From 6 April 2011 we are set to see changes in the way that pension funds can be used to provide benefits in retirement and also changes to the taxation of lump sum benefits paid on death.
In this ‘at a glance guide’ we highlight the main changes.
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 removal of the requirement to have taken the tax free lump sum (also known as Pension Commencement Lump Sum)
- The introduction of capped drawdown
- The introduction of flexible drawdown
- Changes to the taxation on lump sum death benefits
Summary of the current and new Income Drawdown rules:
|Current rules: Unsecured Pension (Income Drawdown)||Current rules: Alternatively Secured Pension||New rules: Capped Drawdown||New rules: Flexible Drawdown|
|Age restrictions||55 to 75||75 onwards||55 onwards||55 onwards when MIR* is satisfied|
|Minimum income||£0||55% of GAD** figure||£0||£0|
|Maximum income||120% of GAD** figure||90% of GAD** figure||100% of GAD** figure||No maximim when MIR* is satisfied|
|Reviews||5 yearly||Annually from age 75||
3 yearly before age 75 then annually from age 75
*MIR = minimum income requirement
** GAD = Government Actuarial Department
Those who are currently in Income Drawdown via Unsecured Pension will be able to continue with their current limits until the fifth anniversary of their most recent review.
Summary of the tax treatment of lump sum death benefits:
|Current rules: Death before age 75||Current rules: Death after age 75||New rules: Death before age 75||New rules: Death after age 75|
|Uncrystallised funds (i.e. no tax free lump sum and / or income taken)||Tax free*||n/a||Tax free*||55%|
|Annuity (if value protection has been included)||35%||n/a||55%||55%|
|Drawdown (inc. Capped and flexible post 6th April 2011)||35%||82%**||55%||55%|
* Up to the lifetime allowance
** Unauthorised payment charge and IHT
For the sake of clarity the 55% tax charge does not apply where a dependent uses the remaining pension fund to provide income through drawdown or purchases an Annuity.
Age 75 & requirement to purchase an Annuity
Currently there is a requirement that a pension fund must be crystallised by age 75 and an income secured, generally in the form of an Annuity.
From 6th April 2011 the requirement to purchase an Annuity will no longer apply.
This means that funds could be left uncrystallised i.e. no income and / or tax free lump sum taken after 75. However, the taxation of lump sum death benefits could make this option unattractive in many cases.
As there will no longer be a requirement to crystallise funds at age 75, there will also be no requirement to take a tax free lump sum (also known as Pension Commencement Lump Sum, PCLS) by the same age.
Under the new rules Income Drawdown will take one of two forms:
- Capped drawdown
- Flexible drawdown
Once a fund is crystallised and any tax free lump sum (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 the maximum income is being reduced from 120% of a single life, level A nnuity to 100% based on the tables provided by the Government Actuary’s Department (GAD).
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 reviews; from 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 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 satisfied the MIR they can enter flexible drawdown which will allow the individual to draw as much as they like from their drawdown 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.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)
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.
Lump sum death benefits
While the new rules appear simpler and offer greater flexibility, to some the biggest criticism is the change to the rate of tax deducted from lump sum death benefits from crystallised funds (drawdown or value protected annuities) on death before age 75. This is currently 35% but will increase to 55% from 6 April 2011.
Lump sums paid from uncrystallised funds remain tax-free but only where death occurs before the age of 75.
However one upside is that the 55% rate of tax will also apply on lump sums paid on death on or after age 75, a considerable reduction from the potential charge of up to 82% as under ASP currently.
What should you do now?
The new rules represent significant changes to how we draw an income from our pensions.
As usual, changes to pension rules can present both opportunities and threats.
We would therefore suggest that anyone considering retirement in the short term review their current arrangements as soon as possible.
Our team of highly qualified and experienced advisers are of course here to help, call us today on 0845 074 7778 or 0115 933 8433 and ask to speak to one of them today.