Freedom and choice in pensions – a Lamborghini or flexible income in retirement?

Following George Osborne’s March 2014 Budget, we have seen further clarification emerge from the government ahead of the changes which become effective from 6 April 2015.*

These changes to pensions, perhaps the most radical in almost a hundred years, allow those aged 55 and above the following options:

  • Take their pension savings as cash
  • Buy an annuity (or other income generating product)
  • Use income drawdown, but without income limits

The government wants to support this increased flexibility with a ‘guidance guarantee’, which offers access to free and impartial guidance. This is not intended to replace the financial advice available from regulated advisers, such as Armstrong Watson Financial Planning Ltd, but to provide key facts and information about the options available.

Let’s explore these options in further detail.

Taking pension savings as cash

This new alternative option is being referred to as uncrystallised funds pension lump sum, which is a bit of a mouthful, so let’s refer to it as UFPLS for ease.

Under this option you have the ability to take out a lump sum equivalent to 25% of the fund value and this will be free of tax. Anything taken in excess of 25% is taxed as income at your marginal rate.

You may continue to make further pension contributions, but will be subject to the new money purchase annual allowance (MPAA) of £10,000 per annum.

Buy an annuity (or other income generating product)

Additional flexibility is being made available with the purchase of annuities.

The income level available will still be payable at least annually, but the maximum guarantee period will no longer be restricted to 10 years. Crucially, the income payment can be increased or decreased and we expect new products to emerge over the coming months to take advantage of this increased flexibility.

Use income drawdown, but without income limits

The new flexible access drawdown (FAD) replaces both capped drawdown and flexible drawdown arrangements that are currently available - drawdown leaves the fund invested, but allows access to an income from it.

If you took out a flexible drawdown plan before April 2015, then this will automatically convert to a new FAD on 6 April 2015.

On the other hand, if you took out a capped drawdown plan before April 2015, you can retain this as a capped drawdown plan going forward and continue with the existing income limits. Alternatively you can voluntarily convert to FAD if your current provider allows it.

FAD allows you to take 25% as a tax free lump sum, referred to as a pension commencement lump sum (let’s call this PCLS) and the remaining 75% to provide you with an income, which when paid will be taxed at your marginal rate of income tax. There will be no restrictions imposed to this income level which could be anything from zero to the remainder of your pension pot.

If you choose not to withdraw any income from your remaining fund after taking your 25% PCLS, then you will be able to make further pension contributions up to the current annual allowance of £40,000 per annum. You may also be able to take advantage of the current carry forward facility, which allows unused pension contributions from up to three previous tax years to be made.

If, however, you have chosen to withdraw an income, then any further pension contributions you wish to make will be restricted to the new money purchase annual allowance (MPAA) of £10,000 per annum.

Whilst these new rules don’t become effective until next April, it is worth noting that some of the current rules may still be beneficial in certain circumstances, so seeking advice could be crucial over these next few months. Contact our Financial Planning Consultants for further details.

*Please note this is based upon our current understanding of the draft guidance available and may be subject to change.

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