Contrary to the headline that many of the news agencies have been running with annuities have not been compulsory since 1995. What the chancellor has done in the 2014 Budget, is to remove barriers and facilitate easier access to the alternative forms of pension income which are already in existence, opening them up to a far greater audience.
So what were the rules before?
Currently in most circumstances pension withdrawal can begin at any point after the individuals 55th birthday subject to the scheme permitting it. After taking the 25% of the pension fund which is available as a tax free lump sum, there have been for some time, a number of circumstances when an individual can access their remaining fund without purchasing an annuity.
Trivial Commutation
From age 60, rules have allowed an entire pension pot or even multiple pots, to be taken as a lump sum if they total less than certain value. That value was formerly set at 1% of the Lifetime Allowance although it has become uncoupled and held at £18,000 for the last 4 years despite the reductions to the Lifetime Allowance in recent years. As usual 25% of the fund would be available as a tax free lump sum and the remaining fund taxed at the individual’s marginal rate.
A further exemption for smaller pensions allowed for up to two of an individual’s pension policies, each worth £2,000 or less each, to be taken as a lump sum irrespective of that individual having other pension funds exceeding £18,000.
Drawdown
For those looking to take an income in a more flexible manner than an annuity and willing to accept some investment risk, drawdown is a popular option. Drawdown as the name suggests allows an individual to “draw down” on their pension fund, each year taking a prescribed monthly or annual amount which is subject to a maximum based on the Government Actuary’s Department (GAD) rate recalculated at periodic reviews. Given the provider and advice costs drawdown has only been justifiable for pensions of a significant size with many pension providers only offering the functionality for pensions of at least £100,000.
Flexible Drawdown
From April 2011 the GAD restrictions on income which are applied to the traditional drawdown regime were removed for individuals who could demonstrate they had a certain level of secured pension income, known as the Minimum Income Requirement (MIR). Although fairly modestly set at £20,000 per annum, the income which can count towards the MIR is a little restrictive; consisting of income from Occupational pensions, Annuities and the State pension. Far more would qualify for flexible drawdown if earned income, property income or investment income were taken into account but they do not qualify as there is no certainty they will continue until death. Once the MIR has been satisfied an individual is free to withdraw as much from their pension fund as they wish, subject to taxation at their marginal rate. In reflection of its more restrictive nature and to highlight the differentiation with flexible drawdown, traditional drawdown has become known as Capped Drawdown.
So what are the new rules?
The new framework will be similar to that of flexible drawdown but there will be no MIR so anyone with any size of pension fund and any level of other income will be able to take as much (or as little) out of their pension fund as they like from age 55.
When it comes into force in April 2015 this will render Trivial Commutation, Capped Drawdown and Flexible Drawdown obsolete.
The risk is that the prior knowledge of these changes coming in, could effectively paralyse the retirement market with clients not wishing to tie themselves into the current system, when one which is potential more attractive to them and certainly less restraining is on the horizon. In recognition of this, to try and smooth the transition, the government have decided to relax the current rules somewhat. Thus the total pension savings for trivial commutation has been increased from £18,000 to £30,000 and the individual small pot figure has been increased from £2,000 to £10,000. Thus if you have total pension savings of less than £30,000 you can now withdraw them all, irrespective of how many plans they are divided among and the size of each of those plans.
Further to this the MIR has been reduced to £12,000 making flexible drawdown a far more feasible option for many.
Although many of the legislative restrictions are being removed, it is important to consider that the tax consequences of lump sum withdrawals may be prohibitive. As they are taxed as income at the individual’s marginal rates a significant withdrawal could easily result in a liability to higher or even additional rate tax which could be avoided with tailored planning.
Is it just pensions that are changing, what about ISAs?
Rapidly growing in popularity in recent years, ISAs have become the go-to tax wrapper for most savers. In recognition of this steadily each year and in contrast to those for pensions, the annual contribution limits have increased, and this budget continues that trend with a jump to £15,000 from July 2014. Up until that time we have the more incremental increase from £11,520 to £11,880 which was announced in the previous budget.
Fortunately along with the increase, in July we can also look forward to a far more straight forward set of rules, removing the cash ISA limit which had its own maximum of half the overall ISA limit, to a single limit which can be allocated between Cash and Stocks and Shares as you see fit. There will be free movement in both direction, once inside an ISA wrapper allowing the possibility to de-risk by moving from equities to cash as you wish whereas currently transferring from a Cash ISA to Stocks and Shares ISA is currently a one-way street.
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