The Six Big Changes To Your Pension

 

‘Responsibility is the Price of Freedom’ (Elbert Hubbard)

 

George Osborne’s March 2014 budget shocked the pensions industry, handing more control over to pension savers and removing the need to buy an annuity – the most radical changes to pensions in almost a century.

 

DIY Investor Magazine reported upon the changes which are summarised below and now highlights some of the issues that have been raised in the interim and considers some of the potential pitfalls that come with such responsibility.

 

 

Pensions at a Glance
Defined Contribution Scheme (DC) – an individual or group personal or stakeholder pension where an employee puts a proportion of their salary into a pension scheme, often matched by the employer. An individual may choose to make Additional Voluntary Contributions (AVCs). The amount achieved in retirement is dependent upon the investment performance of the pension scheme.
SIPP – a Self-Directed Personal Pension with contributions and investments decisions controlled by the beneficial owner.
Defined Benefit Scheme (DB) – a scheme where an employee is guaranteed a proportion of salary in retirement based on historical earnings and length of service. Sometimes ‘Final Salary Scheme’

 

 

CHANGE 1: Flexible Access

 

From April 2015 pension investors reaching or aged 55 have total freedom over how they take an income from their pension up to, and including, taking the whole fund as a lump sum.

Freed from the requirement to purchase an annuity, they can spend, invest or save it as they prefer. The first 25% is tax-free with the rest subject to income tax at the highest marginal rate.

Income taken from the pension is added to any other income an individual has – e.g. salary – which could drive basic rate (20%) tax payers into the higher (40%) or even top-rate (45%) income tax band.

 

CHANGE 2: Drawdown Restrictions Abolished

 

Income drawdown limits are to be scrapped and the individual chooses where to invest, how much income to take and potentially when to pass funds on to an heir.

Such flexibility comes with greater risk than a secure income such as an annuity and the individual assumes responsibility that they will not run out of money in retirement either due to poor investment decisions or by taking excessive income.

 

CHANGE 3: Restrictions to Contributions

 

Pension contributions are subject to a £40,000 annual allowance and specific contribution rules. However, after April 2015 any withdrawals from a defined contribution pension in addition to any tax-free cash, could result in contributions to defined contribution plans being restricted to £10,000.

 

CHANGE 4: Transferring a Defined Benefit (Final Salary) Pension

 

Anyone with a DB pension will be able to make unlimited withdrawals but to do so they will have to transfer to a defined contribution pension (e.g. a SIPP). As very valuable benefits could be lost they will have to receive independent financial advice first.

 

CHANGE 5: Retirement Age

 

Currently 55, the age at which you can take your pension will increase; it will be 57 from 2028 and from then increase in line with the rise in the State Pension age, remaining 10 years below.

CHANGE 6: Reduction in the ‘Death Tax’

 

The Chancellor announced that pension funds paid out before or after the age of 75 will no longer be subject to tax at 55% and beneficiaries of those who die under the age of 75 will not pay tax on withdrawals. A pension provider will be obliged to tell its investors about access to free advice and Mr Osborne announced his intention that everyone should have free guidance to help them make sense of their options at retirement – online, by telephone or face to face.

 

Good News for DIY Investors?

 

So, it’s all good news then? Freed from the requirement to purchase an annuity millions of DIY investors will be taking responsibility for their income in requirement, their number swelled by the estimated five million individuals that are saving for retirement for the first time courtesy of auto enrolment?

Unfortunately it may not be that simple; stagnant wages, low investment returns and increasing longevity have made it harder than ever to invest for retirement. A recent survey suggested that just one in three will achieve the benchmark of two-thirds income that is considered necessary for a ‘comfortable’ retirement.

With more choices to make than ever it is vital that the DIY investor makes time to take stock, consider their income requirements in retirement and map out an investment strategy that delivers risk and reward according to their individual preferences.

There is no doubt that some will opt for fast cars and a champagne lifestyle; some may even squander their hard-earned. But for those prepared to invest some time there has never been more education and information available to those wishing to take personal control of their retirement.

However, a year after these sweeping changes were announced, there are still concerns that many will not be in a position to benefit. Recent research for Xafinity suggests that only five percent of pension schemes will allow investors to take a lump sum whilst others will allow a withdrawal only after funds have been transferred to an alternative scheme, thereby potentially attracting fees and penalty charges of thousands of pounds.

Full flexibility may be a stretch for companies with systems that do not allow them to operate as surrogate banks, but the imposition of additional levies in order to allow the investor to take the control of their finances that legislation allows does not seem in the spirit of ‘Treating Customers Fairly’.

At the time DIY Investor Magazine voiced its concern that the much vaunted Pension Wise service may not be in place in time to cater for the estimated 300,000 pensioners in DC schemes that could apply to it each year, and that is a concern that has proven well founded as access to advice remains inadequate.

The predicted thousands of those between 55 and 64 currently considering cashing in a DB scheme would be well advised to think long and hard before they opt out of a guaranteed, inflation linked pension that also covers their partner. The FCA estimates that the average cash value of a transferred out scheme will be £140,000 but that 40% of those opting out would be ‘irreversibly’ worse off and in some cases ‘left destitute’ in old age.

Overall it has been predicted that £6 billion could be withdrawn from pension accounts and therefore it is unfortunately inevitable that there will be fraudsters and conmen touting the ‘too good to be true’ investment opportunity. DIY investors know that it will be.

One commentator likened this April to the pensions industry’s Y2K – whilst it may be impossible to prevent fools acting the fool, DIY Investor Magazine will be there to help and educate those that are taking a long term and circumspect view.

 

Problems Ahead?

 

George Osborne’s 2015 budget included the reduction in lifetime allowance from April 2016 from £1.25 m to £1 m which continues the downward trend from the 2006 level of £2.5 m.

However, achieving even the reduced figure requires considerable application – assuming a 5% annual investment growth a 30 year old saver would have to put away over £1,000 per month and starting ten years later would require a contribution of around £2,000 per month.

Those waiting to celebrate their semi centennial before knuckling down would struggle to accumulate a seven figure pot because of the £40,000 annual contribution limit. If a 65 year old were to purchase an annuity with £1m at today’s rates they would achieve an annual income of just less than £27,000 – approximately the UK average wage.

The lifetime allowance will increase each year in line with inflation from 2018 but the recent announcement of 0% inflation for the first time since the CPI measure was adopted in 1988 could result in those achieving strong growth from their portfolio facing a punitive 55% tax charge.

The state pension increases in line with the highest of CPI, earnings or 2.5% and it seems likely that those making significant contributions and achieving a good investment return could fall foul, particularly if inflation remains low.

Of course index linking is only a comfort if the allowance itself remains at current levels, whereas recent cuts suggest that may not be taken as a given; there are those that argue that the concept of an annual allowance has been rendered redundant by virtue of the reductions that have been made to annual contributions.

Just as with Y2K, 6th April 2015 was viewed in some circles with some trepidation and some may make some injudicious purchases; DIY Investor Magazine treated the day as the beginning of a whole new era rather than a deadline and is looking forward to the ongoing debate as the real effect of such new-found freedoms become evident.

 

One response to “The Six Big Changes To Your Pension”

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   September 29, 2015 at 6:37 pm

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