Pensions reform

The Budget of 2014 proved to be a surprise, not least to those in the pensions industry, which has been calling for flexibility in income choices at retirement for some time. However, it was scale of the announcements in the Budget that was not anticipated, especially with the lack of consultation and short timescales to implementation according to Harris & Co accountants Northampton.

Pension scheme providers will have had to make immediate changes to their systems to deal with amendments to the defined contribution (DC) pension regime that came into effect from 27 March 2014. These amendments included:

The above rules are intended to be a temporary measure while the government undertakes consultation on the proposed, fully flexible pension offering, due to start from April 2015.

With a general election looming for next May, the government appears to have made a gesture that will prove popular with voters. However, as with most changes in legislation, there are pros and cons to the proposals which are worth considering.

The pros

The biggest perceived advantage of the announcements is the added flexibility which will put consumers more in control.

For years, people have been put off from pensions due to the ‘restrictions’ they put on their money, shying away from investment in the belief that there are better options available elsewhere.

The dislike of the restrictions was compounded by the belief that, should the pension plan holder die, their pension - which they may have taken years saving for - would die with them.

While this latter point was dependent upon the choices made at retirement and did not have to be the case (even under the old rules), the added flexibility will be welcomed by consumers and is likely to encourage people to save more into pension plans in order to obtain the valuable tax relief on contributions and compound benefits of tax free growth.

Death benefits

As stated, clients have been under the misunderstanding about the death benefits attached to pensions in payment, with an assumption that the lifetime of savings will be lost upon death in their entirety.

Actually, the way an individual’s pension benefits are dealt with in the event of death after retirement depends upon the choices made at retirement.

One of the choices currently in existence would be to place pension savings into a capped or flexible drawdown arrangement, allowing an individual to take a regular pension income while retaining control of the assets, rather than swapping their assets for an annuity.

Under current rules, in the event of the drawdown plan holder’s death, the remaining value can be passed to chosen beneficiaries as a lump sum net of a 55% tax charge.

Given the government’s proposal to allow pension plan holders to withdraw all of their funds at a marginal rate of tax, it has also announced a consultation on whether to reduce the tax applied to drawdown pension funds.

Although no conclusion has been drawn on this (it is likely to come out in consultation and be introduced in April 2015), the potential reduction of death taxes applied to drawdown pension plans will be a welcome boon, especially for the pension industry, as it will curb those individuals looking to take funds out of their pension simply to save the high rate of death tax.

Government coffers

It should be remembered that this flexibility of withdrawal comes at a tax cost to the consumer. The government has not altered the amount of tax free cash (25%) that an individual can take at retirement from their pension plan, meaning that any additional withdrawal will be taxed at the individual’s marginal rate.

With the added flexibility introduced by Budget 2014, many are expected to withdraw higher amounts than would have been allowed previously. In turn, individuals are likely to suffer higher rates of income tax increasing government tax receipts in the short term and boosting the economy.

Tax planning

For those individuals keen on considering a wide range of tax planning, the added flexibility will be welcomed. Those who have obtained tax relief on contributions throughout their working life will now be able to withdraw funds from their pension in an unlimited manner.

While this may leave them with an additional income tax liability, it will also provide them with capital to invest.

There are a number of options should an individual be willing to consider investing this capital. These include:

They may be able to reduce their overall income liability via the attaching tax credit, or access valuable wealth preservation strategies that allow them to pass on assets to their loved ones without the deduction of inheritance tax.

Downside

There are a number of disadvantages as a result of the changes to pension, including the risk of increased reliance on state benefits and the benefits of annuities as a long-term income source may be ignored.

State benefits: providing individuals with the flexibility to choose their level of income from their pension savings is a bold move. Undoubtedly, there will be those who will enjoy the additional flexibility and use their pension funds to provide a lifestyle they may not have enjoyed under the old regime.

The consequence of this is that their pension funds will erode quite quickly, possibly to a point where they are worthless, leaving these individuals in a position where they are reliant upon state benefits.

Looking at the general condition of public finances and reforms to the benefits system, this is a worrying prospect and not one, it would appear, that the country can afford.

Annuities: for some time now we have seen various debates played out in the media around the value annuities provide.

Market conditions such as historically low interest rates and quantitative easing (QE) have driven fixed interest yields down to unprecedented levels, meaning that annuity rates have fallen significantly, making them an unpopular retirement choice for many.

The planned flexibility under the new pension rules may only exacerbate the unpopularity of annuities, as people look to take funds from their pension to invest in alternative assets.

This would be a shame, as it should not be forgotten that the aim of a pension is to provide an income in retirement, however long this might be. Annuities can offer the purchaser the benefit of guaranteed income for life, which should not be underestimated as an individual gets older.

In addition, for those who may be able to benefit from enhanced annuity rates due to health considerations, the level of income yield offered by annuities is often higher than available from a whole range of alternative assets.

Summary

The 2014 Budget has been positive for the pension industry which can only be a good thing. Whether the announcements result in retirement panacea for all remains an unanswered question and one that will only become clear in the fullness of time.

Too many individuals spend 30 or 40 years building a pension pot, only to make a decision on how to spend it in 30 or 40 minutes. With all the flexibility now on offer, the requirement for quality retirement planning advice has never been stronger.