tax rate which applies to funds held on death in drawdown is to be reviewed, with the current level being"too high in many cases". This review is to be welcomed, and our hope is that the tax rate is aligned with that for Inheritance Tax at 40%.
Transitional changes in this budget
The Budget for 2014 brings us partly along this road to greater freedom:
- The capped-drawdown limit, referred to above, will increase to 150% from 120% of the equivalent annuity. For example, a person with £1 million of pension savings, having taken out the £250,000 tax-free lump sum, will be allowed to take an annual £66,375 from their £750,000 balance, up from £53,100 beforehand.
- More people will be entitled to the flexible drawdown option, with those earning an annual £12,000 in retirement able now to spend their remaining pension savings as they wish.
- More people are to be included in the provisions for those with smaller pension pots – savers with £30,000 or less won't face restrictions on how much they can take as a lump sum, compared with the £18,000 limit beforehand.
- Provision for small pension pots will also be extended, with the ability to cash in the entire pot widened to plans with £10,000 or less (compared with £2,000 beforehand), and individuals now able to apply this to as many as three plans, as opposed to two previously.
Overall we believe the freedom to spend your money as and when you wish is clearly a benefit to most people. Those who were already using the £20,000 flexible-drawdown limit will in effect see no change. It will however give more freedom to those who would have had to buy an annuity to guarantee their £20,000 annual income and thereby unlock the rest of their savings – from 2015 they will no longer have to purchase those particular products in order to free the remaining 75% of their pension assets.
Those with very small savings pots will find increased freedom to spend has little downside, as the small amount of money in their savings pots mean it's unlikely that any change in spending patterns would send them into a higher tax band.
However, the biggest challenge is to make sure that individuals don't inadvertently push up their taxable income by taking larger amounts in a one-year period than previously would have been allowed. Savers with a pension pot worth around £100,000 will have to avoid the temptation to withdraw more than is necessary in early years, whittling down their savings and pushing them perhaps into the 40% tax bracket.
Ultimately, while people will certainly benefit from the freedom to spend their savings as they see fit, these changes mean an onus is placed on individuals to make sure they plan more carefully their finances so as to meet their goals and avoid any unintentional tax liabilities.
Our guidance to clients
The Government's plans allow for pension assets to be released at an earlier stage in retirement while conversely incentivising the retention of wealth within a pension through the proposed reduction in the punitive 55% tax rate on the transfer of pension assets after the death of the retiree. Given this conflict, determining the most suitable strategy for pension savers will only be achieved by examining each individual's own personal circumstances.
Our approach is to provide unique, tailored and appropriate advice to each individual client. With such significant changes taking place in the pensions framework, we strongly feel that each and every pension saver should look at how these enhancements will affect them specifically and what changes they can make to their pension provision to meet more closely their own personal needs and requirements.
For more information on how these pension changes could affect you, or for details of how Turcan Connell Asset Management can help you plan for your financial future, please contact our experts.
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