The approaching changes to pension legislation will create both opportunity and possible confusion.
This year, the Chancellor has proposed some surprising, but very welcome, changes to the rules on how pension benefits can be accessed. The changes being lined up have been largely well-received, but those eligible to take advantage of the new rules may be confused by the number of choices available.
There are two big changes. The first one relates to the way people can take benefits at retirement and means that people will be able to take the whole of their fund as one lump sum if they choose. The other change is to do with the way pension benefits are taxed on death. The two of these together have acted as a game changer in terms of overcoming some major reservations that have previously discouraged people from investing for their retirement through a pension rather than something else.
In the first of two articles, Andrew Stokes, Head of Pensions at St. James’s Place, explains how the changes will affect the way in which pension benefits can be taken.
What do the changes mean for an individual who, let’s say, has a pension fund of £100,000?
The changes enable everybody to take out whatever they like from their pension in one chunk. Whether or not they should is a different matter. At the moment people can do this if their fund is very small – less than £30,000 – or if their fund is very large and they have a guaranteed pension in payment of £12,000 a year. The changes mean that people with a fund size of, say, £100,000 now have the same flexibility. One thing we have to remember is that all of these flexibilities don’t remove the need for people to be responsible. It’s why getting advice is more important than ever.
What are the tax implications if someone took the whole £100,000 in one year?
Let’s assume the individual has no other income to begin with and they’re going to take the £100,000 as a one-off lump sum (known as an ‘uncrystallised funds pension lump sum’). The first £25,000 (i.e. 25% of the fund) is paid as a tax-free cash amount. The remaining £75,000 is taxed as income. Using the rates that apply from April 2015 this means:
After deducting the tax, the individual receives £80,557.
And that’s for them to live off for the rest of their life?
Precisely. Average life expectancy for a 65-year-old male is 83, and the most common age of death for men is 86 (source: ONS – November 2014), so if they’re taking their benefits in their mid-60s they might have to make that money last 20 years or more.
Do these changes signal the death of annuities?
No, annuities still very much have a role to play. They remain the only way to guarantee a pension income for life. For an awful lot of people that certainty is hugely important – more important perhaps than the flexibility that will be offered under the new rules. I often talk about an annuity essentially being your salary, the income you can rely on, and drawdown being a bonus. So no, I don’t see it as the death of annuities, but I do see them changing.
The government has said it wants everybody who’s a member of a defined contribution pension scheme to get free guidance. What do you think the impact of that is going to be?
Guidance is fine in that it will help people understand what they can do, which is a useful first step. But what most will want to know is what they should do, which is what advice is about. It will mean that those people who want to do things for themselves – who are happy to get information – will be facilitated and will be able to make those decisions. But that’s not the reality for most people. I think most people want advice.
Do you think the need for retirement planning has changed?
No, quite simply because the average size of a pension pot is still very small. The Association of British Insurers reported that 60% of people who retired in 2013 had a pension fund of less than £30,000; 30% had less than £10,000. With numbers as small as that, changes in the way you take your benefits won’t really make a big difference. But what the changes should do is prompt action by people who want to invest for their retirement. That need hasn’t changed.
The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief depends on individual circumstances.