The government have announced a whole raft of proposed changes to pension rules over the past few months.
The changes will provide increased flexibility, but exactly what has been announced? Who will benefit? What should you do now in preparation for the changes?
What has been announced?
The main headline was the removal of the requirement to purchase an Annuity at age 75, however there were also other significant changes including:
- The introduction of capped drawdown
- The introduction of flexible drawdown
- Changes to the taxation on lump sum death benefits
The scrapping of the requirement to secure a pension, most commonly via an Annuity, at the age of 75, has been removed. This will mean investors can stay in Income Drawdown or continue to purchase Fixed Term Annuities past the age of 75, opening up the possibility of leaving surplus pension funds to family members.
The second major change is to the Income Drawdown rules with the introduction of Capped and Flexible Drawdown.
“Capped Drawdown” Once a fund is crystallised and any tax free lump sum (also known as Pension Commencement Lump Sum or PCLS) is paid out, the remaining fund can be used to purchase an Annuity or moved to Income Drawdown.
Capped Drawdown looks similar to the Income Drawdown (also known as Unsecured Pension) of today.
No minimum income must be taken, however there is a maximum amount of income which is available. The maximum annual income which can currently be taken is 120% of a single life, level Annuity based on the tables provided by the Government Actuary’s Department (GAD). This is being reduced to 100% from 6th April 2011 The income limits are also currently reviewed every five years before age 75. This will change to every three years from 6th April 2011, or when the next five year review is due, whichever is later for existing Income Drawdown plans.
This means that going forward the amount of income that can be taken will be broadly similar for annuities and capped drawdown. At present the maximum income which could be taken from an Income Drawdown contract is generally higher than an Annuity.
Capped Drawdown will have no maximum age. Age 75 will however trigger a change in the frequency of maximum income reviewsfrom every three years prior to age 75 and every year thereafter based on the individual’s age (the GAD tables will be extended). The increased frequency and use of actual ages will ensure there is less chance of fund erosion.
“Flexible Drawdown” Flexible Drawdown is a new introduction and will be available to individuals that have secure pension income equal to the Minimum Income Requirement (MIR) in the tax year that Flexible Drawdown commences.
The aim of the MIR is to prevent a member from exhausting their pension funds and falling back on the state.
Initially the MIR will be set at £20,000 a year and there is an intention that this will be reviewed by the Treasury every five years, it will not be index-linked on an annual basis.
Only particular types of pension income will count towards the MIR, such as income from:
- Lifetime annuities
- Scheme pensions e.g. from a defined benefit scheme
- State pensions
Drawdown income is excluded because it is not secure for life.
Where an individual satisfies the MIR they can enter Flexible Drawdown which will allow them to draw as much as they like from their arrangement without limit, but subject to tax at their highest rate.
To prevent abuse of the new rules in the year of commencing Flexible Drawdown no contributions can be made to a defined contribution scheme and the individual must cease to be an active member of any defined benefit scheme.
In addition once Flexible Drawdown has commenced, any further pension contributions will be subject to the annual allowance charge. For these reasons Flexible drawdown should only be used when an individual is sure that they have made all the pension contributions they wish to.
Alternatively Secured Pension (ASP) will cease to exist from 6 April 2011. Those individuals currently in ASP will transition to the capped drawdown rules at the next review as detailed above.
The third major change relates to lump sum payments on death.
Lump sum death benefits are currently taxed on crystallised funds at a rate of 35% on death before the age of 75 and potentially up to 82% after age 75.
The new rules are simpler and certainly offer greater flexibility, although the rate of tax will rise on death before the age of 75.
From 6th April 2011 lump sum death benefits paid from crystallised funds will be taxed at a rate of 55%.
Lump sums paid from uncrystallised funds remain tax-free but only where death occurs before the age of 75.
For those who die before the age of 75 the new rules represent a tax increase, for those who die after age 75 the new rate is significantly lower.
Who will benefit?
The changes will be of most benefit to those that would like additional flexibility in how income is paid from the pension and what happens to any residual money when they die.
For those people who want a guaranteed income for life and have a low tolerance for risk then these changes will probably provide little benefit; an Annuity is still likely to be the preferred option.
Furthermore, for smaller pension funds an Annuity is likely to be the only practical option available.
However, if you want more flexibility in how you take your income or want additional options on death, the new rules may well help.
Although Flexible Drawdown will provide, as its name suggests, greater flexibility, it is likely that only a small number of people will qualify because of the £20,000 per annum MIR.
Capped Drawdown could help many more people who want income flexibility. For example those who have other sources of income, or who’s working hours vary from month to month and year to year.
For those who disliked Annuities, because of the limited benefits available on death, using a Fixed Term Annuity or Income Drawdown plan in conjunction with the new rules will allow them to pass on unused pension funds to their beneficiaries. Although this will of course be subject to a 55% tax charge.
What should you do now?
This really is the $64,000 question; it certainly cannot be answered here in full, as each individual’s circumstances are unique to themselves; however it is possible to give some broad ‘rules of
Taking advice and speaking to a suitably qualified Independent Financial Adviser is a must now as the options have just got wider and more complicated.
The wrong thing to do is to wait, take no action and make decisions based on headlines and newspaper articles. Think over what you want, plan a cash flow showing your income and expenditure, think about what you want to happen on your death; it is only once you have done this can you start to think about how you achieve these goals with the pension you have worked so hard to build up.
Of course we can help you with all this planning, from an initial discussion; through to planning a cash flow and helping you make decisions that are right for you.
Investment Linked Annuity
Fixed Term Annuities
Alternatively Secured Pension (ASP)
Steps to consider leading up to retirement