For all the hype around pensioners’ ‘right to buy a Lamborghini’ some of the more important elements of the 2014 budget may have been lost. Here, Jon Francis, director of SIP Wealth Management, cuts through the hype and identifies the key things everyone with a pension needs to know.
This year’s budget will greatly enhance individuals’ ability to access and control their pensions. The new rules will kick in from April 2015 and temporary measures will be applicable before that. But, firstly, some background.
The existing rules
Under the existing pension rules, savers in defined contribution schemes (as opposed to workplace final salary) have three options to access the money after age 55.
If they have less than £18,000 in total pension savings, the entire lump sum can be taken as cash, subject to income tax. Savers with more than £18,000 can take up to two pensions worth up to £2,000, again subject to income tax.
The second option is to buy an annuity, which will provide a guaranteed monthly income until death.
The final option is to leave the pension invested and take a gradual income, known as an income drawdown. But unless a pensioner can show £20,000 of guaranteed pension income from other sources their annual income is capped.
What has changed now?
Under the new rules, the government has relaxed the rules on several fronts on a temporary basis to give savers greater access to their pensions.
Savers whose total pension savings amount to £30,000 – rather than £18,000 – will be able to take the entire amount as cash, taxed at marginal rates.
Savers with larger amounts in pension savings will be able to take up to three pensions worth £10,000 each as cash, rather than two worth £2,000.
Savers who use “income drawdown” will be allowed to take larger sums as income. This is likely to be several thousand pounds extra a year from each £100,000 in savings.
An individual will need just £12,000 of secured pension income from other sources to make unlimited withdrawals.
What changes next year?
From April 2015, however, the government is removing the constraints completely. Savers will be able to access the entirety of their pension at any time after age 55, subject to income tax at marginal rates on three-quarters of the money.
This means that someone with a £100,000 pension could take £25,000 tax-free and then withdraw the remaining £75,000 to spend or invest as they saw fit. The £75,000 would be treated as income for that tax year, pushing the individual into the higher-rate tax band for the year.
Alternatively, savers will be to take the money in annual lump sums. From April 2015, there will be no cap on the amount of money that savers can withdraw from this arrangement.
Will annuities still be available?
Yes. Those seeking a guaranteed income for life will still be able to purchase an annuity. But instead of automatically being driven to do this, due to the restrictions on accessing pensions, this will not come down to individual choice. This increased competition in this segment of the market could also lead to better deals being available.
So what do I do now?
With the rules so relaxed now, it will be critical to invest time and energy in planning your retirement and making the correct decisions so that your pension pot lasts as long as you need it to. The first thing should simply be to get the right advice: contact your financial planner and start planning for a retirement that you can now control.
6 THINGS TO BEWARE OF
[checklist icon=”arrow-right” iconcolor=”#ffffff” circle=”yes”]
- Older, greyer….
One of the less discussed changes being made by the government is that the age from which savers can access their pensions at all is being pushed back at the same pace as the state retirement age. This means that, initially, it will be more 57 in 2028 meaning those aged 40 or younger now may have to work a little longer.
- Stuck in annuities
Unfortunately, anyone who is already in an annuity scheme will be tied into that contract under the rules of the old system. But those using income drawdown will be able to increase their incomes by requesting a review with their financial adviser.
- Beware of the taxman
Given the loosening up of the rules, it is more important than ever to get good advice when deciding how to manage your money now. Although the government have allowed almost free access to funds, that does not mean savers escape the taxman. Drawing down pensions will become as much about tax planning as anything else now.
- Caution on alternative investments
With savers no longer being forced to buy annuities, the changes could create a new class of eager investors keen to better returns elsewhere. A boom in interest in buy-to-let properties has been anticipated but beware: such investments are not risk free and the higher the potential yield, the higher the risk.
- Inheritance tax becomes a bigger issue
For savers who bought annuities, while they were guaranteed an income for as long as they lived, the payments would stop when they died. The new rules could mean more money potentially being inherited by relatives but more planning will be needed to minimise the tax bill.
- Planning is everything….
The great thing about annuities is the guaranteed income they provide. For those preferring to manage their retirement themselves, good advice and planning will become critical. Quality, experienced financial advisers will become their weight in gold going forward!