Your Wealth. In this newsletter. november A newsletter from our personal financial planning team

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1 november 2014 Your Wealth A newsletter from our personal financial planning team In this newsletter 2 Freedom and choice in pensions 4 Saving for retirement Pension or NISA? 6 For peace of mind, opt for specialist insurance advice From April 2015, members retiring from DC pension schemes will have full flexibility over how they use their fund value to provide pension benefits. The tax fee lump sum option will remain (25% of the fund value up to a maximum of the lifetime allowance) and the residual fund value can either be used to provide a taxable pension income by purchasing an annuity, scheme pension or alternatively can be drawn down on by individuals as and when required. There will also be a significant improvement in the tax treatment of lump sum death benefits, which will enable individuals to pass down the value of their pension funds to heirs in a more tax-efficient way. In our view, the changes will fundamentally change the nature of DC pension schemes. The increased flexibility will encourage pension savings, which can be considered as long-term savings plans with tax advantages, enabling individuals to draw down income when they most need it and, on their death, pass down money in a tax-efficient way to their beneficiaries. In this edition of Your Wealth we focus on: The options for taking pension benefits after April Pension planning opportunities available prior to April Whether, given the post April 2015 options for taking DC pension benefits, it would be better to make DC pension contributions or invest in new individual savings accounts to provide for retirement. We also outline specialist insurance broking services provided by our sister company, Marsh Private Clients, and explain why these might be of interest to those with high value properties. We hope you find this issue helpful. As ever, if you need any help or advice on the topics covered, please don t hesitate to get in touch with me or one of our local consultants you can find our contact details on page 7. Tim Robson FPFS, Chartered Financial Planner

2 freedom and choice in pensions IN BRIEF From April 2015, there will be a radical change to the way you can access pension benefits from defined contribution (DC) pension plans. From 6 April 2015, retirees will be able to access savings via a combination of: A lifetime annuity. Flexi-access drawdown (FAD). An uncrystallised fund pension lump sum (UFPLS). A scheme pension. This article outlines the details of the new income drawdown options and pre-april 2015 financial planning opportunities. It should be noted that pension schemes are not required to make available all of the above and individuals will be able to utilise one or a combination of the options. FAD KEY FACTS Under FAD there will be no restrictions on how money can be withdrawn from DC funds by people over the minimum pension age (currently age 55). The maximum tax free cash allowable will be 25% of the value of pension benefits (subject to a maximum of 25% of the lifetime allowance (LTA) or any protected amount if greater). The residual fund value (net of tax free cash) can be drawn down without limits and will be subject to income tax. As soon as any income is taken it will trigger the new money purchase annual allowance (MPAA we go into more detail on this below). If only tax free cash is taken (with no income) the MPAA is not triggered. UFPLS KEY FACTS A UFPLS is a lump sum payment made from a UK registered pension scheme of which up to 25% will be tax free with the remainder being subject to income tax provided the individual has sufficient LTA remaining. In most cases emergency tax will be deducted on the taxable element, which will mean that the incorrect amount of tax is initially paid, with any over payment needing to be reclaimed from HMRC. As tax free cash cannot exceed 25%, it will not be suitable for individuals who are entitled to a higher tax free cash amount. Taking a UFPLS will trigger the MPAA. MPAA KEY FACTS The MPAA will be 10,000 ( 30,000 less than the annual allowance of 40,000) and, as above, there are a number of ways this can be triggered. Once invoked, DC pension contributions in excess of 10,000 will be subject to an annual allowance (AA) tax charge. The operation of the MPAA and the way it interacts with the AA for accruals under defined benefit (DB) schemes is complex and there are transitional arrangements for tax year 2015/16. We will provide further information on this in the next edition of Your Wealth. INCOME DRAWDOWN DEATH BENEFIT CHANGES Income drawdown of lump sum death benefits will also be affected as follows: DEATH BEFORE AGE 75 Fund value (up to the remaining LTA) can be paid tax free to nominated beneficiaries. DEATH AFTER AGE 75 Fund value will pass to nominated beneficiaries and can either be: Used to provide an income, with payments taxed at their marginal rate of income tax. Paid as a lump sum, net of a 45% tax charge, which will change to marginal rate after April The new rules will apply to death benefits paid out on or after 6 April 2015 as opposed to the date of death. So where payment of death benefits can be delayed until after 5 April 2015 (the scheme administrators have up to two years to make the payment if death occurs prior to age 75), the beneficiaries will be able to take advantage of the new rules. The improved death benefits could lead to an increased interest in transferring private sector DB pension benefits to DC pension plans for individuals who would like to access the new freedom and choice available and pass money down to their heirs on death. PRE APRIL 2015 PLANNING OPPORTUNITIES CAPPED DRAWDOWN Individuals, who would like to draw down on some of their DC pension assets post April 2015, but continue to contribute more than the MPAA of 10,000, could consider entering into a capped drawdown written as one arrangement prior to April The MPAA allowance will not apply to capped drawdown written as one arrangement, rules governing which will be grandfathered into the new regime. This means that individuals who enter into capped drawdown before April 2015 will retain their AA of 40,000. 2

3 At the point they seek to take advantage of the new freedoms and withdraw more than the capped maximum amount they will immediately become subject to the MPAA. FLEXIBLE DRAWDOWN At present individuals using flexible drawdown do not have an AA, which means that any pension contributions made will be subject to an AA tax charge. From 6 April 2015, they will be entitled to the 10,000 MPAA. However, by changing the pension input period (the time period over which contributions are measured for testing against the AA) for tax year 2014/15, it might be possible to make a 10,000 contribution this tax year, as shown in the following example: End current pension input period (PIP) on 30 November Open new PIP 1 December 2014 with an end date of 6 April Contribute 10,000 in December 2014, which will be measured against the tax year 2015/16 MPAA. Contribute a further 10,000 on 7 April 2015, which will be measured against the 2016/17 MPAA. Please note this does not work for anyone entering flexible drawdown in tax year 2014/15 as making a contribution will invalidate their declaration to the scheme administrator. From 6 April 2015 such individuals will have a MPAA of 10,000. WHICH DRAWDOWN OPTION TO CHOOSE? A brief summary of which option might be most appropriate post April 2015, based on what an individual might want to do with their DC fund value, is provided below: Scenario Draw down protected tax free cash only. 25% tax free cash only, no income. Crystallise all benefits. Take tax free cash and phase drawing down on the income drawdown fund value. Phase drawdown and not take all tax free cash immediately. Drawdown option FAD FAD UFPLS/FAD FAD FAD However, care will need to be taken to avoid scenarios like the 75% tax trap we have set out at the bottom of this page. CONCLUSION Whilst the new regime does offer freedom and choice per the Government s intention, it means that individuals will have to carefully consider which option/s are most appropriate for their personal circumstances and objectives. In this respect, they will need to consider how important the following are to them personally: A guaranteed income. Protection for their spouse/ dependents. Protection against inflation. Access to capital. Leaving an inheritance. Capital growth. For more information on these options or to discuss your personal circumstances, please contact your local consultant. The 75% tax trap clare has gross earnings of 100,000 for tax year 2015/16. We have assumed the personal allowance is 10,500. she decides to cash in her personal pension plan worth 30,000, which means she will receive a tax free lump sum of 7,500 and the residual fund value of 22,500 will be subject to income tax. income tax at 40% on 22,500 9,000 additional tax due as a result of lost personal allowance ( 10,500 x 40%) 4,200 net income 9,300 potential inheritance tax payable on net income ( 9,300 x 40%) 3,720 net amount retained 5,580 if we assume Clare spends the tax free cash of 7,500, the reduction in the fund value from 22,500 to 5,580 represents an effective rate of tax of 75%. 3

4 SAVING FOR RETIREMENT PENSION OR NISA? IN BRIEF We compare DC pensions with NISA savings in light of tax advantages and other considerations. With the increase in the annual ISA (known as New Individual Savings Accounts (NISAs) from July 2014) to 15,000, careful consideration now needs to be given to whether DC pension contributions or NISA savings is the best vehicle to save for retirement. We outline considerations for savers. TAX ADVANTAGES Investment returns from DC pensions and NISAs are broadly tax free. This gives them a distinct advantage over other non-tax privileged investments. Where they differ is on the tax breaks given when payments are made and when funds are accessed. MONEY IN For contract-based DC pension plans, pension contributions (up to an individual s available annual allowance (AA) will be paid net of basic rate tax and the plan provider will re-claim the basic rate tax relief from HMRC and re-invest this in the pension plan. Any higher or additional rate tax relief will then need to be claimed via selfassessment. For salary sacrifice arrangements, any higher or additional rate tax relief would be given at source and there would also be a reduction in employee national insurance contributions. There is no tax relief for payments made to NISAs. MONEY OUT Under current legislation, up to 25% of the DC pension plan fund value can be paid tax free, with the residual fund value being taxed at the individual s marginal rate. All withdrawals from NISAs are tax free. We have used a case study (see below) to compare DC pension and NISA savings to identify which option could provide the highest net of tax return. Case study Keith and Hannah are both age 55. Their earnings and ongoing pension contributions are as follows: Keith Basic salary 80,000 Ongoing pension contributions 15,000 Hannah Basic salary 20,000 Ongoing pension contributions 2,000 They have identified that they can save 30,000 from net income. NISA Keith and Hannah could each use their 15,000 NISA allowance. An investment of 15,000 would yield around 20,159 each after 10 years at a real rate of return of 3%. There would be no tax to pay on withdrawing the funds. Pension If Keith chooses to save in his pension; he would be limited to contributing a further 25,000 a year in addition to the 15,000 he and his employer are already paying (assuming he has no unused AA to carry forward). The 25,000 will go into Keith s pension but will only initially cost him 20,000, as 5,000 in basic rate tax relief will be added. He ll also be able to claim back 5,000 via his self-assessment return, making the net cost 15,000. If we assume a real rate of return of 3% for 10 years the fund value at retirement will be approximately 33,598. If Keith takes 25% tax free - that s 8,400, assuming the balance of 25,198 is taxed at 20%, this will leave 20,158, which would leave a net value of 28,558, which is 8,399 more than a NISA. Hannah is a basic rate taxpayer, so the 15,000 paid into her pension would be grossed up to 18,750. This could turn into approximately 25,198 on the same basis after 10 years. This would give her tax free cash of 6,299 and the balance taxed at 20% would leave 15,119. This would leave Claire with a net value of 21,418, which is 1,259 more than a NISA. Assumptions A real rate of return of 3%. Investments chosen under the NISA and pension are the same. Tax rates and allowances are those that apply for tax year 2014/15. Pension contributions are within the AA. Payments out of the pension don t attract a lifetime allowance charge. 4

5 The case study highlights that the benefit of up front tax relief plus the ability to take 25% tax-free for DC pensions will outperform a NISA on a like-for-like basis. The exception to this rule is a basic rate taxpayer funding a pension and paying higher or additional rate tax on the residual fund value net of tax free cash. This situation could become more common under the new pension freedom if individuals try to access their funds in large chunks. TAX There are many other factors that could influence the choice between a DC pension or NISA, savings which are summarised below: A NISA can be accessed at any age, so would be preferable for saving for life events that will occur before DC pension benefits are taken. On death a NISA will form part of the estate for inheritance tax (IHT) unless the underlying stocks and shares qualify for IHT business property relief. Whereas the DC pension fund value could be paid tax free to beneficiaries on death before age 75 and subject to tax at their marginal rate on death after April An employee DC pension contribution could be matched by an employer pension contribution which would further increase the attractiveness of this option. Whether you could be impacted by the annual allowance or lifetime allowance if you were to make DC pension contributions Future changes to legislation. CONCLUSION We would suggest that, based on our current understanding of the relevant legislation, DC pension savings could be more appropriate as retirement approaches, when compared with NISA savings. Furthermore, consideration could be given to liquidating existing NISAs to fund DC pension savings for individuals who have sufficient AA available and who are looking to preserve as much of their savings as possible for their beneficiaries. However, NISAs continue to be important to provide easy access funds before age 55. For more information and investment ideas, please contact your local consultant. 5

6 for peace of mind, opt for specialist insurance advice in BrieF our sister company, marsh, considers how to navigate the common pitalls of insuring a higher value property. Whereas a standard home insurance policy may be adequate for the average three-bedroom home, it may be a false economy for higher value homes. the risks are likely to be more diverse, the potential losses more significant and the process of replacement or repair, more involved especially if you own high value assets and possessions such as expensive jewellery, fine art or bespoke furniture. insuring a higher value property: common pitfalls 1. confusing price with value. any savings made on your home insurance with a standard policy could prove to be a false economy if, later on, you lose thousands on a claim because you didn t have adequate cover. 3. Banking on your insurance to cover you for all eventualities. standard policies are likely to be perils based. this means you are covered only for loss or damage resulting from specified perils such as fire, theft, storm and water damage. 4. Forgetting to check if your insurance policy is warranty-free. standard policies are likely to include an alarm clause or warranty which invalidates theft cover should you, for instance, go out and forget to set the burglar alarm. 5. letting an insurer dictate how you replace lost, stolen or damaged items. You may prefer to have cash or to replace a lost item with something slightly different, particularly if it was one-of-a-kind or had sentimental value. marsh private clients, part of marsh, provides tailored insurance solutions and risk management advice for individuals and families. everything we do is based around personal advice and service, delivered by a team that understands the complex lifestyles led by people with high value assets and possessions. We are delighted to offer you a complimentary audit of your own personal assets and a full premium benchmark against your existing insurance policy. contact marsh private clients please quote reference: mr2 2. under-estimating the value of your home or contents. under-insurance is a serious problem, particularly if your home is worth more than the average. the association of British insurers (abi) estimates that one in four uk homes may be underinsured*. Why not consider having your contents valued by a professional valuer? they offer a variety of valuation services from single items, to basic sum insured calculations, through to full valuations. We suggest you review the valuation every three to five years to take account of fluctuations in the jewellery, art and antique markets. * source: abi ( marsh private clients is a trading name of marsh limited. the information contained herein is based on sources we believe reliable and should be understood to be general risk management and insurance information only. the information is not intended to be taken as advice with respect to any individual situation and cannot be relied upon as such. 6

7 YOUR MERCER MARSH BENEFITS TEAM Our personal financial planning team, backed by our Wealth Manager online investments portal, is on hand to help you shape your wealth. Please don t hestitate to conact us with any queries on the content of this newsletter. Don t forget you can also find financial planning resources, tax information and news items on our dedicated website: CONTACT US London and South Tim Robson tel: Stuart Miller tel: Neville Khorshidchehr tel: MIDLANDS Steven Hilditch tel: Scotland Allan Erskine tel: North Michael Kessler tel: Mercer Marsh Benefits is a service provided by Mercer Ltd which is authorised and regulated by the Financial Conduct Authority. Registered in England and Wales No Registered Office: 1 Tower Place West, Tower Place, London, EC3R 5BU. Marsh Ltd is authorised and regulated by the Financial Conduct Authority. Registered in England and Wales No Registered Office: 1 Tower Place West, Tower Place, London, EC3R 5BU. This newsletter is for general guidance only and represents our understanding of law and HMRC as at November Whilst every care has been taken to ensure the accuracy of editorial content, no responsibility can be taken for errors or omissions, or for actions taken or not taken as a result of any statement in this document. The value of investments can go down as well as up and you may not get back the full amount you invested. The past is not a guide to future performance. Nothing in this document constitutes advice or is intended to be read as such and should not form the basis on which investment decisions are made. 7

8 Copyright 2014 Mercer LLC and Marsh Ltd. All rights reserved. MMB-YW

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