Editor's comment: pensions overhaul
21 Mar 2014
The extent of pension reform announced in the Budget caught most people out, but raises important questions for tax advisers and savers, says Sara White
21 Mar 2014
So there were surprises for everyone in the Budget, not least the announcement about the radical overhaul of defined contribution (DC) pensions as the chancellor focused on the savers, as he describes them.
From 2015, the compulsory purchase of an annuity on retirement will no longer be required and those approaching retirement will be able to make their own decisions about how they spend, invest and access their pension pot.
This came as a broadside to many with the share price of large annuity providers, such as Legal & General, Aviva and Standard Life, plunging as insurers lost £3bn in value after the pension fund shake-up. With returns on annuities at such low levels, for many the news was positive, giving control back to the saver.
How many times does the annual DC pension statement arrive in the post proffering bad news about the paltry projected monthly sum on retirement?
This means that people can choose how they access their DC pension savings; for example, they could take all their pension savings as a lump sum, draw them down over time, or buy an annuity. Supporters of the nanny state were shaken up; it would be losing control of its wards. All too quickly the prospect of a new generation of buy to letters resurfaced; surely a better investment for many than years of payments into a pension only to see its value decimated year after year.
The pensions minister Steve Webb then waded in, making a throwaway comment that there was nothing to stop pensioners spending their savings on a Lamborghini. Just one catch, the new Murcielago Roadster will come in at a cool £211,000 when it hits UK showrooms this month. So probably not, Mr Webb, when more than a third of DC pension pots are valued around the £20,000 mark, but worth a thought.
Giving people pension control is not a new idea; it was included in the 2010 Conservative manifesto. It already works well in the US and Denmark. Australia has been operating a non-annuity based system since 1992 and takes a totally different approach to superannuation; all Australian employees pay a compulsory 9.25% into contributory pensions, employers pay minimum 12%; this is not a voluntary scheme by any means, unlike auto-enrolment in the UK where there are opt-outs.
So the pension announcement immediately changed retirement planning; from a tax perspective the changes are beneficial, but the government also expects to raise £3.05bn in the first five years of the new regime, as tax receipts increase on the back of more cash-ins. But the tax benefit will only be temporary, warned the Office for Budget Responsibility (OBR) reverting to a cost to the exchequer by the 2031.
Tax advisers need to get up to speed quickly as some of the changes took effect immediately.
Tax advisers need to get up to speed quickly as some of the changes took effect immediately. From 27 March, temporary rules came into force pending the outcome of a consultation; the minimum income requirement for flexible drawdown was reduced from £20,000 to £12,000, the amount of total pension wealth which an individual can take as a lump sum, was increased from £18,000 to £30,000 and the capped drawdown withdrawal limit went up from 120% to 150% of an equivalent annuity.
Clearly a plus from a tax perspective is that any amount they draw down after the age of 55 will be treated as income and therefore subject to their marginal rate of income tax in that year rather than the current 55% charge for full withdrawals.
But no government proposal comes without caveats. In the small print there is a note that in 2028, the age at which you can start to cash in a pension will go up from 55 to 57.
There are lots of unanswered questions about these radical reforms, not least the impact on final salary pension schemes and public service defined benefit schemes.
With the rapid implementation of elements of the changes, it is important to act quickly. A consultation will follow shortly but there is a detailed Treasury document, Frreedom and choice in pensions, at http://bit.ly/1elOSp8 which outlines the proposals.
Essential reading I would suggest.