Are the new rules on flexible pension withdrawals what we need, or simply a cynical tax raid on pension funds?

Would you like to get access to all of your pension funds when you retire? After this week’s Budget announcements, it seems like the Government wants to give you full access to do whatever you want with your retirement pots. They even seem relaxed about you spending it all, with one Minister suggesting that you could take the whole pension pot and blow it on a Lamborghini sports car.

This article explores what we know about the flexible pension withdrawals announcement. We also explore the more sinister side of the issue: the fact that this is a £3 billion raid on pensions over just 4 years.

Key points:

  • No requirement to take an annuity from April 2015
  • Not the end of annuities
  • £3 billion raid on pensions in just 4 years
  • Free retirement advice?
  • Retiring soon – should you wait?

No requirement to take an annuity from April 2015

George Osborne, caught all the headlines this week when he announced that ‘no-one will have to buy an annuity’ when they retire. Actually, this statement was a little misleading. Since 2006 no-one has been forced to take an annuity in any case. There are many different options open to you at the moment, including income drawdown, which is a more restricted version of the proposals. In theory this announcement is a great move as there will be much more flexibility permitted. But what does this actually mean?

The end of annuities?

On the face of it, the Budget announcement is aimed at the problems with the annuity market. Currently, most of us use our retirement pension pots to buy a guaranteed income for life. These products have been criticised in recent years since the income provided has reduced compared to previous years. This has been due to some positive developments such as longer life expectancy and lower interest rates. In addition the annuity providers have been criticised rightly by Regulators due to their sales practices.

In my view, this does not spell the end of annuities. Many people will still want the guarantee of future income that annuities bring when you retire.

Pension income after April 2015

The Budget announcement says that from 2015 there will be no requirement to take an annuity with your pension fund. This means that you will be able to withdraw as much as you like after age 55. This is great news for many people. Many are put off from saving into pensions due to the restrictions placed on them when it comes to taking income.

So what will change?

  • You can still take 25% of your fund tax-free
  • You can withdraw as much as you like, but pay income tax at your ‘marginal rate’

Tax issues

You will be charged income tax on your flexible pension withdrawals after the tax-free cash is taken. Currently, these withdrawals would be taxed at 55%. The alternative could be to use a flexible income product such as income drawdown. This would limit the amount you could take as an income each year.

The new proposals suggest that future flexible income from pensions would be taxed in line with income tax rates. Thus, depending on the size of your fund you would pay tax at 0%, 20%, 40% or 45%.

There is some debate about what ‘marginal rate’ means. In theory, this could mean that you pay income tax on the taxable element of your pension plan at the rate at which your income is normally taxed. This would mean that if you are currently a 0% tax payer (or arranged your finances to achieve this), your pension fund would be taxed at 0% too. I suspect that this will not be the case when the legislation passes. The likelihood is that the flexible pension withdrawals would be added to your income for that tax year and taxed accordingly. The larger the fund, the greater the tax you will pay.

£3 billion raid on pensions?

This gets to the heart of the matter. The reality is that the Government sees pension funds as pent-up funds just waiting to be taxed. By relaxing the rules around income, they expect that a significant proportion of the retiring population will dip into their pension funds. They see this measure as a way to create some short-term tax revenue. The Budget documents show the expected additional tax this measure will create in just 4 tax years (source):

The expected additional tax raised from allowing people to take as much as they like from their pension funds from 2015.

The expected additional tax raised from allowing people to take as much as they like from their pension funds from 2015.

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The Government expects that tax receipts will increase for every year until 2030, when they will reduce.

What if you run out of money?

The proposals mean that some people will inevitably take all of their money out of their pensions, and spend it. Government ministers seem quite relaxed about this risk. Steve Webb, the Pensions Minister, even went as far to say that it was up to individuals if they spent the money on a Lamborghini sports car. Danny Alexander, the Chief Secretary to the Treasury thinks that on the whole retirees will be more prudent with their savings.

The reality is that in 2016 the State pension is changing. From April 2016 there will be a flat rate state pension. This means that most people of retirement age after that point should be taken out of means tested benefits altogether. I imagine that the Government is calculating that the benefits bill will not rise as a result of these measures, even if the retired spend all their pension money.

Free retirement advice?

The Chancellor also suggested that everyone who retires should be entitled to get free advice on their pension situation. While this is a laudable ambition, we do question whether this is possible for the Government to provide. He announced that he would pay £20 million towards this goal. This is a drop in the ocean when you consider that every year around 780,000 people reach the age of 65. That’s £25 per person. We suspect that this fund would be quickly swallowed in administration costs.

In addition, the ‘advice’ would actually be guidance only. This means that if you want advice on your retirement income options, you will still need to consult a financial adviser. Financial advisers are best placed to offer individual advice on your actual situation, and to let you know the consequences of any action you might take. Someone offering information and guidance will not be able to answer the complicated questions you are likely to face at retirement.

Final salary pensions

The new rules on flexible retirement income will not apply to public sector pensions, and probably not to final salary pensions. If the Government allowed you to take your public sector pension out of the scheme this could create a huge liability to the State and potentially would undo all that additional tax raising highlighted above.

Retiring soon – should you wait?

If you are reaching your retirement age, and are considering taking your income, then you are probably weighing up your options. The decision is based on your individual circumstances, but here are some considerations:

  • Do you need an income now?
    If you need an income now, then you will be forced into using the current rules. This means taking an annuity or using another retirement income product.
  • Do you want a guaranteed income?
    If you want a guaranteed income then an annuity is probably still the right solution for you.
  • Do you want access to your capital?
    If you want to access some or all of your capital then waiting for the new rules is probably the right way forward. The downside to this is that you will have to wait for at least a year to access your pension pot. You will also need to be prepared to pay income tax on this money. The income you get in the future would not be guaranteed.
  • Do you want to pass on money to your relatives when you die?
    Under current annuity rules the fund tends to be lost when you die, unless you buy additional benefits. Therefore, waiting for the new flexible pension income rules could be attractive if you want to be able to pass on your pension fund in the future. Of course, if you do not take the pension income, the fund can pass to your relatives under current rules anyway.

See also our article on creating an income in retirement.

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