The government is embarking on a radical overhaul of the tax treatment of defined contribution (DC) pension schemes, including removing the requirement to purchase an annuity and changes to the rules on drawn down arrangements
According to Chancellor George Osborne, the changes announced today are expected to put pensioners ‘in charge of their own pension pot’.
The government is to legislate to allow those with a DC pension to draw down from it after age 55 from April 2015, subject to their marginal rate of income tax in what Osborne described as ‘the most far reaching reform of the taxation of pensions since the regime was introduced in 1921.’
The proposals outlined include increasing the capped drawdown limit from 120% to 150% of an equivalent annuity; reducing the minimum income requirement for accessing flexible drawdown to £12,000 from £20,000; and increasing the amount for small individual pension pots that can be taken as a lump sum from £2,000 to £10,000.
The total pension wealth that people can have before they are no longer entitled to receive lump sums under trivial commutation rules will also be raised to £30,000.
These new measures will come into effect from 27 March 2014.
In addition, Osborne said legislation would be introduced to provide a new guarantee that from April 2015 everyone who is in a DC scheme is offered free, impartial face-to-face advice at the point of retirement regarding their choices.
The government will make available up to £20m in the next two years to develop this initiative and Osborne said the government would be ‘working with consumer groups and the pensions industry to develop the new right to advise.’
In his speech, Osborne said that the plans to reform the taxation of DC pension schemes wold have implications also for defined benefit (DB) schemes, and indicated that these would now be subject to consultation.
Anything that makes pensions saving more flexible and attractive has got to be welcome but there will be a worry that individuals might make choices on the premature use of their funds they later live to regret
HMRC estimates the changes could see the Treasury benefiting from an additional tax of £320m in 2015, as pensioners take out money to put into alternative investments now that they do not have to buy an annuity.
Chris Morgan, head of tax policy at KPMG in the UK, said: ‘Changes to pensions drawdown tax is predicted to raise revenue as of next year on the expectation that more people will withdraw funds from their pots if they are taxed at their normal marginal rate (ie basic, higher or additional rates) rather than the punitive 55% rate that was previously levied.’
Alex Henderson, partner PwC, described the changes to pensions drawdown as ‘both significant and unexpected’ but warned: ‘Anything that makes pensions saving more flexible and attractive has got to be welcome but there will be a worry that individuals might make choices on the premature use of their funds they later live to regret.’
The Chancellor’s plans for free investment advice for those in DC schemes at the point of retirement is also likely to present challenges for scheme providers.
Ed Wilson, pensions director at PwC, said: ‘The increased flexibility in retirement should encourage greater innovation in the sector and create scope for new products, but equally it appears providers may be on the hook for the provision of the government's promised face-to-face independent financial guidance. This could place a big demand on the financial services sector. The questions of who will deliver this guidance, and how quality will be assured, need to be answered,’ Wilson said.
Wilson also said that the knock-on effect for defined benefit (DB) schemes could be highly significant.
‘Public sector schemes will not allow members to transfer their pension into a DC arrangement, but the government is consulting with respect to private sector schemes. If people in DB schemes still have the right to transfer to a DC arrangement and can then take it all as cash, this truly represents one of the most significant changes to employer-sponsored pensions we have ever seen,’ Wilson stated.