We don’t usually issue a Budget Guide, partly because there is so much information from so many other sources. Another reason is that there isn’t usually a great urgency and we can discuss changes affecting our clients during their review meetings.
This year, however, things are different. Oh so very different. It’s not overstating the situation to say the changes to pension rules that George Osborne has proposed represent the greatest revolution to pensions since the section 226 contract, the forerunner of the personal pension, was introduced in 1970.
Our overriding message? We all need a basic level of income in retirement, and pensions will continue to be the most tax efficient way of providing for this.
Overview and Comment
We’ll outline the details in a minute, but George’s general idea is to give anyone over the age of 55 the ability to access their pension funds in one go.
There is one obvious question: why?
Why would the Government want to encourage this? The cynical would say to raise tax (the Chancellor admitted in his speech that this would generate massive amounts of tax). Others would say it increases personal freedom. Some might even say it makes pensions more attractive and therefore encourages pension provision.
Why would an individual want to access their pension funds? The answer is as typically clear cut as most financial advice: it depends on your circumstances. Taking the cash out of the pension will incur income tax at 20%, 40% or 45%, so it depends on how the money will then be used. If it is invested and then used to provide an income (taxed again at 20%, 40% or 45%), then the money may well be better left in the pension.
But someone with a large amount of assets outside of pension may prefer to use the money now, perhaps pass it to the kids to help buy a house. With pension funds in payment being taxed on death at 55%, this might make sense. There are rumblings that this rate may be reduced in time for April 2015, in which case keeping the money in the pension fund might end up being the best thing to do after all.
As ever, the rules will affect different people in different ways, so make sure we talk before you take any action.
Now, let’s summarise the rules. They can be lumped into two parts. What will happen in the 2014/15 tax year. And theproposed changes from April 2015.
Here we go. Fasten your seatbelts.
Changes to Pensions for 2014/15
The main headlines are as follows:
- Maximum Drawdown (income from a drawdown pension fund for those over 55) goes up from 120% of prevailing annuity rates to 150% per annum
This only affects those who are taking their benefits, or who are aged over 55 and would like to. It’s not as simple as just asking to increase the maximum being taken (we’re waiting for details), and taking so much out of a pension would almost certainly deplete capital and ultimately reduce income. Plenty of things to consider, so if this interests you, we should talk.
- Minimum secured income needed before Flexible Drawdown is possible reduced from £20k to £12k per annum
Flexible Drawdown is a way of taking as much as you like out of your pension fund. The first 25% of any fund can be taken tax free. It’s the rest that has always been limited (as above) because pensions were always meant to be for income. But, say the Government, if you can prove that you have secured income of £12k p.a. (secured meaning from state pension, pension annuity income, defined benefit scheme income), you can take as much out of your pension as you want, in one go if you so choose. Careful though, as it will be taxed as income. So careful phasing to minimise tax would be best. If this interests you, we should talk.
- Small pension pots can also be taken in one go (remember, 25% tax free, the rest taxed as income (unless benefits have already started to be drawn – in which case the lump sum would be fully taxed)). The definition of a small personal pension pot has gone up from £2k to £10k, and you can have up to three. In addition, if total pension benefits are no more than £30k (previously £18k) they can be drawn as a lump sum.
The £10k limit affects anyone with small amounts in pension funds, even if they also have other large pots or anyone with total pension funds not exceeding £30k. If this is you, guess what? We should talk.
These changes had us on the edge of our seat as it was. But we weren’t prepared for what was to come next…
Proposed changes to Pensions from April 2015
- Ability to withdraw defined contribution pension funds on a totally flexible basis (over age 55 and after 25% tax free has been taken). Amounts withdrawn are taxed as income. Could be in one go, or could be in tranches (for example spread over tax years to minimise tax).
That’s it. In a sentence the overriding principle that pensions are for income is brushed aside. See the comment section above for our thoughts on this, and whether it is necessarily a good thing for individuals.
- Transfers out of Public Sector Defined Benefits schemes (what used to be known as final salary) will be prohibited and the private sector defined benefit scheme situation is being considered.
That’s to be expected. If you let people get their hands on their pension pot there could be a run on public sector pensions, which could be disastrous both for the schemes (who would have to find the cash) and for the individual (who would be giving up guaranteed benefits).
Non Pension Stuff
There were a few announcements that seem very welcome.
- Pensioner Bonds for those aged over 65
- £10,000 maximum
- 3 year rate probably 4%
- 1 year rate probably 2.8%
- This income will be taxable
This gets a bit of a shrug from us. It’s ok, and provides a better rate than the market currently gives. We’ll wait to see the detail.
- The ISA is now to be called New ISA, or ‘NISA’ for short.
No, really. We’re not kidding, this really is true.
- NISA allowance increased to £15k per person from 1st July.
Clearly good news for clients of Ovation, building up a tax free pot for tax free income in retirement makes ISAs, sorry, NISAs essential.
One Last Thought
It’s tempting to think that the ability to get our hands on the pension cash means that we should all start piling our cash into pension funds. We’re big pension fans at Ovation, but, as much as we’d like to see more being paid into pension, we’re urging caution.
Firstly, these are just proposals. What rules actually come into force in April 2015 we’ll have to wait and see.
Perhaps more importantly, politicians seem unable to resist tinkering with pension rules. As a result the rules change constantly, a source of great frustration to those of us who try and help clients make financial plans. So will the ability to take the whole fund still be around in, say, ten years’ time, when another party is in power? There’s no guarantee.
So, our message remains; pensions should be used as a source of subsistence income in retirement, as part of a wider plan involving other types of investment vehicles.
We’ll be discussing the relevant aspects of these changes with clients at review meetings, but if you want to do anything with greater urgency…. we should talk.
The Financial Conduct Authority does not regulate tax advice.