Budget 2014 – The Pensions Revolution
Following the announcement in the budget of the possible changes in Pension legislation from April next year, and the very recent confirmation of how the new rules will look in practice, I thought it would be useful to summarise the changes
The 2014 Budget proposals have been described by some retirement planning experts as a ‘pensions revolution’. The new reforms come at a time when the world of pensions is already undergoing other significant changes.
The annual allowance – the maximum tax-efficient limit for contributions to all your pension arrangements during a tax year – was reduced again for tax year 2014/15, this time to just £40,000 – compared with the £255,000 it was as recently as 2010/11.
There was also another cut in the lifetime allowance. This effectively sets the maximum tax-efficient limit for the overall value of your pension benefits. The lifetime allowance is now £1.25m against a peak of £1.8m.
Automatic enrolment of employees and other workers into pension schemes is gradually progressing through the labour force, having started in October 2012 for the largest employers.
The current structure of the state pension – basic state pension plus, for employees, the State Second Pension (S2P) – will be replaced by a new single-tier state pension, from April 2016. This will cover both the employed and the self-employed, and it will be worth a maximum of about £150 a week in today’s terms, before any transitional increments apply.
In the background, the earliest age at which people will be allowed to start drawing their state pension is set to rise: it will be 66 for both men and women by October 2020, with another year added between April 2026 and April 2028.
The latest proposals announced in the 2014 Budget are designed to change the retirement landscape further by breaking the link between pensions and annuities.
The proposals focus on money purchase pension arrangements, sometimes called defined contribution pensions. These types of pension schemes allow you to build up a fund of money that you use to provide a retirement income and a tax-free lump sum.
Traditionally, most people have used their fund to buy an annuity to provide a regular retirement income, or accessed their fund through a capped drawdown plan.
But from 6 April 2015, all members of a defined contribution arrangement will be able to draw money as they see fit after the age of 55, subject to the rules of their scheme also permitting this. The tax-free lump sum limit of up to 25% of the fund will remain, with the rest of the fund taxable as income.
In theory, the flexibility will allow a pension fund to be treated in the same way as any other investment: you will be able to take withdrawals whenever you want. However, in practice, the tax treatment will discourage the extraction of large sums in a single year. So, unless you really need the extra income, you may want to limit any increase to keep you in your current tax band.
The tax position on death under the current rules is that any money remaining in a pension fund being used for drawdown is subject to a flat tax charge of 55%. The same tax rate also applies to any fund that’s not being used for drawdown if the death occurs from age 75 onwards. Normally there is no inheritance tax due, so with the right trust structure, £1,000 of pension fund can become £450 of cash for your chosen beneficiaries.
The Budget statement said that “…the government believes that a flat 55% charge will be too high in many cases in the future” and promised to “engage with stakeholders” in reviewing the rule. Whether this will mean a reduced tax rate for all, a two-tier system of pension and inheritance tax, or something else remains to be seen.
The standard earliest age at which you can draw pension benefits is currently 55. A consultation document published alongside the Budget proposed that this minimum age should increase in line with the state pension age (SPA), with the first rise being to 57 in 2028, coinciding with SPA reaching 67. However, the document also asked for views on whether a ten-year gap between the minimum pension age and SPA should be reduced to five years, “to allow more time for people to accumulate pension wealth before they reach retirement.”
And at present there is no tax relief on your personal contributions to pensions that you make once you have reached your 75th birthday. The government now wants to consult on whether to revise or abolish this ceiling.
The complexity of the new options has prompted the government to introduce a new right from April 2015 to impartial financial guidance at the point of retirement for anyone with a defined contribution pension. How this will operate in practice is now the subject of discussion between the Treasury, the Financial Conduct Authority and pension providers. One point is already clear: what will be on offer is just guidance, not advice.
There were a range of other interim measures introduced earlier in 2014 to help smooth the transition to the planned changes in April 2015. At this stage the broad outline of the reforms is clear, but not all of the detail. So it’s important to seek advice from a professional who can keep you up to date with the reforms and build a complete picture of how the new retirement landscape could affect you.
If you require any assistance or have any queries on this or any other issue, please do not hesitate to contact me.
The value of an investment with St. James’s Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.
The levels and bases of taxation and reliefs from taxation can change at any time and are generally dependent on individual circumstance.