Viva la Pension Revolution?

Changes were announced in Budget 2014 that will have significant implications for those coming to retirement age. Pensioners are being given greater choice over what to do with their savings but what will be the tax implications when they exercise these newly found freedoms?

Pre April 2015

The biggest changes to defined contribution pension savings will occur in April 2015. Between 27 March 2014 and April 2015, a set of transitional rules have been put in place which will lessen the restrictions on withdrawal which were applicable before the Budget announcement:

1.    Trivial lump sums (for those aged 60 or over)

a.    Those with total pension savings up to £30,000 (was £18,000) may take the entire amount as cash
b.    Those with total pension savings above £30,000 (was £18,000) may take up to three pensions worth £10,000 (was £2,000) each as cash.

2.    Purchase an annuity which provides a guaranteed monthly income for life
Compulsory purchase of an annuity by the age of 75 was abolished in April 2011 but the earliest age you can do this is 55.

3.    Capped income drawdown (for those aged 55 or over)

Taking a gradual income whilst leaving the remaining assets invested. The capped drawdown limit has been raised from 120% to 150% of an equivalent annuity.

4.    Flexible income drawdown (for those aged 55 or over)

Flexible income drawdown is an option that allows you to take unlimited, taxable withdrawals from your pension. The level at which a person qualifies for flexible drawdown has been reduce to receiving £12,000 (was £20,000) each year from ‘secure pensions’.

All of these withdrawals are taxed at marginal rates, subject to the initial 25% tax-free pension lump sum.

Post April 2015

Post April 2015, individuals aged 55 or above (rising to 57 from 2028) will be able to take the whole of their pension pot as a cash lump sum subject to income tax at marginal rates on 75% of the money withdrawn. This is in contrast to the current 55% charge for full withdrawal. The 25% tax-free pension lump sum will continue to be available.

A rush to access this cash could therefore increase the income tax payable by pushing pension income into the higher rate bands. Currently income falling into the level of total income above £41,865 is taxed at 40% and above £160,000 is taxed at 45%.

By taking smaller annual lump sums it will be possible to stay within the basic rate tax (20%) or even the tax free personal allowance currently set at £10,000. There is a need for careful tax planning to ensure tax isn’t paid needlessly when there is the possibility of splitting receipt of pension funds between tax years.

Individuals may still purchase an annuity should they so wish.

Individuals will also still be able to purchase a drawdown product. However, there will be no limits on the amount someone can withdraw from their drawdown arrangement each year, and there will be no minimum income requirement which people have to satisfy in order to withdraw from their pension.

After Withdrawal of Pension Funds

From July 1 2014, all ISAs will become New ISAS (NISAs). You can put up to £15,000 a year into a NISA and this can be cash, all in investments, or a mixture.

Those with significant pension funds may wish to consider the Enterprise Investment Scheme (EIS). The potential benefits can include gains free from capital gains tax, generation of a tax-free income and exemption from inheritance tax after two years.

Looking Forward

The 2015 proposals are still in consultation which is being run for the full 12 week period with a shut off date for responses of 11 June 2014. Although changes are not expected, holding off acting on pension withdrawal until the Finance Bill 2015 is published should provide further clarity.

The new system will see no changes to tax relief during the accumulation phase of pension saving (the maximum relief going into a pension fund is determined by annual allowance and lifetime allowance which have been reduced to £40,000 and £1.25 million respectively on 6 April 2014).

Giving greater access to pension savings will be widely seen as a positive move but without thorough tax planning in advance to decide how and when to extract the funds and where to place them afterward, some individuals will undoubtedly forfeit the tax benefits already stored up from years of prudent saving and investment.

For more advice, either on your own status or that of someone working for your business, speak to your accountant.

This article is based on current legislation and practice and is for guidance only. Specific professional advice should be taken before acting on matters mentioned here.

Umesh Modi BA ACA, is a Chartered Accountant and Tax Advisor, and a partner at Silver Levene LLP. He can be contacted on 020 7383 3200 or umesh.modi@silverlevene.co.uk