Fine-tuning the big pensions shake-up

On 21 July the Treasury issued its response to the Budget consultation which ended on 11 June, providing further clarification on a range of potential changes.

A permissive statutory override will be introduced to ensure all defined contribution schemes are able to offer their members increased flexibility.

The government explained that the introduction of a statutory override mandating that schemes provide flexible payments would be disproportionate. However, some schemes may like to offer flexibility to their members, but would prefer not to amend their scheme rules because of the potential legal and administrative costs.

In these situations, the government would prefer the schemes were in a position to provide flexibility without having to amend their rules.

Having a permissive statutory override allows schemes to ignore their scheme rules and follow the tax rules instead, to pay out payments flexibly or to provide a drawdown facility.

Individuals will be able to transfer between defined contribution schemes up to the point of retirement if their scheme does not offer flexible access.

The government will make a number of changes to the tax rules to allow providers greater freedom to create new and innovative products that more closely meet consumers’ needs, including allowing annuities to decrease and allowing lump sums to be taken from annuities.

The government intends to change the current tax rules in order to:

■ Allow lifetime annuities to decrease;

■ Allow lump sums to be taken from lifetime annuities;

■ Remove the 10-year guarantee period for guaranteed annuities;

■ Allow payments from guaranteed annuities to beneficiaries as a lump sum, where they are under £30,000.

New tax rules will be put in place to ensure individuals do not use the new flexibilities —which are intended to provide people with greater access to their retirement savings — to avoid tax on their current earnings by diverting their salary into their pension with tax relief, and then immediately withdrawing 25 per cent tax-free.

All in all though, three cheers from me for Mr Osborne

Those who choose to draw down more than their tax-free lump sum from a defined contribution pension will be able to benefit from further tax-relieved pension saving, and make further tax-free contributions to a defined contribution pension of up to £10,000 a year.

Those currently in ‘flexible drawdown’ have an annual allowance of £0 (they are unable to make further pension contributions under the current rules), but from April 2015 will be subject to a new annual allowance limit of £10,000.

Those who draw more than their tax-free lump sum from a defined contribution pension will still be able to benefit from further tax-relieved pension saving, and make further tax-free contributions to a defined contribution pension of up to £10,000 a year.

This means that following their first flexible withdrawal, an individual will be able to contribute up to £10,000 a year with tax relief to a defined contribution pension.

This £10,000 annual allowance will only apply if an individual accesses a defined contribution pension worth more than £10,000.

Individuals can make withdrawals from three small pension pots and unlimited small occupational pots worth less than £10,000, without being subject to a £10,000 annual allowance on subsequent contribution.

The current ‘capped drawdown’ system will be ‘grandfathered’ for those in capped drawdown on 5 April 2015.

This means that those in capped drawdown at this point will not have a £10,000 annual allowance but will have the full annual allowance. However at the point they withdraw more than the capped amount, they will have a £10,000 annual allowance.

The government believes it would be unfair to apply the £10,000 annual allowance to this group of individuals, as they entered capped drawdown without the knowledge that they would be subject to such a rule.

The government will increase the minimum age at which people can access their private pension under the new tax rules from 55 to 57 in 2028. The change will apply to all pension schemes aside from those in the public sector that will not link their normal pension age to state pension age from 2015 – namely for the firefighters, police and armed services.

The government is clear that the 55 per cent tax charge on pension savings in a drawdown account at death will be too high when the new system is established in 2015. The government intends to announce the changes in this year’s autumn statement.

Defined benefit schemes

The government will continue to allow transfers from private sector defined benefit to defined contribution schemes (excluding pensions that are already in payment). The government will, however, introduce two new safeguards to protect individuals and pension schemes.

■ There will be a new requirement for an individual to take advice from a professional adviser who is independent from the defined benefit scheme and authorised by the FCA, before a transfer is accepted;

■ There will be new guidance for trustees on the use of their existing powers to delay transfer payments and take account of scheme funding levels when deciding on transfer values. At present, pension fund trustees have the power to ask the regulator for a longer time to make transfer payments if the interests of the members, or the scheme generally, will be prejudiced by making the payments within the usual period.

■ The government intends to consult on removing the requirement to transfer first to defined contribution schemes for those defined benefit members who wish to access their savings flexibly.

■ The government continues to believe that transfers from unfunded public service defined benefit schemes should be banned (there is not any money there). Transfers from funded defined benefit to defined contribution schemes will be permitted, and safeguards similar to those in the private sector will be introduced where appropriate.

As set out in the consultation document, the trivial commutation and small-pot rules will continue to apply to defined benefit schemes.

These rules allow individuals to take up to £30,000 of total pension savings as a lump sum, or a £10,000 small pot as a lump sum regardless of total pension wealth. The age at which an individual can make use of these rules will also be lowered from 60 to 55.

These are the biggest changes to pensions for more than 100 years and generally are all positive.

The following are some points to particularly note:

■ The Treasury acknowledges there are circumstances where individuals may find it advantageous to transfer out of a defined benefit scheme (such as debt management, health status or family situation, that is, the transferor is single.) It is, however, very sensible that such transfers will be subject to regulated advice that will highlight the potential disadvantages of such action.

■ Those under the age of 43 should note the proposed increase in the minimum pension age from 55 to 57 in 2028, and the proposal that this will increase further as the state pension age increases.

■ For those individuals in flexible drawdown, the new rules mean there will be an opportunity to make tax-relievable contributions up to £10,000 a year into their pension that was previously unavailable.

■ For those currently in capped drawdown, the ‘grandfathering’ of current withdrawal limits, which if breached will mean a fall in annual allowance from £40,000 to £10,000, will need to be monitored closely by those in this position.

All in all though, three cheers from me for Mr Osborne.

Andy Gadd is head of research at Lighthouse Group

Key points

■ The Treasury has provided further clarification on a range of potential changes announced in the Budget.

■ The government will make a number of changes to the tax rules to allow providers greater freedom to create new and innovative products.

■ The trivial commutation and small-pot rules will continue to apply to defined benefit schemes.