The new rules helping to unlock your pension

How will changes to annuities affect your pension?

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This year’s Budget caught the pensions industry by surprise. The Chancellor’s announcement that he would be introducing the biggest relaxation in how pension benefits are drawn for decades was not at all expected. So what are the changes and what do they mean for you, if you’re planning, or approaching, retirement?

What are the key changes?

1. For those who choose capped drawdown, the maximum amount of income they can take has increased from 120 per cent of the Government Actuary Department (GAD) limit to 150 per cent, i.e. an increase of a quarter.

2. For those who want unlimited withdrawals from their drawdown fund (called flexible drawdown) you used to have to have at least £20,000 a year guaranteed income which was defined as state pensions, final salary pensions and annuities. This has now been reduced to £12,000 per annum and the government intend to remove this altogether from April 2015 so that everyone can take an unlimited amount of income or capital out of their pension fund at any time in retirement.

3. From April 2014, those with a pension fund of up to £30,000 or up to three funds with up to £10,000 each to fully convert these without buying an annuity or going into drawdown.

Death while in drawdown

The government are also reviewing the tax treatment for those in drawdown when they die. One advantage of drawdown is that when you die any remaining funds pass to your nominated beneficiaries such as your spouse or children, as opposed to an annuity where the fund is lost on death. There is though currently a 55 per cent tax charge on death (though no inheritance tax) and the review is looking at potentially reducing this, perhaps to income tax rates, from April 2015.

Finally, the government recognise retirement options are complex and people need advice at retirement for what is one of the most important financial decisions they will make in their lifetime. As a result, it is planned that everyone reaching retirement will be given access to independent financial advice to help them make this decision from April 2015, though precisely how is still be consulted on.

“Be wary of converting your whole pension fund, as you will pay income tax on three quarters of it – potentially taking you into higher rate tax, even if you have never paid 40 or 45 per cent tax before”

What does this mean for me?

That more flexibility and choice is being offered is good news though the potential for making the wrong choices potentially increases. Much has been mentioned in the press about buying Ferraris and similar, but for most fully converting your pension won’t be the most tax-efficient option.

Why?

1. Because though 25 per cent of a pension fund is typically available tax free as a lump sum the balance of the fund is taxed as income. Therefore if you decide to fully convert your pension fund you will pay income tax on three quarters of it – potentially taking you into higher rate tax, even if you have never paid 40 or 45 per cent tax before. The Chancellor estimates HMRC will take an extra £1.5 billion pounds in tax next year as a result of the changes!

2. Pension funds have tax favoured tax treatment in a similar manner to ISAs, but when you take your money out of your pension unless you put it in an ISA the tax advantages are lost.

Consideration also needs to be given to where your income in retirement is going to come from. If you convert your pension and spend the proceeds what are you going to live on?!

Annuities will also remain appropriate for those who want or need a guaranteed level of income and shouldn’t be ignored simply because they don’t have the flexibility of drawdown.

Hopefully it is apparent that expert professional advice is essential, especially when close to retirement. The new rules offer greater flexibility but also the opportunity to make costly mistakes. Find a whole of market financial adviser near you.

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About the author

Roland Jones has worked in the financial services industry for over 25 years having joined straight from university. He has been an IFA for 20 years with a specialisation in pensions.

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