14th April 2014
The chancellor’s recent budget was watched with baited breath by millions and received with excitement – there was to be a radical overhaul of the way pensions worked in Britain. People would finally get access to their pensions with no need to buy an annuity.
Many, especially those of us in the pensions industry, will have had one eyebrow firmly raised. After all, the requirement to purchase an annuity was abolished in the genuinely radical pensions overhaul back in 2006 – what is commonly known as A-Day.
Before 2006, since 1995, you could draw down an income from a pension pot but had to purchase an annuity by the age of 75. The 2006 pensions reforms stopped this, gave us a Lifetime Allowance (the total amount you’re allowed to have in your pension pot) and instituted a single set of rules for all pensions.
But, 5 years after the 2006 abolition of annuity requirements, and 3 years before the 2014 abolition of annuity requirements came the 2011 abolition of annuity requirements.
Again with much fanfare, this renamed alternatively secured income and unsecured income to “capped drawdown” and gave us something new – flexible drawdown. That is, take as much as you like from your pension, but you need £20 000 per year secured first. This can be by a combination of pension scheme annuity and state pension only.
So, essentially what’s happened now is that the £20 000 secured income requirement for flexible drawdown has been scrapped. Before this is implemented, there is a changeover regime for 2014/15. This consists of the right to take pension pots under £30 000 in cash rather than the previous limit of £18 000, and you can take around 25% more income per year than you could before. Remember: when you take the small pension pot in cash, you’ll receive 25% tax free and the rest you’ll pay tax on at your marginal income tax rate.
So what difference will this new, uncapped drawdown make in a year’s time? Essentially, it will target those in the middle – people with more than £30000 in their pension pots, enough to derive a meaningful income, but less than those who could secure a £20 000 annuity/state pension income anyway. These people will be able to take all their pension in cash. Most will find out what it’s like to get pushed from a basic rate to a higher or additional rate tax payer that year, and then try and reinvest what’s left in a less efficient tax wrapper.
In a survey of defined contribution scheme owners by Hymans Robertson, 44% of respondents said they would take most or all of their pension pot in cash with a large number expressing confidence in “managing their pension pot themselves”. However for most, this confidence will be misplaced. Moving the pension pot to a SIPP (or QROPS if the person is an expat) gives a large degree of investment freedom while avoiding a potentially crippling income tax liability. And what’s worse, it’s hard to imagine the chancellor didn’t foresee this windfall. And a windfall it could very well be.
According to the Pensions Policy Institute, the average amount used to purchase an annuity (after the 25% tax free) is around £25 000. The small amount of income this would generate, whether by annuity or drawdown, even combined with the state pension, probably wouldn’t generate much if any income tax at all. However taking the money at once will indeed generate some income tax for the treasury.
But the real prize is in those who have only ever been basic rate tax payers but have, through a lifetime of work, built up a pension pot of perhaps £400 000 or more. Enough to generate a living income of around £25 000 per year (about £3000 in income tax for the chancellor’s coffers). Taking the whole thing as cash will generate nearly £170 000 in pure income tax for the exchequer.
The reason I don’t think these so-called reforms aren’t important is more because they shouldn’t be to you. While you can take your pension pot at once, in cash, in most cases you probably shouldn’t.
If you live abroad though, there was a part of the budget which might impact you severely, but which you probably missed. The government has announced that tax allowances are to be reviewed for non-residents. This throwaway statement might signal the end for the around £10 000 you can earn each year tax-free.
The chancellor has said “To ensure the UK personal allowance remains well targeted, the government intends to consult on whether and how the allowance could be restricted to UK residents and those living overseas who have strong economic connections in the UK, as is the case in many other countries, including most of the EU.”
A single person living overseas with a combined pension from the UK of £30 000 per year currently pays £4000 in income tax. The elimination of the personal allowance could increase this by 50%.
These combined changes are set to increase pension transfers to tax-efficient overseas jurisdictions, not only to save tax but also to seek long term reliability and assurance and escape flippant rules changes and political wrangling that tend to accompany a UK general election.
Justin Harris, managing director, Chase Belgrave