Budget: your flexible friend

The Budget of 19 March 2014 was a “game changer” for pension savers in defined contribution schemes in the UK, awarding the access to such pension savings that the pension industry and pension savers have been demanding. It can be seen as a retaliatory strike in the battle being waged by HM Revenue & Customs against pension liberation. The changes will also impact defined benefit schemes.

Critics cite the risk of pensioners using their pension savings to buy sports cars, with catastrophic results for public finances. The counter argument, of course, is that those who have saved to fund their retirement should have choice and flexibility and are more likely to invest and use their money to fund their standard of living in retirement.

The most significant changes are scheduled to apply from April 2015, but interim provisions apply from 27 March 2014, all subject to legislation.

Changes from April 2015

Flexibility on pension withdrawals

The fundamental change from April 2015 is that pension savers with defined contribution arrangements will have no restrictions on income withdrawal and will no longer have to buy an annuity at retirement, which many consider to be poor value. Instead, on reaching 55, these savers are to be given flexibility to choose whether:

to take up to 25% of their fund tax free up to the lifetime allowance;
if the rules of the pension scheme allow, to take up to the whole of the rest of their fund as a lump sum on payment of tax at their marginal rate of income tax. Currently a 55% tax charge applies;
to keep the fund invested.

There would be no restrictions on timing or what the person can do with those funds, so they could be invested or spent as the pension saver chose. To try to mitigate against pension savers making poor choices at retirement, the pension provider or pension scheme will have to offer free and impartial “face-to-face” advice. This will impose additional costs but is sensible and consistent with encouraging good choices.

Interim changes from 2014

Increased pension savings threshold for lump sum cash

The total amount of wealth from all registered pension schemes that a person can have and still be able to take a lump sum at age 60 is increased substantially, from £18,000 to £30,000, for the applicable period after 27 March 2014. So, if the total amount of pension wealth does not exceed £30,000, a person could take all of it, with 25% tax free, up to the lifetime allowance. This applies to defined benefit schemes too.

The maximum amount that can be taken as drawdown income each year will be increased to 150% of an equivalent annuity, up from 120%, for applicable pension years from 27 March 2014.

The minimum income from other sources that a person must have before they can take advantage of a drawdown arrangement will reduce from £20,000 to £12,000 per annum.

These measures are designed to offer increased flexibility until April 2015, when the total flexibility measures are intended to come into force. Subject to 25% tax-free cash up to the lifetime limit applying, the drawn down amounts are taxed as income at marginal rates. A substantial increase in interest in drawdown arrangements is expected.

Small pots taken as lump sum

For payments made after 27 March 2014, where a person has a personal pension pot of up to £10,000, total pension wealth is ignored and they can take up to the whole amount as a cash lump sum from age 60. The number of these pots which they will be able to access in this way is increasing from two to three, so the maximum total will be £30,000.

Some final comments

The age limit for access to pension savings generally will increase from 55 to 57 from 2028, and after that will be aligned with state pension age.

There is concern that a consequence of these changes will be an increase in transfers from defined benefit to defined contribution schemes, with financial implications for defined benefit schemes and unfunded public sector schemes in particular. So, the Government has proposed a ban on transfers from such public sector schemes and will consult on a ban on transfers from other defined benefit schemes.