Alphabet soup of pensions reform

My concern is whether the regime that emerges in April 2015 bears any resemblance to that outlined by Mr Osborne and expected by the public.

HMRC has now released draft legislation and guidance on the new pension freedoms that will take effect from 6 April 2015 and form part of the Taxation of Pensions Bill. So how does it all translate from English into pensions? (As usual, the legislation is sprinkled with acronyms.) Let us look at more of the detail.

1. Flexi-access drawdown

Flexi-access drawdown (FAD) will allow an individual to take a pension commencement lump sum (PCLS) in the same manner as under current capped drawdown rules. The balance of the crystallised fund can be taken as taxable income, with no upper limit, and will be taxed at the reci-pient’s marginal rate. Anyone who enters drawdown for the first time on or after 6 April 2015 will be deemed to be entering FAD.

One of the Treasury’s concerns was whether pensioners would take out money at the age of 55, then pay it in again as new contributions – receiving further tax relief. Various solutions have been suggested, to the -extent of prohibiting further contributions after commencement. A zero annual allowance would achieve this, but would prevent legi-timate partial retirement where benefits are ac-cess-ed to supplement a part-time salary and where auto-enrolment requires ongoing contributions.

HMRC’s solution has been to introduce a redu-ced annual allowance of £10,000 a year for money purchase contributions. So if any income is taken under FAD, the ‘money purchase annual allowance’ of £10,000 a year is triggered. Taking PCLS only (nil income) will not trigger the MPAA, but buying a short-term annuity will.

2. Uncrystallised funds pension lump sum

It will be possible to take a lump sum of any amount from uncrystallised funds of which 25 per cent will normally be tax-free, with the remainder taxed at the recipient’s marginal rate.

There should be little difference between partial crystallisation under FAD with maximum income (all the crystallised fund) and taking a -UFPLS, which will trigger MPAA. UFPLS is only available after the age of 55 or if ill-health conditions are met. It is not avail-able earlier, where the individual has a protected retirement age or for child dependants).

UFPLS can only be paid where there is enough lifetime allowance. It is not payable where it would entitle an individual to receive higher amounts of tax-free payments, enhanced protection or an LTA enhancement factor, such as under primary protection, pension credits or transfers from Qrops. Individuals can still enter FAD and take all the drawdown element as one payment of taxed income.

3. Lifetime annuities

The rules on lifetime annuities are being relaxed so income from them can be flexible. Annual rates will be allowed to go down, as well as up. That is, we may see annuities that drop when state pension becom-es payable, allowing bridging until state pension age or the classic U-shaped income in retirement.

The 10-year maximum time limit on guarantees has also been removed. The annuity can pay out for any period following the member’s death, provided it is set out in the initial annuity contract. The open market option requirement has been removed too. The member no longer has to be given the opportunity to select the insurance company from which he buys an annuity, though this can still be offered.

Buying a lifetime annuity will not trigger MPAA.

New benefit options: As is often the case, there is a fine line between designing a new, simpler benefit regime and offering transitional rules that preserve existing benefits where possible.

From April 2015, money purchase schemes will be able to offer any combination of the following four ways of taking benefits:

• Income drawdown: this will now be known as flexi-access drawdown.

• Taking a single or series of lump sums from uncrystallised funds: known as uncrystallised funds pension lump sums (UFPLS).

• Buying a lifetime annuity.

• Scheme pension.

Capped drawdown will not be an option for new entrants.

Mike Morrison is platform marketing director of AJ Bell