Budget 2014 was expected to yield few surprises with many commentators predicting that the Chancellor would save any notable changes for 2015 in the run up to the next election.
However, George Osborne announced radical reforms to UK pension rules which (although subject to consultation) should result in individuals being able to have full flexibility and freedom to do what they want with the pension savings they have accumulated.
Whilst the reduction of the annual allowance to £40,000 and lifetime allowance to £1.25m from 6 April 2014 were already known, there were radical reforms proposed with regards to how individuals can access their pension benefits.
Changes from 27 March 2014
Flexible Drawdown: The yearly guaranteed minimum income requirement which is needed to allow someone to access flexible drawdown has been reduced from £20,000 to £12,000. This means that anyone who can demonstrate they have £12,000 of ‘guaranteed’ pension income (e.g. from state pension and/or annuities) will not be subject to any restrictions on the level of withdrawals they can take from their drawdown arrangement.
Capped drawdown: For individuals who are ineligible for flexible drawdown but who still want the flexibility to draw an income from an invested pension fund without buying an annuity, the maximum yearly income limit has been increased from 120% to 150% of the otherwise available annuity based on GAD tables. This increased income amount applies to drawdown income years starting after 26 March 2014.
Triviality limit increased from £18,000 to £30,000: Individuals over age 60, with total pension savings of £30,000, or less, can now take all their pension savings as a trivial commutation lump sum.
Small pots limit increased from £2,000 to £10,000: For individuals over age 60, small pension pots of up to £10,000 can also now be taken as a lump sum and the number of small personal pension pots that can be taken as a lump sum has been increased from two to three. These payments can be made regardless of the value of the individuals total pension savings and can be made in addition to any trivial commutation lump sum payments.
Changes from 6 April 2015
From 6 April 2015, everyone in a defined contribution (DC) scheme will be able to access their entire pension from age 55. The pension commencement lump sum will remain tax free. Any income can then be drawn without limit and will be taxed at the saver’s marginal rate for income tax.
These proposals, assuming they remain unchanged, will therefore provide significantly more choice for pension savers. It should be noted, however, that the government has proposed a ban other than in exceptional circumstances, for a member of a public sector defined benefit (DB) scheme to transfer to a DC scheme. The Government will consult on whether, and if so to what extent, similar restrictions should be imposed on transfers from private sector DB schemes to DC schemes.
What does this mean for annuities?
Whilst the reaction in the financial markets appeared to be based on an assumption that investors will shun annuities the reality is that this conclusion is not necessarily correct as many pensioners will still require security of income in old age and many will be relying solely on their pensions to provide this.
In addition, for many people it may simply not make sense to extract a fund, the majority of which may end up subject to higher rate tax, only to then invest in products where income and gains are taxed further.
However that is not to say that annuity rates would not come under pressure if the proposals go ahead. The clear argument against annuities of course was always that, unless purchased with a guarantee period or dependents pension, they offered poor value if the annuitant died in the early years and including these options added to the cost.
Although at present there isn’t a compulsion to purchase an annuity, the budget proposals arguably result in annuity purchase becoming even more of a voluntary choice. This could therefore mean that individuals wanting to purchase an annuity might disproportionately be those who expect to live a long time. Insurers may then be forced to respond by reducing annuity rates and demand may fall further to just those who expect to live a long time.
Clearly though, with historically low gilt yields and many individuals failing to shop around for the best annuity rate it is clear that the government feels the annuity markets are not working. The hope and expectation is that giving more flexibility will prompt providers of retirement income products to develop more innovative solutions to better meet the needs of pensioners.
Whilst making pension savings more accessible will be welcomed in many quarters this has come as a surprise, particularly given the focus on Britain’s pension savings ‘gap’ in recent years and against the backdrop of auto-enrolment. What is clear is that advice is essential to ensure you make the correct decision.
For further information on how these pension changes may affect you please contact us directly. This article is for information purposes and should not be construed as advice. You should contact an Independent Financial Adviser to clarify any of the issues raised. Quest Financial Solutions do not take any responsibility for actions taken as a result of reading this article