NEWSLETTER: What the Budget changes really means for pensions
Contributed by MW Pensions
04 April, 2014
A fundamental change in UK pensions
Since Pensions Simplification (remember that!) came into force in 2006, pensions has received much negative press and ever increasing complexities and constraints. During that time the Lifetime Allowance has been repeatedly cut back to £1.25M and the Annual Allowance axed from £255,000 to £40,000. Whilst there are still restraints on how much contribution can go into a UK pension, the Chancellor announced sweeping changes that will allow people much greater freedom to actually take money out of their pension pot. After all, it is their money!
What hasnt changed?
Quite a lot:
- The planned reduction from 6.4.14 in the Lifetime Allowance to £1.25M goes ahead
- The planned reduction from 6.4.14 in the Annual Allowance to £40,000 goes ahead
- Fixed Protection 2014 has been introduced
- The announced Individual Protection 2014 will be introduced
- No change as to which investments are tax free and which are not
- The minimum age at which benefits can be drawn remains at 55 for the time being at least
- No change in the maximum 25% Pension Commencement Lump Sum
- No change on the 55% tax applicable when a member or their spouse in drawdown dies leaving no dependants - though this will lead to some anomalies as we discuss later.
So what has changed NOW?
The way that benefits can be taken from a pension fund has changed dramatically. A whole raft of changes came into effect from 27th March 2014. In summary these are:
Increase in maximum drawdown
The maximum drawdown for capped drawdown pensioners increased to 150% of the relevant GAD rate. This will apply for all drawdown pension years starting on or after 27th March 2014.
Lowering of Minimum Income Requirement for Flexible Drawdown
The Minimum Income Requirement for Flexible Drawdown reduced to £12,000 per annum
Increase in Trivialisation Limit
The trivial commutation limit rose to £30,000. This allows members over 60, with total pension savings of £30,000 or less, to take out all of those savings as one or more trivial commutation lump sums (though anything in excess of the Pension Commencement Lump Sum will be subject to tax at their marginal rate).
Small Pension Pots
The amount that can be taken as a taxed lump sum from small pension pots rose from £2,000 to £10,000. In addition, the number of small post that can be taken rose to three.
Removal of 6 month requirement to buy an annuity
After the Budget, on 26th March, the Treasury announced that where an insurance company pension contract requires the purchase of an annuity within 6 months of the member taking their lump sum, that requirement would be removed from 27th March 2014. It is estimated that this will affect up to 400,000 people who are due to take their lump sum between 27th March 2014 and November 2014.
What are the changes that come into force in April 2015?
The principle announced in the Budget is clear from 6th April 2015 people will be able to draw as much pension as that want whenever they choose, so long as they are aged at least 55. Apart from the Pension Commencement Lump Sum, whatever income they draw will be taxed at their marginal rate of income tax. So potentially the tax could be anything from zero to 45%.
What is missing is the detail. So lets look at some of the issues.
When precisely can someone take as much as they like after 6th April 2015?
Will 6th April 2015 be the relevant date for everyone or will people in drawdown on 5th April 2015 have to wait till the start of their next pension year? Consider someone who went into drawdown on 20th March 2013. They have to wait until 20th March 2015 before they can opt to take out 150% of GAD, which they could take annually in advance and actually receive on say 20th March 2015 (at least in theory). Can they then take as much as they like out again on 6th April 2015 or do they have to wait until 20th March 2016? Logic would suggest that 6th April 2015 should be the date, but since when did logic apply to pension legislation?! We will have to wait and see how the actual legislation is written
The death tax anomaly
Let us look at an extreme example to make the point. Consider the case of someone who is over 55 and in drawdown and who, without their pension assets, is comfortably over the IHT threshold. If they have a £1M pension fund, then they could draw it all out and pay 45% tax on it. Suppose that the next day they and their spouse are both killed in the proverbial car crash. The £550,000 that they have just received from their pension pot will go into their Estate and be subject to a further 40% IHT charge ie £220,000. So effectively they will have incurred a total tax charge of 67%. If the member had left the £1M in their pension fund, the tax would have been 55% and there would be no more IHT payable as pension assets are outside of IHT.
Now consider someone with a more modest pension pot of say £100,000 whose other assets for IHT purposes are say £250,000.For the sake of simplicity let us assume that if they drew out the whole £100,000 they would pay tax on the whole £100,000 at 40% (in practice they would probably only pay tax at 20% on part of the £100,000). Then if they and their spouse were killed the next day in that proverbial car crash, the £60,000 net pension income would go into their Estate and as the total Estate of £310,000 was less than the IHT threshold, no further tax would be payable. If the member had left all the money in the pension fund, the tax payable would have been 55%.
This is nonsense. We understand that the Government is going to review this anomaly..
Defined Benefit Schemes
All the drawdown changes being introduced will specifically only apply to Defined Contribution schemes. So those who are in a Defined Benefit Scheme can only draw their pension in accordance with the Rules of that scheme which effectively means regular income over their whole lifetime. The Government has made it clear that they will introduce legislation that will ban people who have a public sector Defined Benefit pension from transferring it to a Defined Contribution Scheme.
We can imagine that some people with Public Sector pensions will not be best pleased about that, especially those with a small pension (but above the trivialisation limits), who might prefer to give up future annual pensions for a higher income now.
What about private sector Defined Benefit Schemes? Will there be a legal ban on them all or will it be down to individual schemes to make their own rules? Is there a constraint of trade issue here?
It is unclear what happens if someone in a Defined Contribution Scheme (say a SSAS) has elected for a Scheme Pension. Do the new relaxations apply to them from April 2015 or are they classed as Defined Benefit?
Are the changes legally overriding?
It is clear that the changes effective from 27th March 2014 are overriding legislation, so pension providers are not required to change their scheme rules in order for members to benefit from the changes. However, will the April 2015 changes also be overriding? And if they are, by what date, if any, will trustees be required to implement the changes within their own scheme rules?
Rises in the minimum pension age to 56+
As part of the Budget announcements, the Government advised that it will consult on increasing the minimum pension age so that it remains ten years below state pension age, for which legislation will also be introduced in a future bill. So at some future date, the minimum age at which benefits can be taken will increase above 55. Under current legislation, the State Pension Age is due to rise to age 66 between 2019 and 2020 and to 67 between 2026 and 2028. But these increases are gradual. Let us hope that an increase to age 56 as the minimum age for drawing benefits from a pension scheme is done simply and with adequate notice.
A political budget?
As a firm we are apolitical. But sadly, as we all know, pensions are political and there are undoubtedly some political drivers behind these decisions. Annuities have (understandably) been considered as poor value for money for many years. Many people will, as soon as they can, take advantage of the increase in 2014 of the maximum pension to 150% of GAD. Similarly, millions of people will take advantage of the 2015 changes and take substantial income soon after 6th April 2015. This will have two immediate impacts:
- It generates very substantial additional tax revenues in 2014 and especially in 2015 that will help reduce the National deficit
- They will quickly spend much of this additional income. Holiday companies, TV and computer dealers, and car showrooms for instance are likely to get major boosts.
Both the above will improve the countrys economy- and of course there is a general election due in May 2015!
In terms of macroeconomics, the effect of these changes will be to advance the timing that the Treasury receives taxes due on pension payments, Instead of them being spread evenly over 20 or 30 years, in most cases they will heavily skewed towards a much earlier date.
We welcome the changes. They will, we believe, encourage more people to save via SIPPs.
Gilt Yield for Drawdown
The gilt yields to be used for drawdown calculations are:
We do not give financial advice and no comments here are intended as such. The above information is based on our understanding of the legislation governing pensions at the time of writing. Before taking any action you should consult a qualified financial and/or tax adviser. Levels, bases of and reliefs from taxation may be subject to change.
This Newsletter is intended for professional advisors only, not members of the general public
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