In a role I previously held we used to wait years for a decent pension change to come along and when one did, getting people interested was sometimes not easy. Compare that with what has happened so far this year.
The changes are truly radical and have continued to catch us by surprise. There is no long lead-in time, either – implementation is from 6 April 2015. With the Taxation of Pensions Bill now confirming the changes, the majority of which have been previously announced, there is less than six months to go.
Choice
The changes are about flexibility and choice for those individuals with defined contribution pension funds (for example, individual or group personal pensions, stakeholder pensions, self-invested personal pensions and additional voluntary contributions). They do not apply to individuals with defined benefit arrangements. The flexibility will be available for those who have reached the normal minimum pension age (currently 55).
The change that first shook us was announced by the chancellor in his Budget speech in March 2014. This was that individuals with defined contribution arrangements would be able to take as little or as much of their pension pot as they wished – there would be no minimum or maximum.
The changes will introduce a distinction between drawdown pension funds created before 6 April 2015 to which the existing rules may continue to apply, and drawdown pension funds first created on or after 6 April 2015, which are called ‘flexi-access drawdown funds’. There are no restrictions on the amount of withdrawals that can be made from these.
Tax-free cash continues to be paid as a lump sum before any drawdown is paid. Drawdown funds set up before 6 April 2015 can continue to be used for capped drawdown. However, an individual with an existing drawdown fund may convert it into a flexi-access fund so that unrestricted withdrawals can be made. All existing funds used for pre-6 April 2015 flexible drawdown will automatically become flexi-access drawdown funds.
An alternative option to a flexi-access drawdown fund is an ‘uncrystallised funds pension lump sum’ or UFPLS. This is the option that has grabbed the front pages with headlines of ‘pensions to be bank accounts’. Under this option, individuals can access as much of their fund as they wish, without having first to designate the funds as available for drawdown; of each payment, 75 per cent will be taxable as pension income at the individual’s marginal rate of tax and 25 per cent will be tax-free.
An individual will not be able to use UFPLS if he has either primary or enhanced protection along with the right to a tax-free lump sum of greater than £375,000 on 5 April 2006.
However, is this change really new? Under the existing rules it has been possible to ‘phase’ drawdown; it is just that this facility has not been widely available or used. Phasing has been used, for example, where an individual wished to receive a certain amount of drawdown each month, and each payment would consist of tax-free cash and taxable pension.
If an individual accesses his fund from an UFPLS, a flexi-access drawdown fund (someone just taking a tax-free lump sum is unaffected) or a flexible annuity, he will be subject to a £10,000 ‘money-purchase annual allowance’ (MPAA).
An individual continuing with capped drawdown, which commenced before 6 April 2015, and remaining within his drawdown limit, will retain the £40,000 annual allowance (this generates a planning opportunity for the next six months) as will an individual with defined benefits, although in the latter the allowance will depend upon the value of their money-purchase saving.
It appears that individuals who were in flexible drawdown prior to 6 April 2015, and who will be converted to flexi-access drawdown, will be allowed to make contributions of up to £10,000; currently they are not allowed to make further contributions.
The MPAA cannot be increased by unused annual allowance from previous years. Needless to say, there are some complications surrounding the calculation of the MPAA and its interaction with other rules.
The announcement by the chancellor at his party’s annual conference of the abolition of the tax on death when funds are in drawdown was a welcome change. Currently, on the death of the member, it is only possible for someone to pay his pension fund free of tax if he has not started drawing benefits and is under the age of 75. If drawdown was being taken then the fund would be subject to a tax-charge of 55 per cent.
I have focused on drawdown, but annuities will, of course, still be available and important. The changes will allow all the different categories of annuities to reduce as well as increase in value. In some circumstances this will trigger the MPAA. Lifetime annuities will no longer be subject to the maximum 10-year guarantee period. Buying a short-term annuity will also restrict the annual allowance to the MPAA.
The minimum age for taking trivial commutation and small pot lump sums will be reduced from the age of 60 to the minimum pension age (currently 55). At the same time the trivial commutation lump sum death benefit will increase to £30,000. These lump sums will only be available from defined benefit schemes as, with the other changes being introduced, they are redundant for defined contribution schemes.
And finally, as a further step to ensure individuals do not exploit the new rules, the total amount from tax-free sums that can be ‘recycled’ is being reduced to £7,500.
The government expects about 130,000 individuals a year will take advantage of this new flexibility, as against about 5,000 individuals who used flexible drawdown. Scheme trustees and managers will be able to utilise a scheme override to take advantage of the new rules.
Welcome it or not, this brave new world is fast approaching.
Colin Batchelor is an independent pension consultant
Key points
■ The recent pension changes are truly radical and have continued to catch us by surprise.
■ There are no restrictions on the amount of withdrawals that can be made from the ‘flexi-access drawdown funds’.
■ Annuities will remain available and important.
Chancellor’s reforms
The changes being introduced from next April mean the following: for those who die before the age of 75 there is no tax charge.
Beneficiaries can receive a lump sum tax-free. If they wish to draw an income this is also tax-free.
An annuity can be paid, but only to dependants, and this will be taxed; for those who die on or after the age of 75 there are three options for the beneficiaries:
* Take the fund as a lump sum. This will be taxed as an interim measure at 45 per cent initially, but it is planned to move to the beneficiary’s (ies’) marginal rate of tax from April 2016.
* Take drawdown payments or purchase an annuity (dependants only) with the income on both being subject to tax at the beneficiary’s (ies’) marginal rate.
* Take lump sums through drawdown, again subject to tax at the beneficiary’s (ies’) marginal rate. For anyone in drawdown who dies before 6 April 2015, serious consideration should be given by the beneficiaries to not taking any benefits from the deceased’s drawdown fund until after the new rules come into effect on 6 April 2015.