What does the future hold for pensions?

It was widely thought that most of the policies to be rolled out in the Budget had already been strategically 'leaked' by the Tories.

How wrong we all were. Towards the end of his speech Osborne dropped the bomb: "No-one will have to buy an annuity."

Within an hour of uttering that sentence, billions of pounds had been wiped off the market value of several of the larger insurers that provide annuities. Companies were panicking. Senior managers were pulled out of meetings and conferences. All hands to the pump!

Twelve months on, it's time to look back at the year that was, and assess the fallout from the changes and how they are shaping up in reality.

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Pension reforms

The pension reforms are a good place to start, because it was these changes that made the biggest headlines. Previously, buying an annuity was generally the automatic next move for defined contribution pension savers. Insurers would write to pension holders and send them a quote for their own 'in-house' annuity.

Despite past calls for consumers to 'shop around' in the open market to ensure they found the most suitable type of annuity for their circumstances, most people simply went with the quote their pension provider gave them.

But with gilt rates - upon which annuity rates are based - bumping along at extremely low levels, and annuity holders living longer than ever, annuities were becoming very poor value for money.

The Financial Conduct Authority (FCA) had launched a review in February of last year of what it called the 'disorderly' annuities market, saying it was 'not working well for consumers'. It said that four out of five people who bought an annuity from their pension provider could have got a better deal by shopping around.

With the review of the annuities market already under way, Osborne's Budget represented a seismic shift for that industry - or perhaps rather a wake-up call.

The alternative to an annuity was to leave the fund invested in the stock market and go into income drawdown, taking an income directly from it. But this carried the risk of capital loss if markets fell; and unless you had a substantial separate guaranteed income, the amount that could be drawn each year was monitored and limited.

The new pension plans have changed that. From April, it's possible to withdraw any amount you want from your pension; anything taken out above the 25% tax-free lump sum will be subject to your marginal rate of tax.

This makes drawdown easier and more appealing - but it also means that far more people are likely to opt to take cash, either in lump sums or as a regular income, instead of taking an annuity that guarantees income for life.

People who want an annuity can still get one, but people who want to draw their income directly from their pension savings will have freedom to do that instead. The trouble is that once the cash is gone, it's gone for good.

Isa freedoms

Osborne also freed up the opportunities for Isa saving with his plans for 'new Isas'. First of all he increased the limit you can save each year by £2,480, to £15,000 for the 2014/15 tax year.

The 2015/16 limit will be £15,240 and future rises will aim to keep pace with inflation. This means that, along with the £40,000 pension allowance, investors can save a total of over £55,000 each year in mainstream tax-efficient wrappers.

Not only do you have a much wider choice when it comes to arrangements for funding your retirement, but the way pensions and Isas will be handled when you die has also been given an overhaul by the government.

When an Isa holder dies the surviving spouse or partner can now inherit their Isa tax benefits. They'll do this by getting a one-off increase to their Isa allowance, equal to the amount held by the deceased.

Pensions have also become easier to pass on. Under the old system, you could only pass on a pension pot tax-free if you died before age 75 and had not touched the pot. If you died after 75 or had accessed the pension fund, the entire pot was subject to a harsh 55% tax when it was passed on.

Under the new system the pot can be passed to a chosen beneficiary tax-free if you die before the age of 75, whether or not you have taken income.

If you die after your 75th birthday the beneficiary can still withdraw the money but will pay income tax at their marginal rate. In fact, your next-of-kin will actually get more from your pension pot if you pass it on (and if you die before age 75) than you will if you use it yourself.

The question as to the intended purpose of a pension perhaps needs revisiting, given that a pension is now more attractive as a vehicle to pass on wealth than to use for income in retirement. One central rule remains unchanged, though: you can't take it with you.

One of the more remarkable features of the Budget - aside from the annuities aspects - was Osborne's promise that every retiree would have access to free, impartial financial guidance.

This will take the form of Pension Wise, a government-funded array of internet, telephone and face-to-face channels aiming to outline the options available to retirees, while stopping short of a personally tailored recommendation, which would cross the line into regulated advice. It's still not quite clear what this will look like, or how effective it will be.

The FCA also dismayed insurers by demanding at the last minute that they tell retirees about options for their pension funds. This policy has been informally dubbed the 'second line of defence' and is at least as woolly as the government's guidance guarantee.

Realities of the new regime

Previously, defined contribution pensions were for most people a relatively bleak option - you could save into one if you wanted, but when the time came to retire you would be forced to buy an annuity, unless you had a substantial pot or a separate income (such as a final salary pension from an earlier job) that made income drawdown a viable alternative.

When you died, your hard-won savings would be passed on, but subject to harsh taxation.

The new rules make savings decisions at every stage of life more complex. Should you save into a pension, an Isa, or both at once? How much access to your savings before retirement are you going to need? Is auto-enrolment preferable to an existing company scheme? Or is a self-invested personal pension better for you?

But the pensions reforms mean that as you approach retirement, the options open to you have also become much more complex. The question of how you generate an income in retirement is no longer simply a matter of finding the right annuity.

For example, should you use part of your pot to buy an annuity and thereby guarantee at least some income, and then hope for good returns on your investments to supplement that? Should you postpone taking the state pension or continue working and saving? What can you do if you don't want an annuity but do want security? What about the new 'flexi-access' products coming onto the market?

Then there's the conundrum for those with larger pensions over whether to try and conserve their fund for future generations, given how generous the tax environment is. This might be done, perhaps, by using Isas, rental property or other investments to generate an income.

Who will do what with your pension?

What revisions are the political parties promising or threatening for the current pension system, should they be elected in May?


  • No plans to review pension taxation, but the best way to control tax relief is by tweaking annual allowance (now £40,000) and lifetime allowance (now £1.25 million).

Liberal Democrats

  • Review tax relief and possibly move to a flat rate. Pensions minister Steve Webb has been mulling over the idea of a flat rate, ranging from 25 to 33%. The lower end could save the government money, but the higher end could result in a net increase in government payout.
  • Restrict lifetime allowance to £1 million.


  • Cap charges on drawdown.
  • Reduce lifetime allowance to £1 million and annual allowance to £30,000.
  • Restrict tax relief for 45% taxpayers to just 20%, using money saved to fund jobs guarantee pledge.


  • No plans to change anything until new reforms have bedded in.

Tom McPhail, head of pensions research at Hargreaves Lansdown, on the two main parties' plans:

"Let's start from the assumption that we can see the direction of travel for a Tory (led) government: more individual responsibility, market competition, low taxes on death, incentives to defer consumption with limited allowances, probably an increasing emphasis on self-provision for care, possibly in the form of additional incentives such as tax-free payments from pensions to pay for care.

"A Labour (led) government would be a very different beast. I'd expect them to start gently but progressively unwinding the new freedoms, capping tax relief for higher earners, shifting emphasis onto governance, more trustee-based pensions, and less individual responsibility (and choice)."

This feature was written for our sister website Money Observer

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