In his 2014 Budget the Chancellor, George Osborne, surprised us all with his announcement regarding much greater flexibility being offered to members of defined contribution (DC) pension schemes when they retire. The proposals are due to take effect from April 2015, although they remain subject to consultation at present, the consultation closing in June.
The main proposals
With effect from April 2015, DC scheme members will, after the age of 55, be able to take their whole pension pot as a lump sum, with 25% of it being tax-free and the remaining 75% subject to income tax at their marginal rate – rather than the current 55% charge for full withdrawal. Note that the withdrawal will be treated as income, so may result in a higher marginal tax rate. Pension savers will be free to use or invest their pension pot as they wish, with the option of taking some or all of their savings as cash, using a drawdown product or purchasing an annuity. The Government is consulting on the details between now and June.
The Government also announced plans to prevent those in public sector defined benefit schemes transferring into a DC scheme to take advantage of the new flexibility. These schemes are, for the most part, unfunded, meaning that the taxpayer would have to pay for any such transfers immediately, rather than gradually over that individual’s retirement. However, transfers from public service schemes to other defined benefit (DB) schemes will still be allowed, raising the possibility that members of public service schemes might make a two-stage transfer, first to a private sector defined benefit scheme and from there to a DC scheme. Having said that, the Government is consulting on whether members of funded DB schemes – including private sector schemes – should be allowed to transfer to DC schemes.
The Government will be introducing a requirement for pension providers (in relation to contract-based schemes) and trustees (in relation to trust-based schemes) to provide “free and impartial face-to-face guidance on their choices at the point of retirement” with effect from April 2015.The Government is committing £20 million (over 2 years) towards establishing this initiative; it suggests that this money might be used to support the development of guidance materials, training or to support the building of capacity in the charitable advice sector. The guidance will be expected to meet certain quality standards developed by the Financial Conduct Authority (FCA). However, the Government expects that many individuals will go on to seek (and pay for) further, more tailored advice on their options from a financial adviser, comparison website or annuity broker.
This requirement for guidance builds on the recent announcement by the Association of British Insurers that it would commit pension providers to:
- having a conversation with their customers – or an impartial advice or guidance service – about their retirement options,
- delivering a comparison of annuity quotations for customers, or an introduction to an intermediary who will do so, early and prominently in their retirement process and
- asking all customers for information about their health and lifestyle, which they can use to obtain an enhanced annuity rate.
However, retirees may expect to live for 25 to 30 years after retirement and, if they are not going to purchase an annuity, surely they will need further guidance during their retirement? There must be a danger that those retirees who are not accustomed to obtaining advice on their finances will find themselves using a product that does not suit their changing expenditure profile some years after their retirement.
The Government proposes to increase the age at which people can access their private pension savings, without a tax charge, from 55 to 57 with effect from 2028 and that minimum age is then expected to rise in line with future rises in State Pension Age.
The Government is also consulting on whether the tax charge of 55% of the fund, applying on death after drawdown commences, should be reduced.
In the meantime …
Pending the introduction of these reforms next year, from 27 March 2014 the guaranteed pension income required for flexible drawdown has been cut from £20,000 to £12,000 and the capped drawdown limit has increased from 120% to 150% of the Government Actuary’s Department rate.
The trivial commutation limits have risen from £18,000 (across all pension arrangements) and £2,000 (in a single arrangement) to £30,000 and £10,000, respectively, with effect from 27 March 2014. Previously only two “small pots” of up to £2,000 could be taken as cash from personal pensions but the number allowed has been increased to three. (People could already take an unlimited number of these small pots from occupational schemes.)
The return of the Granny Bond!
A new pensioner bond from National Savings and Investment (NS&I), available to anyone over 65, will be available from 1 January 2015. The interest rates on the bonds have not yet been finalised but are expected to be in the region of 2.8% for a one-year bond and 4% for a three-year bond. Up to 10 million bonds will be issued and people will be able to invest up to £10,000 in each bond.
Tackling the liberators
HMRC has been granted new powers, from September 2014, to de-authorise schemes that it suspects of being used for pension liberation fraud and to block the registration of schemes which it deems unsuitable. The powers will allow HMRC to refuse to register a scheme, or de-register an existing scheme, if it believes that either:
- the scheme administrator is not a fit and proper person or
- the scheme has not been established to provide pension benefits.
HMRC will assess fitness and propriety from information it requests and from examining documents at business premises.
Our comment
The new flexibility opens the door to planning for income to match pensioners’ spending patterns:
- possibly an initial period of part-time work when a lower level of pension income is required,
- a period of higher spending while active, on, for example, foreign holidays,
- a subsequent period of lower spending when becoming less active and
- further higher spending to accommodate later-life care needs.
Tax legislation has not encouraged the introduction of financial products beyond traditional annuities to cater for people’s retirement. The changes now proposed, to allow people much greater flexibility over how they use their pension savings, may be expected to lead to greater innovation and a range of products that actually address individuals’ needs.
We expect there to be a significant impact on schemes’ investment strategy. The Government fears that allowing members of DB schemes to transfer to DC schemes (so that they can take advantage of the new flexibility), will lead to a material reduction in schemes’ holdings of Gilts and corporate bonds. At present it is estimated that DB schemes hold more than 50% of the IL Gilts in existence, so such a change would have a significant impact on demand for these bonds – and so on their yields. However, they appear not to have considered the likely effect on DC schemes’ investment strategies. Many DC arrangements use “Lifestyle” or target-date investment strategies, that deliver a bond and cash portfolio to members of DC schemes as they approach retirement. This may be inappropriate for those who intend not to annuitise, so schemes should start reviewing their default strategies as a matter of some urgency.
There has been speculation that there will be a spate of people taking their whole pension fund in cash at retirement and investing in buy-to-let property, fuelling further house-price inflation. However, since the withdrawal of the fund will be taxed as income, if your fund is large enough to buy a house, you are likely to pay tax at 45% on part of that withdrawal. This prospect may, therefore, be less attractive than the media are suggesting. In any event, the majority of pension funds are too small to provide an adequate income in retirement, let alone extend to the purchase of property.
Finally, one cannot help noticing that, if people encash their whole fund at retirement, the Government collects all the tax on that pension fund at once, rather than gradually through the individual’s retirement, and, in many cases, at a higher rate. But we’re sure that would not have influenced the Chancellor’s thinking at all!