George Osborne stunned pension savers, financial advisers and Annuity providers alike, with his proposals in the Budget, that from April 2015 it would no longer be a requirement to provide an income from a pension and the whole fund could be taken as a lump sum.
So what’s changed? How will you be affected? Is it good or bad news if you are close to retirement?
We’ve got all the answers.
Let’s start with the basics, exactly what changes are proposed?
First things first,we should all remember these are currently just proposals. We will now enter a period of consultation, which could see changes between what is currently proposed and the final set of rules.
Now let’s confirm the type of pensions which are affected, they are:
- Personal Pensions (including Group Personal Pensions)
- Stakeholder pensions
- Self-Invested Personal Pensions (SIPPs)
- Small Self-Administered Schemes (SSAS)
- Defined Contribution Occupational Pensions (not Defined Benefit or Final Salary schemes, such as those NHS employees or teachers are members of)
At the moment most pensions can be taken from the age of 55, with up to 25% of the pension pot available as a tax-free lump sum and the balance providing an income.
Most people use an Annuity to generate income; in fact 440,000 were bought over the past year, according to figures from the Financial Conduct Authority (FCA).
Alternatives to an Annuity include:
- Income Drawdown, also known as Capped Drawdown
- Flexible Drawdown
- Investment Linked Annuity
- Fixed Term Annuity
So what are the proposed changes?
- From April 2015 pensioners will still be able to take up to 25% of their pension pot from age 55 onwards. But, there will be no restriction on the amount of income they can take, in fact if they wish the whole fund can be taken as a lump sum; this is a massive change, possibly the biggest in a generation
- Any money withdrawn from the pension pot, except of course the tax-free lump sum, will be added to other income, for example the State Pension or salary, and then taxed at the marginal rate of 20%, 40% or 45%
- For those people who still want to create an income from their pension and don’t want to take the whole fund as a lump sum, all the existing choices, including an Annuity will be available.
“What should I do if I am retiring soon?”
Whilst the new proposals will certainly give extra flexibility and more choice, there will be added complication and an even greater number of decisions which need to be made.
The Government has put in place interim measures to help people retiring before 6th April 2015; these are as follows and apply from 27th March 2015:
- The Minimum Income Requirement (MIR) which you must satisfy to qualify for Flexible Drawdown, will be cut from £20,000 gross per year to £12,000
- The maximum income available from an Income Drawdown plan will be increased from 120% of the GAD rate to 150%
- For people with less in their pension pot, the triviality limit is being increased from £18,000 to £30,000
- Whilst the small pot exemption, which allows small pensions to be taken as a lump sum, will rise from £2,000 to £10,000 and the number of pots which can be taken under this rule will increase from two to three
Of course these interim rules will fall away from 6th April 2015, when everyone will have unrestricted access to their pension.
“What should I do if I have just bought an Annuity?”
If you have only just bought an Annuity you could well still be in the ‘cooling off’ period, which might allow you to change your mind if it is the correct decision to do so.
Those people who have recently committed to an Annuity should review their decision, preferably by contacting an Independent Financial Adviser, who can advise you whether the Annuity is still appropriate or the new proposals mean an alternative option would be better.
“What should I do if I am already retired?”
That all depends on the option you chose to turn your pension pot into an income:
Lifetime or Enhanced Annuity This can never be changed, so there is nothing you need to do
Income Drawdown At your next policy anniversary you will be able to increase the maximum amount of income you take, from 120% of the GAD rate to 150%, a limit which will be removed from April 2015
If you have guaranteed income of at least £12,000, from the State Pension, a Lifetime or Enhanced Annuity or a Final Salary / Defined Benefit scheme, you could also qualify for Flexible Drawdown now.
Fixed Term Annuity You will have to wait for your fixed term to expire and then consider which option suits you best
“Will everyone just take their pension as a lump sum?”
Many people are concerned that greater flexibility will lead to people frittering away their pension and then relying on state benefits.
However, the Government doesn’t believe this will happen, not least because the Flat Rate State Pension will be introduced from 2016. George Osborne has also said that people should be trusted with their own pension.
At this early stage, we believe that those people with small pension pots are likely to take advantage of the new rules and take their entire pension pot as a lump sum; of course if this is the case it will be important to make sure there is enough income to pay the bills, both now and in the future.
For other people, who need to create an income from their pension pot, taking large lump sums is unlikely to be the answer. We expect a proportion of people still to buy an Annuity, whilst Income Drawdown, where the fund remains invested and an income is take each month or year, will become more popular.
“Is this the death of Annuities?”
We expect more people, especially those with relatively small pensions, to take advantage of the new rules and take the entire pension pot as a lump sum.
We also expect more people will simply keep their fund invested and draw down income as they need it, whilst planning carefully to ensure they have sufficient income for the rest of their lives.
But, for those people who want a guaranteed income, which will continue until they and perhaps their spouse die, no investment risk and a relatively simple solution, an Annuity will still be an attractive option.
A word on Annuity rates. At the moment no one knows with any certainty whether these proposals will push Annuity rates up, as providers offer better rates to try and secure business, or they will drop as less people chose this option.
What are the advantages of the changes?
- More flexibility in the amount of income which can be taken
- The ability to take ad hoc lump sums
- People with small pension pots will not be forced to buy an Annuity, which under the current system is their only practical option
- We are likely to see greater innovation, with new solutions for generating an income from your pension pot being offered
- People will have more flexibility to take lump sums to repay debt or mortgages outstanding at retirement
- People may be able to retire earlier, by taking higher incomes from their pension fund, until the State Pension kicks in and then reducing the income from their pension to a sustainable level
What are the disadvantages of the changes?
- People who take their entire pension pot as a lump sum could end up paying significantly more tax than if they took an income from their pension pot
- Anyone who takes large lump sums, or indeed their entire pension pot as a one off payment, could be left with insufficient income to meet their outgoings
- If the returns generated by the pension pot, are less than the investment returns, income could fall in the future, leaving the pensioner unable to meet their outgoings
- If the pension fund remains invested the income is not guaranteed and could fall, unlike an Annuity, where the income is guaranteed
- Anyone who buys an Annuity before the 6th April 2015 will not be able to take advantage of the new rules
A word about younger people
As part of the changes, the Government has proposed increasing the age at which a pension can be taken, from 55 to 57 from 2028.
After then the age at which a pension can be taken, will be set at 10 years before the State Pension Age, which is of course due to rise over the coming years.
These changes mean younger people will have to wait longer to retire, although the change is likely to affect only a handful of people, with very few able to build up sufficient capital to retire at 55.
Confused? That’s not surprising, but we’re here to help
The changes will give every pensioner more flexibility and greater control over their pension, but there will be questions, complications and challenges:
- But how do you take advantage of the new proposals?
- What combination of lump sums and income should you take?
- How can you be sure you won’t run out of money before you retire?
- How should you invest your pension?
- Is an Annuity now the wrong option?
These are just some of the questions you will need to answer before you can make an informed choice.
Our team of Independent Financial Advisers is experienced in developing retirement income strategies for clients the length and breadth of the UK.
If you are approaching retirement and would like advice on your options call one of our IFAs today on 0115 933 8433, alternatively enquire online or email email@example.com