Budget 2014: Radical pension overhaul to benefit retirees
Access to defined contribution pension pots is to be radically overhauled, in measures announced in Wednesday's blatantly pre-election Budget.
The government says the aim is to allow people freedom to access their pension savings as they wish, subject to their marginal rate of income tax.
A number of immediate changes have been announced, including:
A reduction in the level of guaranteed income required in order to qualify for "flexible drawdown" (with no limits on the amount of pension income that can be drawn annually), from £20,000 to £12,000.
An increase in the capped income drawdown limit from 120% to 150% of the payout from an equivalent annuity. This means that those who don't qualify for flexible drawdown still have an alternative to annuity purchase.
With effect from April 2015, all tax restrictions have been removed on the options open to pension investors at retirement.
They can still take up to 25% as a tax-free lump sum, but if they wish to withdraw up to their entire pension at any time, they will be taxed at their marginal tax rate - 20% for most retirees.
At present, withdrawals in excess of 25% of the pension pot are taxed at 55%.
In addition, there will be no obligation to buy a lifetime annuity, though that option is still there. Investors will have a free choice between an annuity, income drawdown and other retirement products on the market.
To help them make that decision, chancellor George Osborne proposes to introduce guaranteed access to free, impartial advice for everyone when they retire. Up to £20 million over the next two years has been set aside to fund this service, but no details have been released on how it will be provided.
Advisers and wealth managers have welcomed the "roll back of the nanny state".
Adrian Walker, retirement planning manager at Skandia, describes it as 'the final nail in the coffin of forced annuities'.
Tony Clare, pensions advisory partner at Deloitte, says: 'Income drawdown accounts for about 15% of the UK's £11 billion annuity market, and these changes will make it much more widespread.
"About 400,000 people buy an annuity every year, and many could increase their retirement income by about 15% a year using income drawdown."
Stephen Ford, head of investment management at Brewin Dolphin, forecasts that the changes "will result in the almost immediate death of the annuity - which we have long called for".
He adds: "It is a huge change in the flexibility of the pension system, with lower taxes and higher lump sums."
This article was written for our sister website Money Observer
Tax-free lump sum
An inelegant phrase that is nonetheless accurate in what it describes: a one-off payment to a beneficiary that is free of any form of taxation. Usually received when using a pension fund to purchase an annuity, as 25% of the overall fund can be taken as a tax-free lump sum.
An alternative to an annuity, income drawdown (also known as an unsecured pension) allows you to take income from your pension fund while the fund remains invested and so continues to benefit from any fund growth. The drawdown of income has to be calculated carefully as taking too much income could exhaust the pension fund so experts say the annual drawdown must not exceed what the assets would normally yield in an average year. The invested pension fund could also be hit by market turbulence and the value of the assets could fall.
Defined contribution pension
Often referred to as a “money purchase” scheme, although offered by employers (who may pay a contribution) these pensions are more likely to be free-standing schemes that a person contributes to regardless of where they are employed. Here, the level of benefit is solely dependent on the accumulated value of the contributions and their performance as investments. Therefore, the scheme member is shouldering the risk of their pension, as the scheme will only pay a pension based on the contributions and investment performance. The final pension (minus an optional 25% that can be taken as tax-free cash) is then commonly used to purchase an annuity that would provide an income for life.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.
This is more usually a feature of car insurance but it can also crop up in contents, mobile phone and pet insurance policies. An excess is the amount of money you have to pay before the insurance company starts paying out. The excess makes up the first part of a claim, so if your excess is £100 and your claim is for £500, you would pay the first £100 and the insurer the remaining £400. Many online insures let you set your own excess, but the lower the excess, the more expensive the premium will be.