The Chancellor has announced a major overhaul of the way in which individuals can draw their funds from defined contribution (DC) arrangements. With effect from April 2015, individuals will be able to put their DC funds into payment much more flexibly than now.
The 25% tax-free cash limit will continue to apply, but individuals will be able to do any of the following with their remaining funds:
- They will be able to withdraw all their funds as cash with tax levied at the individual’s marginal income tax rate.
- They will be able to purchase a drawdown product (without any cap on the amount individuals can withdraw each year).
- They will still be able to purchase an annuity.
These changes will align the UK pensions market more closely with those of Australia and the US where DC pensioners have similar flexibility will be explored more fully in a series of pensions reform semianrs we are holding in May 2014.
The Government is consulting on these changes, which are expected to come into force in April 2015. However, there will be some immediate changes to come into effect from 27 March 2014 to increase the options available currently:
- The limit on trivial commutation (taking small pots as cash) will increase from £18,000 to £30,000 across all schemes.
- The limit on being able to take individual small pots as cash will increase from £2,000 to £10,000 (and individuals will be able to take three such small sums from personal pensions, as compared to two at present).
- The capped drawdown limit (i.e. the percentage of a typical annuity that an individual can draw down each year) will be increased from 120% to 150%. (From the start of the next scheme year beginning after 27/03/14)
- The minimum income requirement for flexible drawdown will be reduced from £20,000 to £12,000, meaning that anyone who has secured an annual pension income of £12,000 (including state pension) will be able to take their remaining funds as cash.
The increased limits for trivial commutation and individual small sums also apply to defined benefit (DB) schemes.
Defined benefit (DB) schemes
The April 2015 proposals only apply to DC pensions. However, there will also be implications for DB pensions. In particular, members of public sector DB schemes will be banned from transferring out to DC schemes in order to take advantage of the new flexibility. This will prevent a significant drain on the Exchequer arising from a large number of transfers from unfunded schemes.
At present, the proposal is for the ban to apply to both funded and unfunded public sector schemes. Transfers from public sector DB schemes to other DB schemes will not be affected.
The Government is also considering whether similar measures are needed to prevent or restrict in some way transfers from private sector DB schemes to DC.
The consultation also confirms that the increased trivial commutation limits described above for DC schemes will continue to apply to DB schemes even when the new DC taxation framework comes into place.
Although this is a major change in the taxation of DC pensions, it should be noted that most of the elements of the ‘A-Day’ tax regime (introduced in April 2006) remain in force: the annual and lifetime allowances will be reduced with effect from April 2014 as previously announced and the unauthorised payments regime will still apply as before. There are, however, a few other changes being considered:
- The consultation considers whether changes may be needed to the tax charge on death benefits from drawdown pensions in payment (which is currently 55%).
- The Government is exploring the idea of removing the age 75 limit for individuals to receive tax relief on contributions, which would bring further flexibility to retirement as individuals would be able to accrue further tax-relieved benefits after age 75.
- The Government has also announced that it will explore the idea of phasing in an increase in the minimum pension age from 55 so that it is 57 when the state pension age is increased to 67 in 2028, with a view to keeping a ten year gap between the minimum pension age and state pension age in future as the state pension age rises.
It is perhaps also pertinent to point out that the new “flat rate” basic state pension of £144 per week (adjusted for inflation) will be available to anyone retiring after April 5th 2016 with at least 35 years of NI contributions to their name.
Whilst the relaxation of the complex rules around pension withdrawal is to be welcomed, detailed financial planning is now more crucial than ever. Making sure that your pension contributions work as hard as they can for you before retirement and then ensuring that your pension fund is not exhausted early will be crucial.
These changes, alongside the new higher investment limits for ISA contributions of £15,000 per person from 01/07/2014, will radically alter the way that individuals can plan for retirement.
Our use of sophisticated cash flow modelling software to create and manage your ongoing retirement plans combined with our range of risk-targeted, low-cost investment portfolios make us ideally placed to help you navigate this brave new world of pensions with confidence.