Updated 13 March 2018
New pension rules came into effect in April 2014. Here are three things you must know pre-retirement to make sure you don’t lose money from your pension pot.
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Pensions is a fast-moving marketplace, considering these are plans you are likely to save into for 30 years or more before you retire. This year is notable because the government has made the biggest overhaul of the pensions regulations since 1921, which is creating a vast in the way you can take your pension when you retire. In short, once you have taken your 25 per cent tax-free lump sum, you can then take the remainder of your pension as and when you wish from April 2015.
“From April 2015, you will be able to take your pension as you wish and do with it whatever you wish. This means you can withdraw your entire pension in one go if they wish and spend it on anything they like”
Even before this year’s Budget on 19 March, there were already plans to change the rules on how you could build your pension and these were implemented as planned on 6 April. But for those looking to maximise their pension savings now, there are three main things to consider to prevent unwanted tax bills in later years:
Failing to deal with any one of these on its own could be sufficient to derail your pension plans, but thanks to their inherent interaction, you cannot deal with any in isolation without running the risk of a triple whammy at retirement.
So, what does it all mean?
1. You can take your pension however you wish from April 2015
There was a massive change in the pensions regulations announced in the Budget, with the complete removal of stipulations about how you can take your pension once you retire. Until now, those over 75 have been able to take 25 per cent of their pension tax-free and then have been required to either take an income through drawdown of their pension pot thereafter, or to buy an annuity which will give them an income for life.
“The minimum secured pension income needed to apply for flexible drawdown has been reduced from £20,000 to £12,000, and you can take three small pension pots as lump sums under the new rules, instead of two”
But in the biggest pension rule shake-up in living memory, the Chancellor George Osborne announced that from April 2015, you will be able to take your pension as you wish and do with it whatever you wish. This means you can withdraw your entire pension in one go if they wish and spend it on anything they like. The tax charge will be reduced – from the current rate of 55 per cent if you choose to withdraw your entire pension in one go – to whatever their marginal tax rate is in that year. So it could mean that people with low incomes could pay no tax at all on their pension withdrawals and this will apply from age 55.
In the meantime, there have already been changes made to the rules relating to drawdown which will help to increase the flexibility for people who are taking their pension income this year. The Chancellor announced a rise in the capped drawdown limits from 120 per cent of an equivalent annuity to 150 per cent from 27 March. In addition, the minimum secured pension income needed to apply for flexible drawdown has been reduced from £20,000 to £12,000 for the same date, and you can take three small pension pots as lump sums under the new rules, instead of two. While this may be of less use to executives, it could certainly be useful for other family members who may have saved less into a pension over the years.
2. The lifetime allowance has dropped to £1.25m and you have lost one fifth of the annual allowance
The lifetime allowance – the amount you are allowed to have in a pension without incurring a hefty tax charge from HM Revenue & Customs – has reduced from £1.5m to £1.25m. You have also had the amount you can put into a pension and still gain tax relief cut from £50,000 a year to £40,000 for the 2014/15 tax year, which means you will have to think carefully about how you will use your money to maximise your family’s pension savings.
Anyone exceeding the lifetime allowance when they retire – and remember, this not only includes payments made into your pension and tax relief, it also includes investment growth – will face a tax charge of 55 per cent on anything above the limit. So this would mean someone having over £1.25m in their fund this tax year could face a tax bill of £137,500.
Acting prior to the rule change on 6 April would have given you access to fixed protection, which would have protected your fund and any growth up to a maximum of £1.5m. But you can still apply for individual protection if your fund was valued at between £1.25m and £1.5m on 5 April, which is less beneficial but means you can still accrue benefits as an active member of a pension scheme.
Executives are likely to have generated substantial pension pots at a variety of companies they have worked with and not checking how much each is worth could potentially leave them open to this tax charge if they breach the limit. Given that nearly two thirds of pension holders do not know the value of their combined pension savings and that one in four men have more than three pension pots this could be a relatively large problem among higher earners.
An additional difficulty is added if you consider that the state retirement age will rise to 68 by the mid-2030s, meaning there is more time for the funds to grow beyond the £1.25m cap if they are not regularly checked. So you will need to work carefully and consistently with your adviser to keep your pension fund below this limit.
The fall in the annual allowance is expected to hit around 140,000 people and the limit has been severely eroded from £255,000 in 2011. If you are regularly using the full allowance, you will have to consider alternative means to deal with your pension planning, which could include putting additional money into your spouse’s pension to secure your joint standard of living when you retire.
These additional payments to other pensions are not limited to £3,600 despite a widespread misunderstanding of the rules and a good adviser can help you maximise your wealth distribution, whether it is into a relative’s pension pot, or alternatively to another type of investment that would be more suited to your needs.
Of course, you also need to ensure that you are claiming all of the tax relief available to you from your pension payments, as you may need to claim the higher rate tax relief on a self-assessment form from HMRC.
3. Auto-enrolment could hit your pension protection
As if that was not enough, you may also fall foul of the new auto-enrolment rules which are designed to help employees. While auto-enrolment is widely considered to be a good thing for the majority of people because it encourages pension saving where previously there may not have been any, as an executive it could potentially harm your pension planning.
“Without this protection, any amount you have built up in your pension pots over and above the £1.25m limit which came into force in April, will face a 25 per cent tax charge”
The reason is that auto-enrolment is a statutory requirement for all companies employing staff and will also be applied to executives of the company. If you have previously taken, or plan to take within the next month, enhanced or fixed protection of your life allowance then being in an auto-enrolment scheme has the unwelcome side-effect of removing any prior or current protections you have in place.
Unless you opt out of the scheme within the first month after you have been auto-enrolled, you will be considered as a member of the scheme by HM Revenue & Customs, and consequently lose any lifetime allowance protection you had put in place.
Without this protection, any amount you have built up in your pension pots over and above the £1.25m limit which came into force in April, will face a 25 per cent tax charge if you use the additional amount to generate a pension,or at 55 per cent if you take the additional amount as a lump sum.
What you should do now
The way that these rule changes intertwine mean you cannot simply plan to mitigate one of them without having a potential impact on another. So you should take advice as soon as you can to make the most of your pension planning for the coming years without having to be concerned about additional tax charges or a loss of income.
About the author
Alan Smith is the CEO of Capital Asset Management. His specialisms include: wealth management, strategic financial planning and creative tax planning.
Please note: The opinions, beliefs and viewpoints expressed by our contributing authors do not necessarily reflect the opinions, beliefs and viewpoints of unbiased.co.uk.