Advisers should be emphasising to clients just how much the proposed new rules for drawing retirement benefits have made registered pensions easily the most attractive vehicles for long-term savings. The effective abolition of inheritance tax on death benefits have significantly added to their attractions. Most objections to investing in registered pensions have revolved around their inflexibility and the position on death. The professional and admin costs of running drawdown were also a major downside.
The main change is for people who reach the age of at least 55 to able to draw as much or as little as they wish directly from their pension without having to buy an annuity. Of course the option of annuity purchase will still be available and will provide the best answer for many people. Regardless of what clients choose, they will be able to receive 25 per cent of their pension savings as a tax-free lump sum.
Better yet, clients will be able to go into drawdown while reinvesting into their pension. At present, once someone starts drawing funds directly from their pension, they cannot make any further pension contributions. But from 6 April 2015, there will be a limited ability for people in drawdown to make contributions into a money purchase pension. The limit on contributions will be £10,000 a year (in addition to any carried forward unused pension relief from previous years) rather than the full £40,000 annual allowance. But unlike the £40,000 standard annual allowance, it will not be possible to carry forward this special “money purchase annual allowance” of £10,000.
The reason for this restriction in an otherwise very liberal regime is to stop the use of pension contributions for tax avoidance by people aged 55 or more making £40,000 contributions and then immediately paying themselves the £40,000 from the pension fund. That way they would have avoided all National Insurance contributions as well as income tax on the lump-sum element.
But even if a client is subject to the money purchase annual allowance, the normal £40,000 annual allowance will still be available to cover savings into defined benefit schemes (for example, those that provide benefits based on the employee’s final earnings). For example, if you have £7,000 of pension savings subject to the £10,000 limit, then £33,000 of the normal annual allowance will be available. If the £10,000 limit is exceeded, then the excess will be subject to an annual allowance charge and the normal allowance will be £30,000.
Flexible or capped
If a client is already in flexible drawdown, they will be treated the same as anyone else from 6 April 2015, subject to the money purchase annual allowance. But if they are in capped drawdown, they will retain the normal annual allowance if their income remains within the capped drawdown limits. An adviser might suggest protecting a client’s normal annual allowance by entering capped drawdown in the current tax year but to do this the client must be 55 before 6 April 2015.
A key job for advisers could be to save clients from themselves – stopping them paying more tax than necessary. The message to get over to clients is simple. Leaving aside the question of their future income needs, they should always take tax and financial advice before deciding how much to draw from their pension. Any drawings above the tax-free lump sum will be subject to income tax as additional income. Whatever they leave in the pension plan is free of tax on any investment income and capital gains. It will only become taxable in the year they take the withdrawal.
Clients should also be made aware of the Chancellor’s announcement at the Conservative Party conference. He said the death benefits from pension schemes would generally be free of IHT and this should greatly increase the incentive for clients to keep their funds in their pension plans. Broadly speaking, the position will be there will be no IHT or income tax on pension benefits on a person’s death before age 75 – pretty much as now; but where a person dies after the age of 75, the beneficiary of the deceased person will just pay income tax at their marginal rate(s) on the benefits when they encash them after 5 April 2016 and 45 per cent in 2015/16. They will not have to pay the current 55 per cent tax.
The full details should be in the Autumn Statement on 3 December, when some of the missing pieces should become apparent.
Danby Bloch is editorial director of Taxbriefs Financial Publishing
Pensions flexibility: the new rules – keep your clients up-to-date
Keep your clients up to date with a personalised guide to the new rules and proposals first announced in the Budget affecting retirement income. The latest edition to our Key Guides series covers:
- Revisions that took effect from 27 March.
- Total drawdown flexibility that should be available from April 2015.
- The Chancellor’s announcement on the flat tax rate on death benefits
- New Class 3A NICs.
- Likely increases to the minimum pension age.
- Reductions on death benefits for some individuals.
To find out more call Alex Broughton on 020 7970 4196