You’ve probably heard quite a kafuffle about the personal pension changes due to take effect on the 6thApril 2015. Perhaps you’re planning to buy that sports car that has been enticingly dangled in front of you by the media which has told you it’s OK to pull all of your money out of your pension pot?
However, as with many stories in the media, there are details behind the headlines that you need to consider so before you pilfer your pension, give Midland Financial Solutions Director and Chartered Financial Planner, Kevin Edwards, a chance to explain what’s really going on behind the hype….
In the Budget of March 2014, the Government announced some of the most radical changes to Pension Legislation in recent history and those changes will be coming into force on 6thApril 2015.
Overall the new regulations are very positive, giving all of us more control over our personal pension funds and allowing members of ‘Defined Contribution’ Pension Schemes unrestricted access to their pension pots after the age of 55. But it’s important to know the potential drawbacks before you make any decisions, so what are the current pension guidelines?
What’s the current situation?
Currently an individual can usually take 25% of their pension fund as a tax-free lump sum, but the remaining fund has to be used to provide some form of pension income (although the income doesn’t have to be taken immediately).
A popular and traditional method of securing a pension income was to buy a Lifetime Annuity, effectively swapping your remaining pension pot for a guaranteed level of income for the rest of your life. This guarantees a set amount income as long as you live, but you don’t have any flexibility in your income. Once an annuity is set up, it can’t be changed and annuity rates have been historically low (as they are mainly linked long-term interest rates) – so Lifetime Annuities aren’t perfect, although they still have a place for some. However, there are also alternatives.
One alternative option to a Lifetime Annuity is Pension Income Drawdown, which can provide the flexibility to vary the level and frequency of the income taken and also pass on the remaining funds on death (less a rather nasty 55% tax charge at present, if passed on as a lump sum*). However, ‘Capped Drawdown’ has a limit on the maximum amount of income that you can take each year. Of course, this option isn’t without potential drawbacks either. An individual effectively takes on the investment risk – for example, if the underlying investments fall sharply or fail to grow enough over time to replace the income being spent, the fund could be completely eroded.
*The Government are also proposing changes to how pension lump sum death benefits will be taxed from April 2015, which should be less punitive from a tax perspective.
What’s changing with the new legislation?
From April 2015, individuals could in theory take all their pension fund as a lump sum. However, before you head to the bank to spend, spend, spend – there’s a few catches! Apart from your tax-free cash entitlement, the remaining funds taken would be taxed as if you’ve earned the income!
This means that if you chose to take large amounts of capital from your pension, it could result in you having to pay Higher Rate (40% for 2014/15) or even Additional Rate (45% for 2014/15) Income Tax!
And as if that wasn’t bad enough, if you wanted to continue making pension contributions, as well as taking an income, you could find that the amount you are able to contribute in the future is significantly limited, which could severely restrict Business Owners’ ability to take money out of their companies in a very tax efficient manner.
Other drawbacks to be aware of are that taking chunks of capital from your pension could affect your eligibility for means-tested State Benefits and would also count as capital if ever you were assessed for residential or nursing care fees.
Also, anyone with a potential Inheritance Tax (IHT) liability should seriously consider their situation, as under the new rules being introduced pension funds can potentially be passed on to children and grandchildren free of tax, whereas taking the capital out of the pension ‘wrapper’ will result in those assets sitting in your taxable Estate!
Will the changes automatically apply to me?
It depends what type of pension you have. The scope of the legislation includes Personal Pensions, Stakeholder Pensions, Retirement Annuity Contracts, Self-Invested Pension Plans (SIPPs) and Small Self-Administered Schemes (SSASs). However, the legislation changes do not extend to members of ‘Defined Benefit’ Pension Schemes (also known as Final Salary Pensions) or Section 32 ‘Buy-Out’ plans, which were used in the past to secure pension benefits for members of Occupational Pension Schemes that were ‘Wound-Up’.
Although the legislation allows extra flexibility, members of older pension plans may find that their pension provider is unable (or unwilling) to offer the same level of flexibility so it’s important that you check what your options are.
What’s the good news?
If you want or need access to your money, then it is good news. You’ll have complete flexibility as to how much you can take from your pension funds. However, if you are considering choosing this option, it’s vital that you think seriously about your overall financial planning – it would be very easy to spend your pension funds too quickly, leaving you short of income in retirement, and that’s not where you want to be!