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Keeley Paddon: The dangers of pension freedom

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We have had almost a year for the dust to settle following the surprises revealed in the Chancellor’s 2014 Budget, and the new legislation has been working its way through Parliament. In essence, the Government wants to change the pensions landscape in which the current suite of retirement products work and introduce a new option. 

Flexi-access drawdown will operate in the same way capped drawdown does at present but there will be no limit on the income taken. After an individual has taken their entitlement to the tax-free lump sum at outset (usually 25 per cent of the policy value), they can choose to take as much or as little of the remaining pot as they wish and it will be added to any other income they have in that tax year to determine the rate of tax that will apply.

Under this option, if any income is taken, future pension contributions will be limited to a £10,000 maximum annual allowance. Interestingly, those in existing capped drawdown plans, which were set up prior to 6 April 2015, will retain the £40,000 annual allowance, where income is set at 150 per cent of GAD or below.

Meanwhile, the new uncrystalised funds pension lump sum option allows policyholders to take a chunk of money from an existing pension plan. Twenty-five per cent of the payment will be tax free and the remainder subject to the marginal rate of income tax. Again, under this option, any future pension contributions will be limited to a £10,000 maximum annual allowance.

While the industry awaits the review of current FCA guidance, advisers generally accept this type of contract is not actually suitable for every individual. It is a sophisticated contract, preferably suited to those with larger funds (unless there are other assets to rely on in retirement) and a client’s attitude to risk needs to be appropriate.

Another further issue is that of means testing for the purposes of other state benefits, such as housing benfit, council tax deductions, income support and income-based jobseekers allowance. The Department for Work and Pensions has confirmed pension funds will be treated as “capital” with the existing £16,000 rule applying. The decision makers will take funds accessed flexibly into account and will apply the “deprivation of capital” rules as they do now.

Meanwhile, the current rules on annuity plans will also be relaxed to allow plans to offer increasing and decreasing income levels, as well as lump sum payments to beneficiaries on death at any time. 

Late last year, the Government also announced the removal of the 55 per cent tax charge on death under drawdown in certain scenarios. When an individual under the age of 75 dies, they will be able to give their pension pot to any beneficiary tax-free. This also covers cases where the individual’s pension is already in drawdown. There will be no tax when the pension is passed on and the beneficiary will not have to pay income tax on the money they withdraw from the pension.

Under the new system, the 55 per cent tax rate will no longer exist. Those aged 75 and over who have not yet started their pension or are taking a drawdown pension will be able to pass on their remaining defined contribution pension to any beneficiary, who will then be able to take it as a drawdown pension at their marginal rate of income tax, or as a lump sum taxed at 45 per cent (then taxed at marginal rate from 2016/17).

Although the new rules come into force in 6 April, beneficiaries of anyone who dies before that date can still benefit, as long as payment is delayed until after the 6 of April.

The consultations on retirement flexibility also includes a proposal to raise the age at which an individual can take their private pension savings under the tax rules from 55 to 57 in 2028, at the point that the state pension age increases to 67. From then on, the minimum pension age in the tax rules will rise in line with the state pension age so that it is always 10 years below. This change is proposed to cover all pension schemes that qualify for tax relief, with no exceptions. Ill health early retirement will still be allowed as usual.

Keeley Paddon is head of technical at SimplyBiz Group 

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Comments

There are 4 comments at the moment, we would love to hear your opinion too.

  1. At a practical level there are some important unanswered questions;

    Will pension pot providers allow existing clients to access their money from their current plan?

    Will they require that the money is switched to a new plan to facilitate flexi access?

    What will they charge for this facility?

    How efficient will they be at offering this?

    Two months to go, pension providers should surely have all the answers ready. Perhaps MM can do a survey?

  2. Nick

    I just hope that the majority of providers will be either unable or unwilling to do this. If a switch is required I hope the charge is 10% (at least). I hope they will revert to their usual (in) efficiency.

    From my perspective everything possible should be done to discourage the average person for taking this disastrous step.

    Unless of course:

    1. Crispin Odey’s forecast turns out correct
    2. The client has plenty of other assets
    3.The client is in very poor health and is single.
    4. The fund is less than £50k

  3. It’s probably me being a bit slow but is there any difference between the uncrystallised pension lump sum option and what you can currently do under phased flexible drawdown (other than not having to meet the MIG test) Today if I wanted £20,000 net income as a basic rate tax payer I could crystallise £23,529 of my fund giving £5,882 as PCLS and the remaining £17,647 would be taxed at 20% giving £14,117 net income, a total of £19,999.60. How will that be different under the new regime?

  4. John – no difference as far as I can see but if you were still wanting to pay personal pension contributions the new lower 10k allowance would apply as you would have exceeded maximum GAD limits.

    That is unless you were still accruing within a Defined Benefits scheme, when the 40k annual allowance applies, plus carry forward,so in theory you could wipe out a Defined Contributions pot and build up more DB benefits, transfer to DC later on and do what you like with the pot.

    No doubt the new pensions guidance staff will be up to speed on all this.

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