A pension becomes a genuinely versatile tool

Some investors consider the accessibility restrictions on pensions and the potential high taxation on death unappealing. However, the new pensions rules coming into force in April will change how pensions are used.

Investors have greater flexibility when accessing income and capital as well as greater choice and lower tax when passing on unused funds. In addition, the new rules confirm that the traditional advantages of pensions, such as tax relief on contributions, will be retained.

Among the key changes is more flexibility in income withdrawal. Once an investor reaches age 55, they will be able to take out any level of income and have no restriction on the frequency of withdrawals. An investor will continue to be able to take up to 25 per cent of their fund as a tax-free lump sum with additional income being taxed at their marginal rate. Furthermore, investors already using flexible drawdown will have the opportunity to contribute up to £10,000 per annum for the first time.

Under current rules, flexible drawdown investors (who must be in receipt of at least £12,000 per annum of guaranteed pension income) can utilise complete income flexibility. For anyone else, the choices are limited to either an annuity or capped drawdown.

The new rules introduce flexi-access drawdown, allowing investors to take control of their income by being able to vary it at any time should their circumstances change.

Usually, pension funds are held outside of the investor’s estate for inheritance tax purposes. Currently, a pension can only be paid out tax-free when death occurs before age 75 and benefits have not been taken from the fund. Otherwise a lump sum less 55 per cent tax or regular income less the dependant’s marginal rate, would be paid. From April 2015, should the investor die before reaching age 75, they can pass on their pension tax-free.

If they die after age 75, the pension is passed on free of tax but any capital or income withdrawals are subject to tax at the beneficiary’s marginal rate, or less 45 per cent should death occur in tax year 2015-16.

Additionally, the rules governing who can receive the pension are being relaxed, permitting anyone to be nominated as a beneficiary.

Where investors are concerned over the inheritance tax liabilities of their estates, they have the opportunity to decrease the value of their estates by transferring assets into their pensions.

Where death is likely to occur on or after age 75, careful planning can ensure the succession tax bill is minimised by including basic rate or non-taxpayers, such as grandchildren, as beneficiaries.

The same age-related tax position will apply when the beneficiary dies. Along with the pension funds they themselves have saved, they will be able to pass on inherited funds free from inheritance tax to their own beneficiaries, known as successors. This change represents the introduction of multigenerational tax planning, providing beneficiaries with opportunities to pass on any unused assets in a way that cannot be matched by any other mainstream investment vehicle.

The new rules enable a pension to become an increasingly versatile tool within an investment portfolio. They will provide tax relief on contributions, tax-free growth during accumulation, flexible income in retirement, and the opportunity to pass on assets to anyone tax efficiently. Using pensions in combination with alternative investment options will provide investors with a comprehensive and flexible long-term investment solution.

Paul Evans is pension technical manager at Suffolk Life