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For anyone concerned with retirement the past 18 months have been a tense time. With the media, the Government and even the barman at your local talking pensions, how we save for our golden years has been the red-hot topic on everyone’s lips. And it’s no surprise; the new legislation surrounding pensions has been shrouded in a dark curtain of mystery and we are only now being allowed to peep inside. The secretive nature of the new changes is frankly putting us all on edge, but finally we are being drip fed some answers to curb the feeling of suspense. All very dramatic of the Treasury, but it’s not often they are afforded the opportunity to captivate an audience.
So just what are the changes and what do they actually mean? With so many rumours and theories being bandied about, I’m sure it will not come as a shock to hear that, frankly, we are all confused! The pension landscape has felt like a kaleidoscope on a spin cycle these past 18 months, but, thankfully, we now have some solid and stable answers.
I would like to add here that, with these legislative changes, we’re only really talking private pensions known as ‘Defined Contribution’ or ‘Money Purchase’ pensions. None of these changes apply to the State Pension or pensions where what you’re paid is a proportion of your final salary – known technically as ‘Defined Benefit’ pensions. There are ways to convert these Final Salary Pensions into a pot of cash, but careful, expert research needs to be conducted first, which can be best achieved with the help of a specifically qualified financial planner. Only individuals who hold the G60 qualification may advise on these type of transfers, so be very careful of scammers cold calling you to offer this service. At Efficient Portfolio, we hold this qualification, so if you do need help, please let us know.
So, let’s begin by firstly looking at the Pension Freedom timeline, to give you a clear picture of just what happened in the 12 months from March 2014 to March 2015:
19th March 2014: Freedom and choice in pensions – Consultation on the pension reforms announced in the 2014 Budget
1st October 2014: Treasury makes further announcements; this time focusing on tax and the beneficiaries of pensions.
3rd December 2014: Osborne announces that the 55% Death Tax will be scrapped on pensions.
19th March 2015: Pension freedom was confirmed!
Hopefully that gives you a taster of the progression of pension reform, but to give you real answers on what everything means, and how it affects you, I need to take you back to March 2014- the time when the seed of pension freedom began to germinate.
Freedom is Ours!
Rather than paraphrase, these were Mr. Osborne’s exact words at the 2014 Budget: “We will legislate to remove all remaining tax restrictions on how pensioners have access to their pension pots. Pensioners will have complete freedom to draw down as much or as little of their pension pot as they want, anytime they want. No caps. No drawdown limits. Let me be clear. No one will have to buy an annuity.” In other words, if you are a pensioner, you can take your entire pension in one go. George Osborne, the emancipator of the pension pot, has given you the thumbs up to do what you want with your money. Freedom is yours! Of course, as we now know, these proposals have been confirmed!
So what does ‘freedom’ actually mean?
Traditionally, at retirement, a pension offers 25% of the savings as a tax free lump sum, and the remainder is used to purchase an income; often through buying an annuity. Annuity rates have fallen to all-time lows and retirement income have come tumbling down with them. This has led to more and more people, who have sought advice, using a route called ‘drawdown’. This is similar to the traditional method, in that you can take your tax free lump sum, but you leave the rest of the money in a pension and draw an income from the investment. This income can be varied to give you flexibility, and if you do not spend it all, you can leave it to the kids (minus some tax of course) instead of it lining the coffers of a life insurance company!
So you can effectively take all of your money out in one go and jolly well do what you want with it! Sounds wonderful, doesn’t it? Or maybe not. Just to bring you back down to Earth, just for a second, I must warn you not to squander all of your cash the moment you retire. If you do that, you will have to rely on the state. Means tested pension benefits have been scrapped, so you will be left to rely on around £148 per week; not a particularly appealing prospect. Food for thought if you were contemplating blowing your pension pot on a new Lamborghini!
Sensibility aside, this new piece of legislation truly is a wondrous thing. Osborne’s announcement is a huge benefit for retirement planning, as it gives people many more planning options, especially when it comes to tax. For example, for some it might be wise to take their money out faster than they need it. This could then be used to fund NISAs or to give to the children to avoid Inheritance Tax.
There are numerous solutions for effective tax planning, so many in fact that I do not have room here to expand too far upon this subject. But it is worth bearing in mind that with the freedom to control your own pension pot, you also have the freedom to protect your wealth against tax more effectively. For example, if your estate is worth over £325,000, your loved ones will be charged a rate of 40% for the pleasure of inheriting it. That is unless you take action and put into motion some financial plans to protect your estate. With control over your own pension you can opt to put some of your wealth into Trust for your loved ones, and prevent a large Inheritance Tax bill. Please also note that taking money out of your pot may trigger a tax charge. You should check with a professional Financial Planner how much the tax will be before you take the money.
This new legislation is not just great news for people on the cusp of retirement. Work life is changing, and more and more people want to phase in their retirement; people want to gradually reduce the work they do rather than completely stopping. With this in mind, the new pension rules will encourage people to start planning their future early; in order to facilitate their dream retirement. People are also likely to save more for their retirement if they know they have the flexibility to get their money back in the way they want it. It will also mean that advice at and in the lead up to retirement is even more important to ensure they maximise their options.
So to summarise the announcement of the March 2014 Budget, freedom is upon us, but with freedom comes responsibility. Whilst it is not my place to tell you how to spend your hard earned cash, I would recommend some careful and strategic planning to maximise your pension pot, minimise your tax, and ensure you do not run out of money during your lifetime. But then again, if you want to live the life of luxury aboard a lavish cruise-liner, be my guest. Retirement is about enjoying the proceeds of your success, and I am all for people ‘front loading’ their retirement by ticking off the bucket list.
So, in short, The March 2014 Budget and the subsequent conformation of these proposals in March 2015, signified flexibility, freedom and choice. You can take your pension however you want to; but there is more to the pension changes than just this.
Tax and Beneficiaries
The plans will saw the Treasury scrapping the 55% Pensions Death Tax charge and making alterations to the tax treatment of various lump sum death benefits. They told us that from April 2015 various lump sum death benefits, including pension protection, annuity protection, drawdown pension and uncrystallised funds, can be passed to a beneficiary tax free if the individual dies before the age of 75. This is a huge step forwards in helping families leave a legacy and provide for their loved ones.
From April 2015 until 2016/17, if the individual dies post 75, the funds will be charged at 45%. But from 2016-17, the beneficiaries of individuals who die at 75 or older will also see the residual pension tax at a marginal rate; meaning that beneficiaries should, theoretically, have a larger inheritance bestowed upon them.
This all sounds like a dream come true for many of us, but it did seem slightly unfair for those individuals who died prior to the new legislation coming into force. But fear not, the Treasury delivered again, stating that the beneficiaries of any individual who dies after 29th September 2014, but before 2016/17, will be able to ask the scheme administrator to delay the benefit payments, meaning that tax should be able to be deferred until a time where it will charged at a lower rate. This rule, in part, also applies to any individual who dies under the age of 75, however in these circumstances the payments can only be delayed by 2 years. Further to this, any pension wealth that a person inherits will not count towards the beneficiaries’ life time allowance, which is currently set at £1.25 million.
It is worth noting that not all of these tax changes are completely set in stone as yet, but that does not mean that you shouldn’t start to think about your retirement and what new legislation means to you. One of the main things you can do is to start to think about your beneficiaries. Under new rules, if you do not nominate a beneficiary, your pension scheme provider will decide ‘who deserves it most’. Of course, their choice may be wildly different from your own, so it’s vital to look at some estate planning for your family’s future.
October 2014 saw the plans of the Treasury coming to light and, believe it or not, they actually looked like they will benefit retirees and their beneficiaries. Like with all tax related affairs, legislation can be complicated and have huge ramifications if you get it wrong. Owing to this, would also recommend speaking to a professional. Now that the odds seem to be in the favour of your retirement, there is no better time to do this. If you, or anyone else you know, would like to speak to us at Efficient Portfolio, we would be delighted to help.
An IHT Cut, Just in Time for Christmas!
Just when we thought it couldn’t get any better for the world of pensions, on the 3rd December 2014 in his Autumn Statement, Mr. Osborne threw us an even more acute curve ball; he announced that the 55% Death Tax in pensions would be scrapped. Whilst less well publicised, this later change is even more dramatic if we look at the bigger implications. These two significant changes will revolutionise how the UK will finance their retirement:
Firstly, an upside that we have already focused on: Pension Freedom. The Autumn Statement further cemented the notion that pensioners would finally have the flexibility to utilise their pension pots as they saw fit; whether that was to buy their dream house on the beach or gift money to their loved ones during their lifetimes.
|£10,500 – £42,285||20%|
|£42,285 – £100,000||40%|
|£100,000 – £121,000||60%|
|£121,000 – £150,000||40%|
|£150,000 – £200,000||45%|
However, the downside of taking all of your pension in one go is that you will pay Income Tax on this money at your marginal rate. What I mean by, is that if you are taking out a lump sum of £200,000, as an example, you will pay tax at the following rate on the different slices:
So to take out £200,000, over and above the tax free element as a lump sum, will mean that you only actually pocket £123,737 of your money. This is an effective tax rate of 38%. Not sounding quite so attractive now is it! Add to that the fact that the money is now in a taxed environment rather than the tax free shelter provided by the pension, and it’s starting to make even less sense. The alternative of drawing the money out gradually, by taking an income of £34,500 per annum, means you could pay an effective tax rate of 15%, or, even better, at £10,500 and paying no tax at all.
So what about the long term prospects of what happens to the money upon your death? This brings us nicely onto the removal of the 55% tax charge. Without this tax, the pension has become a really quite powerful estate planning tool. Money left in your pension will pass to your beneficiaries completely free of Inheritance Tax if you die before the age of 75. If you die after the age of 75, it will be taxed at the recipient’s marginal rate. This could of course be the grandchildren, who may be non-taxpayers. This could pay for their education, or the family holiday. Who’d have thought your teenage children could be paying for their parents to go on holiday to save tax!
Another consideration, is that not only is the pension growing in an environment that is protected from tax, potentially it could also be protected from long term care fees too. Only time will tell whether this is the case, but this has certainly presented some interesting planning opportunities that could significantly increase your family’s wealth. We might see some examples where people in their 70’s and 80’s are making pension contributions as part of their estate planning. It will probably make sense to generate as much income from your other assets first, to preserve the pension as long as possible to maximise what you leave behind to your loved ones.
Whilst it is not my place to tell you how to spend your hard earned cash, I would recommend some careful and strategic planning to maximise your pension pot, minimise your tax, and ensure you do not run out of money during your lifetime. We use tools like Lifetime Cash-Flow Forecasts to model these scenarios for our clients to ensure they maximise their money whilst living out the retirement of their dreams. Retirement is about enjoying the proceeds of your success ticking off the bucket list, but if you can also leave a legacy with it, even better!
Confirmation of Our Hopes
You may remember that the March Budget 2015 saw the battle of the briefcases: The much anticipated announcement from the guardian of the red case versus the slightly ill-advised attempt at humour from the man sporting the yellow. But let’s not dwell on Mr. Alexander’s satirical efforts, as it was Mr. Osbourne’s speech that we were all eager to hear.
For a whole year we had been teased with the talk of change. The prospect of possible reformations to our pensions and taxes had dangled over our heads like sword of Damocles and uncertainty had taken grip of the nation. But, finally, in the early spring of 2015, we were given some answers. And they were actually quite positive!
There was great news for children’s mental health services, a boost for charities and retribution for the banks. There was even talk of faster broadband speeds and mobile networks, which, coupled with falling employment, growth in the economy and a promise to support all regions within the UK, could mean that future of Britain’s businesses looks bright. And we can even afford to have a drink to celebrate, as taxes on beer, cider and spirits have all been cut! But most importantly, the news we’ve been waiting for; Pension freedom was confirmed!
From April 2016, people who have an annuity will be able to effectively sell it on, so that they can benefit from the pension freedom’s mentioned at last year’s Budget. Currently, if you’ve purchased an annuity you are unable to sell it without having to pay at least 55% tax on it! However, from April 2016, the tax rules will changes, enabling people who already have an income from an annuity to sell what they chose and pay their usual rate of tax on the income. Flexibility in retirement was certainly our highlight of this Budget, as it brings with it a plethora of benefits, including the freedom to enjoy your retirement how you want to, more tax planning opportunities and far more control over your life during retirement.
For me, there are 3 key benefits to come out of the Pension Freedom phenomenon:
1. Flexible access to your pension pot. The ability to do what you want with your money.
2. Better tax planning opportunities, meaning that you could minimise the amount of tax you pay on your retirement funds.
3. Increased estate planning opportunities and the scrapping of IHT on pension pots, enabling you to leave a greater legacy to your loved ones.
However, as I have said before, with freedom comes responsibility. Taking all of your money out in one fell swoop may seem like the most appealing option, but you must consider your choices wisely. If you do not plan your withdrawals you could leave yourself without sufficient income to sustain you in retirement or you could face a hefty tax bill. I cannot stress this enough, but plan, plan, PLAN!
If you would like to talk to someone about planning finances around retirement, Efficient Portfolio, a chartered, independent firm, can help. As a member of ‘The Dream Retirement’ you are also entitled to a free Exploration Meeting with Efficient Portfolio; this usually costs £497 and is designed to get to the heart of your concerns. One of the advisers at Efficient Portfolio will then be able to make suitable suggestions to your circumstances and recommend the steps needed to help you achieve your goals. Contact them today to book your free meeting.
The new pension legislation has presented increased opportunities for people in retirement and you shouldn’t be scarred of them. Through careful research and planning, these changes can really help you to make the most out of your retirement and live out a life that is full of everything you dreamt of. But be careful – jumping in head first is not the sensible choice.
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