Are pensions becoming too flexible?
George Osborne has announced a raft of measures that will make it easier for savers to access their hard-earned pension funds when they retire.
First and foremost savers will no longer have to buy an annuity with their pension, but if they do decide that this is the best way to secure their income in retirement they will get the benefit of free, independent advice.
For those that decide not to use an annuity, the income drawdown rules have been relaxed meaning savers will be able to take 150% of the income they would have been able to achieve with an annuity. Flexible drawdown plans do not have any restrictions on the level of income that can be taken but plan holders need to be able to demonstrate that they have sufficient pension income. In this year's Budget, Osborne decreased the minimum income requirement from £20,000 to £12,000.
There have also been significant changes in the rules for taking smaller pension pots as lump sums. Savers will now be able to cash in three smaller pensions worth up to £10,000 and take the money as a lump sum, irrespective of any other pension savings you might have.
An additional £10,000 in an occupational trust scheme may also be taken (where your employer runs the scheme on your behalf unlike conventional group personal pensions where you set up a scheme with your employer but your contract is with the pension provider).
Previously you could only cash in two pensions worth up to £2,000. In addition, savers will be able to take funds worth up to £30,000 as cash (with 25% paid tax-free) – an increase from £18,000.
These changes will come into force on 27 March 2014 and the government will now consult on taking your whole pension as a lump sum from April 2015.
It is safe to say that the pensions industry has been blown away by the surprise reforms. Pensions specialist, Dr Ros Altmann said her budget wishlist had come true: "After so many years of waiting for good news, suddenly so much comes at once. Like the proverbial number 13 bus, a whole raft of policies has come at once.
"This is undoubtedly a Budget to boost Tory votes. Savers and those with good-sized pension funds will feel much better off. Even smaller savers are being helped with higher amounts of pension money being available as cash lump sums."
Tom McPhail, head of pensions research at Hargreaves Lansdown, added: "The government is finally treating pension savers like grown-ups. These reforms will make pension saving much more attractive for everyone and get more people saving for their retirement."
However, while savers will undoubtedly relish this flexibility, some in the industry have expressed concern. These restraints, after all, were put in place to ensure that retirees don't spend too much too soon and outlive their savings.
Michael Ward, managing director of comparison website, payingtoomuch.com, said: "If an annuity does not get purchased at retirement, our worry is that even the most sensible person will be tempted to spend more of their pension cash than they planned. And as they will have no guaranteed income for life, which an annuity does provide, we could see a generation relying on benefits after their pots have run dry."
Peter Quinton, head of annuities at Retirement Assured, also pointed out that this additional freedom savers are being given could increase their risk in retirement. "Experience has shown that when faced with the choice of money in the hand, or guaranteed stream of future payments, most people choose the former – even in the face of good advice."
But Laith Khalaf, head of corporate research at Hargreaves Lansdown, said that Osborne was correct in trusting savers to manage their own savings. "Savers are not daft. If you have diligently saved for retirement throughout your life, you are unlikely to suddenly decide to blow it in a six-month spending spree."
He points out that savers will recognise the tax benefits of keeping money in a pension. "Investments in a pension grow free of UK income and capital gains tax, even after you start drawing it. Keeping the money in the pension therefore means sheltering it from the taxman."
"Ironically it is the fact that you can't get at your pension when you want to that makes people want to take it out in one go. If you can access it whenever you want, it just becomes a tax-free home for your savings."
This has been borne out in Australia where savers are already able to take their pension as a lump sum. "People do tend to maintain their funds in a pension post retirement," he adds.
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.
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.
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.