On the heels of the chancellor’s “pension revolution” and proposed pension reforms, it has become clear that millions of Britons will experience a significant change in their retirement funding.
Under the chancellor’s proposals, millions of individuals nearing retirement age will be allowed to spend their pension funds however they want.
Announced in the 2018 Budget, the move will do away with the current annuity purchase requirement for individuals with defined contribution pensions.
According to the government, the pension overhaul will provide retirees with the added flexibility to spend their pension savings however they like. Meanwhile, Labour has branded the policy as “reckless.”
Targeting the annuity regimes, beginning April 2017, individuals will be able to freely access their pension savings upon reaching retirement age, at which time they will be subject to their marginal income tax rate, rather than having to pay the obscene current charge of 55 percent for a full withdrawal.
Preceding the reform, chancellor Osborne has announced interim measures that will immediately make it more accessible for people to drawdown by reducing the flexible drawdown income requirement from £20,000 to £12,000. The capped drawdown rate of the Government Actuary’s Department will also be raised from 120 percent to 150 percent.
The chancellor also announced trivial commutation rules changes, in which the pot size that can be cashed in will increase from £2,000 to £10,000. The lifetime limit will also increase to £30,000.
Most importantly, Osborne’s proposed pension changes will do away with the need for people in a defined contribution scheme to buy an annuity, and those that did will be provided with impartial financial advice.
Overview of Temporary Rules
The chancellor also announced the implementation of temporary rules that will be in force until the new changes take effect on 6 April, 2017.
If you are 60 years or older and you have a pension pot under £30,000 that you have not touched, you can now withdraw your entire savings if you so choose. While the first 25 percent withdrawn is tax-free, the rest is taxed at your income rate during the same tax year.
Before taking advantage of the new pension rule changes, it would be wise to determine how much tax you will have to pay on the money you withdraw from the pot.
If your pension is in capped drawdown, in which you are restricted to only taking out a certain amount each year, the amount you can take out from your drawdown pot will jump from 120 percent to 150 percent.
Meanwhile, if you have a capped drawdown and a minimum “secured pension income” of £12,000 a year, you are allowed to transition to a “flexible drawdown” that provides you with total freedom over the amount you can take out of your pension fund. Prior to 27 March, you were only able to transition to flexible drawdown if you had a minimum secure pension income of £20,000 a year.
It is important to remember that any money taken out of a drawdown fund is taxed at an individual’s marginal rate, so it may be wise to withdraw money in phases in order to minimise tax costs.
Examining the Proposed New Rules
The government is currently consulting on the proposed rule changes set to take effect on 6 April, 2017. However, experts expect that people 55 years of age or older will be able to take their entire defined contribution pension savings in a lump sum and do whatever they wish with the money.
As mentioned, up to 25 percent of a person’s pension savings can be taken tax-free, with the balance being subject to income tax at their marginal tax rate.
For example, Ralph is a 58-year old accountant with a taxable income of £40,000. He has £200,000 in his pension fund and decides to take out all of his money on 15 May, 2017. Ralph will receive 25 percent or £50,000 without tax and the remaining balance will be taxed at 40 to 45 percent.
Also, since his total taxable income exceeds £100,000, his personal allowance will also be lost. If Ralph were to have spread the withdrawals out over a few years, he would have paid less in taxes.
If you are a pensioner and have already obtained an annuity with your pension savings, then these proposed pension changes will likely not affect you. You will continue to receive your annuity as normal from your pension provider.
However, other pension savers can now begin enjoying greater control of their pension pots. While this freedom has been a long time coming for some, others are weary of the effects it may have on less responsible pensioners. In the end, just remember that withdrawing pension funds may trigger tax charges, so you should determine how much tax you will owe prior to taking out any money.