Pension reforms present exciting opportunities

3rd December 2014

You may be aware of various pension reforms which were announced earlier this year, and will come into effect from the 6th April 2015. The original proposals raised a number of questions, and these have largely been clarified by the Chancellor in his Autumn statement. Therefore, we thought it would be helpful to briefly outline the new wide reaching rules, some of which are already effective and some which will come into effect next April.

Objectives of the Reforms

The new legislation will apply mainly to Defined Contributions schemes, such as Personal Pensions, Group Personal Pensions and SIPPS. The overall objectives of the reforms are to significantly increase the amount of flexibility around drawing benefits from this type of scheme. In addition, the new rules will significantly affect the treatment of death benefits from these types of arrangement, and the changes will largely be beneficial to the pension member, providing greater flexibility and generally more favorable tax treatment. I am therefore summarising the main legislative changes which will come into effect on the 6th April 2015.

Increased Flexibility around drawing Pension benefits

Broadly speaking, the options currently available for drawing benefits from a Defined Contribution arrangement are to take up to 25% of the pension fund as a tax free lump sum, with the balance of the fund being used to either purchase an annuity, or provide income through the income drawdown facility. Income drawdown is currently available in two guises, either Capped Drawdown where the overall level of income is restricted, or Flexible Drawdown which allows unlimited income but is only available to individuals who have other guaranteed pensions totalling at least £12,000 per annum. Under the new rules, there will be two new forms of income drawdown. Firstly, Flexi Access Drawdown will allow income to be drawn from the pension fund, but without the current limits that apply to Capped Drawdown. Alternatively, another option called Uncrystallised Funds Pension Lump Sum will be available, and this will allow an individual to withdraw a portion of their pension fund, with 25% of the withdrawal amount being treated as a tax free lump sum, and the balance being taxed as income. However, any individual utilising either of these new options will have their Annual Allowance (maximum pension contributions allowable in any year) reduced from the usual £40,000 to £10,000, for Defined Contribution schemes. This is somewhat different to the treatment of Capped Drawdown, whereby the individual retains an Annual Allowance of £40,000. Capped Drawdown will no longer be available for new applicants after the 5th April, although for those individuals already in Capped Drawdown prior to next April, they will retain the flexibility of the higher Annual Allowance. A by product of the new rules provides a slightly improved position to those individuals already in Flexible Drawdown. Currently, they are unable to make any further pension contributions, although from next April, they will be able to contribute up to the reduced Annual Allowance of £10,000.

Death Benefits

Under the current rules, where death occurs before any benefits have been taken from a Defined Contribution scheme, the fund value can be paid out to the selected beneficiaries, completely tax free. However, where pension funds have been crystallised and benefits are being taken, it is possible for the surviving spouse to continue to draw an income from the pension fund, although this income is taxable. Alternatively, the surviving spouse can receive the value of the pension fund as a lump sum, but this is subject to income tax at 55%. Under the new legislation effective from next April, if the investor dies before age 75, the pension fund can be passed to a surviving spouse or any other beneficiary, completely free of tax and regardless of whether pension benefits are in payment or not. If death occurs after age 75, then the beneficiary can draw monies from the pension fund, subject to their marginal rate of income tax. Bearing in mind that most pension funds are exempt from inheritance tax, the new rules will provide the opportunity to pass pension funds down from one generation to the next, avoiding any inheritance tax implications.

Planning Opportunities

The new rules will therefore provide much greater flexibility and the tax treatment of death benefits will generally be far more favourable. In relation to death benefits, it might be worth considering redirecting death benefits after 6th April 2015 to pass to children or other family members, as opposed to the usual nomination for death benefits to pass to the surviving spouse. In some instances, there could be significant advantages in this course of action, in relation to inheritance tax planning. For individuals aged 55 or over wishing to access pension benefits from a Defined Contribution scheme, whilst also retaining the ability to make significant pension contributions in the future, it might be advantageous to crystallise a portion of their pension fund via Capped Drawdown prior to April 2015. This course of action will then mean that the individual will retain the higher Annual Allowance of £40,000, as a maximum pension contribution each year. In future, it may also be more attractive to continue making contributions of up to £3,600 per annum gross (£2,880 net of basic rate tax relief) even where an individual has no earnings. The increased flexibility around drawing the benefits from a Defined Contribution scheme will make this far more attractive, although for individuals aged 75 and over, no tax relief will be available on pension contributions, as is currently the case. Finally, the Chancellor has also confirmed that no transfers will be allowed out of unfunded defined benefit public sector schemes (such as the NHS scheme, Civil Service pension scheme and Local Government pension scheme) after the 5th April 2015. It would appear that this is designed to stop people transferring out of these schemes in order to gain the new additional flexibility under Defined Contribution schemes. However, the opportunity to transfer is still available up until the 5th April 2015. This does not affect members of funded private schemes ability to transfer their benefits elsewhere both pre and post April 2015. You will appreciate that this is very much an overview and summary of the new rules, and there will be some aspects of the legislation which will be more relevant to you than other parts. We will, of course, be happy to discuss this with you in greater detail, at our next review, to establish how the new rules will impact on your own situation, and to recommend a suitable course of action, if appropriate. However, if you feel that more urgent action is required, before the 5th April 2015, then please do not hesitate to let me know. This might be the case if, for example, you are considering accessing pension benefits in the near future, but would like to retain the flexibility to make pension contributions in the future, in excess of £10,000 per annum.