13th February 2015

We have written before about the new pension legislation that is due to come into effect from April 2015. On the whole the legislation is welcome, but what do the changes actually mean?

How much income can I take? Can I spend my entire pension?

You may have read extravagant headlines such as ‘Pension pots can be used to buy Lamborghinis’ over the past year. Sound appealing?

From 6th April 2015 you will be able to draw your entire pension fund out as income in one go. But the big question is – why would you?

  • 25% of pension can be drawn as a tax free lump sum but the balance (75%) will be subject to income tax – significantly reducing the actual cash in your pocket!
  • What will you live on in retirement?

For the majority this change will not mean extravagant purchases or world cruises but welcome flexibility regarding how and when you draw income.

What options do I have at retirement?

You are able to draw up to 25% of the value of your pension plan tax free. The balance can only be used to provide you with an income. Broadly speaking three options will be available from 6th April 2015;

  • Flexi-access Drawdown – will allow you to take as much income from your pension fund as you wish having already withdrawn the tax-free cash. Any income drawn will be subject to income tax.
  • Uncrystallised Funds Pension Lump Sums (UFPLS) – will allow individuals to make withdrawals from their pension fund as and when they wish. Each withdrawal is regarded as part tax-free cash (25%) and part taxed income (75%).

Both of the above are essentially different mechanisms to achieve the same thing.

  • The third option is to purchase an annuity. An annuity provides a guaranteed income for life offering both simplicity and certainty.
How much can I contribute to my pension?

You are currently able to pay pension contributions of up to £40,000 per year into a pension plan. This limit has changed several times but for the majority of people it will remain as is throughout 2015/16.

However (there is nearly always a BUT….), this limit will be reduced to £10,000 per year should you draw income, via Flexi-access Drawdown, or any benefits via UFPLS post 6th April 2015.

What happens when I die?

Simply speaking if you die before the age of 75 any death benefits payable (whether income or a lump sum) will be paid to your nominated beneficiary free of tax. This is a vast improvement on the current 55% tax charge which applies to lump sum death benefits payable once you have drawn your tax free lump sum.

The position post 75 is less favourable, albeit still an improvement on the current rules. If death benefits are drawn as an income this will be subject to tax at your beneficiary’s highest marginal rate. If death benefits are drawn as a lump sum they will be taxable at a flat rate of 45%, reducing to your beneficiary’s marginal income tax rate, from the 6th April 2016.

All this means that Financial Planning is essential

It is clear that anyone looking to take benefits from their pensions will have a lot to consider if they are to make an informed decision about the most appropriate course of action including:

  • How important is it for you to leave your pension fund to a beneficiary rather than secure a guaranteed pension in your lifetime?
  • How long do you need your pension income to last and how much income can you take, therefore, without risking running out of funds?
  • Should you secure a base level of income for your lifetime with a proportion of your pension fund whilst retaining flexibility to use the balance in accordance with the new rules?

It is clear that those making such decisions will have to prioritise conflicting objectives. It is also clear that making assumptions about life expectancy is pivotal to the process; and, with very few exceptions, it is impossible to make an accurate prediction.

We are convinced that having a Lifetime Cashflow, in which the likely outcome of differing scenarios can be illustrated, is essential for the decision making process. We help our clients understand the possible consequences of the various options available to them so that they can sleep at night in the knowledge that they have chosen wisely.

Please contact us if you would like to discuss whether and how we can help you.