Your IndustryApr 1 2015

Retirement income options from April 2015

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Individuals who opt for an annuity can still make tax-relievable pension contributions up to £40,000 a year.

New flexible annuities may also be developed as the government has relaxed rules on what this type of product must deliver, including longer guarantee periods and the ability for income to decrease.

Payments from a flexible annuity limit tax-relievable contributions to £10,000 a year.

In terms of what happens to the pot on death before the age of 75, and if a joint life annuity was purchased, the annuity payments will be made tax free.

While the new flexibilities will offer the opportunity for products to be launched that better reflect the new, flexible pension climate, what puts many off annuities is the decision to purchase one is irrevocable.

Unless the customer bought a dependants pension, David Macmillan of Aegon points out the pension dies with you, so there is limited opportunity to pass on funds to loved ones.

Drawdown

Turning to drawdown, the new simpler flexi-access income drawdown allows people to manage their income throughout retirement, giving control and flexibility.

People can take as little or as much income as they like and flexi-access drawdown gives people the ability to manage their income tax position.

With flexi-access drawdown funds continue to be invested – so there is the potential for investment growth. Unused funds at date of death can be passed on to loved ones with flexi-drawdown.

If death is before the age of 75, dependants pay no tax on the lump sum or income, allowing funds to be passed down the generation tax-free up to the lifetime allowance. Over age 75 the fund is passed on free but income will be taxed at marginal rates.

Ultimately flexi-access income drawdown allows flexibility, so by using this option you leave the door open to purchase an annuity with unused funds at a later date.

Cash can therefore be ring-fenced to use to pay for things such as long term care costs. On the downside, there is a risk that people can run out of funds if they drawdown too much.

Online tools could help with flexi-access income drawdown, but Aegon’s Mr Macmillan points out advice may be needed.

Ultimately this option may not be suitable for everyone, as some savers may not have the risk appetite or their pension pot may be too small.

As income drawdown is classed as a flexible product, once an individual has taken more than the tax-free cash sum of 25 per cent, Mr Macmillan says future tax-relievable contributions are limited to the new money purchase annual allowance of £10,000 a year, instead of £40,000.

Cashing in

People can cash in their entire pension pot, or receive ad-hoc payments with 25 per cent of each payment is tax-free, an option known as the ‘uncrystallised fund pension lump sum’.

There are no limits on the amount that can be taken in cash and any money left in the pension pot will pass tax-free to the individual’s beneficiary where the amount is within the lifetime allowance, with death under the age of 75 allowing future withdrawals to be made tax free.

Any money at date of death which has been moved out of the pension, will form part of the individual’s estate and taxed accordingly. Like an annuity, the decision to cash in your pension is irrevocable.

For the UFPLS option, the whole amount crystallised will be paid out in one go and 25 per cent will be tax free.

There are restrictions on who can use these payments, excluding anyone with enhanced or primary protection with a tax-free cash protection attached, or a standalone lifetime allowance enhancement factor.

Mr Macmillan points out many schemes will not offer cashing in options and people may have to transfer to get access to their cash. Others will allow access, but could charge hundreds of pounds for ad hoc lump sums, limit the frequency of withdrawals, or insist on minimum sums left in cash.

In terms of the tax ramifications, cashing in your pension moves the pot out of a ‘tax-protected environment’. Moreover, large withdrawals will be initially taxed at emergency rates, with clients needing to claim the money back later.

Talbot & Muir’s Claire Trott warned that for those not already in receipt of an income from their provider an emergency tax code will be used, which will assume the amount paid is a newly recurring monthly instalment and tax it accordingly.

This could see taxes of as much as 45 per cent applied to any amount above £12,500, with 40 per cent likely to kick in on amounts of over £3,500. These amounts could even be lower if the individual is already receiving state pension.

Ms Trott added that any overpayment may not be able to be reclaimed until the end of the tax year, as “if the fund is not extinguished there is no P45 to be used to reclaim the tax mid-year”.

The government has said that anyone taking cash who then subsequently runs out of money in the fund will be considered to have deliberately drained their fund and could lose their right to state benefits.

Future tax-relievable contributions with this option are also limited to £10,000 a year, rather than £40,000.

Triviality

For small pots, there will be the ability to cash in small pots provided the value is less than £10,000 and the total value released is less than £30,000. Individuals in this bracket will still be allowed to continue to make tax-relievable contributions of £40,000 a year.

This is because the small pots are not counted towards an individual’s lifetime allowance of £1.25m. There is no limit on the amount of small pots that can be cashed in under trust-based schemes.

This option allows savers to consolidate tiny pots into small pension pots to then cash them in.

These are lump sum payments made up of 25 per cent tax free lump sum and 75 per cent taxed income.

Death benefits

In terms of all the retirement income options, Talbot & Muir’s Ms Trott says the death benefit changes will be the most significant under the new regime for many advisers, giving greater options for intergenerational planning.

Firstly, she says the difference between crystallised and uncrystallised funds has been removed when looking at tax charges on death.

The main differentiator is if the member dies before or after their 75th birthday. The rules regarding who can receive a beneficiaries’ drawdown has also been changed to include non-dependent beneficiaries.

On death before the age of 75, the beneficiaries can take a lump sum tax free or designate to dependants drawdown from which income will also be paid tax free.

Uncrystallised benefits where taken as a dependant’s drawdown will now be tested against the lifetime allowance, whereas previously it was not.

If the death is after age 75, then lump sums taken in 2015 to 2016 will be taxed at 45 per cent and the beneficiary’s marginal rate thereafter. If taken as a beneficiary’s drawdown then income payments will be taxed at the beneficiary’s marginal rate.

On subsequent death of a beneficiary in the beneficiaries are in drawdown the tax treatment for the next beneficiary - called a successor - will be reviewed in relation to the current beneficiary’s age at death.