Chancellor George Osborne’s Budget 2014 announced a range of significant changes to UK personal pension schemes – a series of bold policy amendments that included what the Chancellor himself referred to as “the most far-reaching reform to the taxation of pensions since the regime was introduced in 1921”. At the heart of the proposed pension reforms was the wish to allow people far greater flexibility to choose what they want to do with their pension savings, with some changes taking effect from 27 March 2014, and others due to be implemented in April 2015.
Reaction to the proposed changes has been mixed. Politically, allowing people greater responsibility to make their own financial decisions is very much in line with both traditional Conservative values and Liberal Democrat attitudes to individual freedom of choice. Labour’s response has been muted, with shadow chancellor Ed Balls saying that “we need to scrutinise it very carefully”. Others have been more damning of the proposed changes, however – James Lloyd, director of public policy think-tank the Strategic Society Centre, described the announced changes as “possibly the most catastrophically bad policy decision made by this government”.
So what exactly do the pension reforms amount to, and how might these changes affect pension holders? Let’s first look at the changes that have already taken effect from March:
- To qualify for access to flexible drawdown from your pension pot, you previously needed to have a guaranteed annual income of £20,000, made up of state pension, lifetime annuity, scheme pension or equivalent overseas pension payments. This qualifying limit has been reduced to £12,000, allowing easier access to flexible drawdowns.
- For those who don’t qualify for flexible drawdown, capped drawdown arrangements now allow greater access than previously, with the maximum drawdown each year increasing from 120% of an equivalent annuity, to 150%.
- It was previously possible to fully withdraw lump sum funds from up to two “small pots”, valued at up to £2,000, regardless of your overall total pension wealth. The upper limit for defining a “small pot” has been increased to £10,000, and it’s now possible to take lump sums from up to three pension pots.
The cumulative effect of these changes is increased flexibility and greater access to your pension savings. However, it should be noted that as recently as last month customers of some pension providers – including Legal & General and Friends Life – were complaining that companies would not yet allow them to take advantage of the changes announced in the Budget. In fact, representatives of some of the country’s largest pension firms have complained that the Budget changes were announced without prior consultation or advance notice to the businesses which actually provide pension products to the public, meaning that they still have work to do to ensure their schemes comply with the new rules.
The biggest and most controversial pension change is still to come. In April 2015 the government will completely overhaul the tax rules that currently apply to defined contribution pension pots, making it much easier for people over 55 to withdraw lump sums from their pension funds.
Under the current system, holders of defined contribution pension schemes can withdraw up to 25% of their pension savings tax-free, while any further withdrawal is charged at a punitive 55% tax rate. The existing tax regime means that very few pensioners withdraw more than the tax-free quarter of their pension wealth. Many existing pension schemes make the purchase of an annuity either compulsory, or the only practical option once the tax rate is taken into account – in fact every year around 420,000 people use their pension savings to buy an annuity to provide a guaranteed income in retirement.
Osborne intends the tax changes from next April to mean that “no one will have to buy an annuity”. In short, the punitive 55% tax rate for withdrawing from a pension scheme is being abolished, and tax will only be charged at the marginal rate based on the individual’s income within that tax year. It is estimated that the majority of pensioners will pay tax on pension withdrawals at the 20% rate, compared to the current 55%. In practical terms, this is likely to result in retirees exploring other investment options – including investing in property – rather than relying on annuities to provide a retirement income.
While these changes certainly seem to offer greater choice and flexibility, this very flexibility means it will become more important than ever that those planning for retirement receive informed and independent investment advice. While George Osborne’s Budget speech committed to provide everyone who retires on defined contribution pensions “free, impartial, face-to-face advice on how to get the most from the choices they will now have” – and confirmed that £20 million has been earmarked over the next two years to implement this – it is as yet unclear exactly what form this pension advice might take … or who will be providing it.
For now we can only speculate what the larger impact of these changes might be on the provision of pensions and the options available to people upon retirement. The government’s position is that flexibility in pension options will mean greater competition among annuity providers and therefore a better range of deals for the public – however critics have suggested that this could equally lead to a thinning of the annuities market, driving up prices. James Lloyd, writing for Money Marketing magazine shortly after the Budget announcement, indicated that perhaps only time will tell: “The key test set for the Chancellor’s reforms now – and in future by historians – will be whether they result in higher incomes on average for [defined contribution] savers.”
Author: Steven Miscandlon