Freedom and Choice in Pensions. Your guide to the changes

Transcription

1 Freedom and Choice in Pensions Your guide to the changes

2 Contents Freedom and Choice 3-5 in Pensions Buy an annuity 6-7 Remain invested entering drawdown Take a cash lump sum 10 Will providers offer 11 these new options? Other considerations Changes being made to defined benefit pension schemes Guidance or advice? 18 What should you 19 do now? Freedom and Choice in Pensions In April 2015 the biggest reforms made to UK pensions in a generation were introduced. This guide will set out the options now available and enable you to decide what is best for your financial future. It is intended to be for information, and not to be taken as financial advice. Furthermore, it is our understanding based on current legislation. These reforms are part of the Government s policy to encourage people to save for their old age and give themselves greater financial security in retirement. The changes mainly apply to defined contribution (also known as money purchase) pensions. Some examples of defined contribution pensions are personal pensions, stakeholder pensions and many employer group pension schemes and master trusts. The change that has received the most publicity is the freedom to draw as much or as little from your pension pot from age 55. You can: Buy an annuity, or other income generating guaranteed products that may emerge Remain invested - such as by entering drawdown with no income limits applied Take your entire pension savings as a cash lump sum Most of the reforms do not apply to defined benefit pensions at this stage, although this may change in the future. Take a look on page 16 for more information. 2 3

3 Your Choices Follow our simple flow chart to help you decide what options may be best for you. Do you have a pension? YES NO Do you have a defined benefit pension? Do you have a defined contribution pension? YES NO YES Have you already bought an income for life with your pension pot? Do you work? Yes Would you be interested in swapping your income for a lump sum? The Government is consulting about making this possible, with the intention it will be available from April 2016 NO No no action required NO Are you 55 or over? YES NO I m employed Ask to join your company pension YES I m self-employed Consider paying into a personal pension NO Do you have a retirement plan and are you on track to meet your targets? I don t work You can make contributions up to 2,880 a year and get tax relief Do you want to take your pot as a cash lump sum, receive a medically enhanced pension or have flexibility in taking your benefits? Yes - Do you want a guaranteed lifetime income? Are you ready to retire? No - Do you need some cash immediately to help you clear debt, such as your mortgage? Yes - Great news. You can consider whether these new freedoms will help you meet your retirement goals No - Start planning now. Book a meeting with us and we can help create your personal retirement plan You could cash in some of your pension pot Yes - You will need to seek financial advice. Final salary pensions offer valuable benefits that normally should be protected No you can draw a pension directly from the pension scheme Yes - I want my entire income guaranteed Yes - I would like some guaranteed income but would also like some flexibility to cover my essentials No - I want to keep my pension invested for flexibility and growth. I understand this is more risky than buying an annuity and my savings may run out before I die My pension is small so I want to take it as a lump sum Annuity Remain Invested Cash Lump Sum For more information see page 6 For more information see page 8 For more information see page

4 Buy an annuity An annuity is a type of investment that can be purchased with your pension pot and guarantees a lifetime income. This income is usually paid out on a level basis but you can choose to have an income that increases by a fixed amount or in line with inflation, however this will reduce the starting amount of income you receive. Annuities remain the best solution for many retirees, providing a known income for their retirement which can include protection for their partner and dependants. To enable further competition and innovation in the annuity market the following changes have been introduced: Lifetime annuities will be able to decrease as well as increase once in payment. This will allow annuities to be more closely linked to the annuitants needs, for example reducing once the pensioner becomes eligible for the State Pension Lump sums can be payable from lifetime annuities provided that they are specified when the contract is set up Removal of the ten-year maximum guarantee period for guaranteed annuities, which will allow payments made to beneficiaries from guaranteed annuities to continue beyond the current ten year maximum Payments from guaranteed annuities can be paid to beneficiaries as a lump sum when the income remaining in the guarantee period is under 30,000. This will allow beneficiaries to receive income payments as a lump sum if they wish, rather than having to spread these out over the remaining guarantee period The range of allowable beneficiaries is being extended to allow those other than a spouse, civil partner or financial dependant to be a beneficiary For example: The new flexibilities may make annuities more attractive in some circumstances, although there is a danger that taking a high level of income earlier in your retirement could leave you short of funds in the future, particularly if you underestimate your life expectancy. Annuities will still have to make a payment at least annually for the life of the annuitant, as per the current rules. Freedom and Choice in Pensions to be extended to your existing annuity? Following the reforms introduced for those who have not yet taken their pensions, the Government is consulting about whether these freedoms could be extended to those who have already bought an annuity with their pension fund. The intention is to create a secondary market where existing annuities can be sold, with the purchaser receiving the income stream for the life of the selling annuitant in return for a one off lump sum payment. Any lump sum received could be taken as a taxable lump sum or could potentially be held within a Flexi-Access Drawdown plan with income taken as required. This will not be introduced until April Please contact us if you are interested and we will keep you updated with any developments. Mr. Smith, 60, decides to buy a lifetime annuity with his pension fund of 100,000. He takes 25,000 as a tax free lump sum, and a pension provider converts the remaining 75,000 into a level income of 3,649 per annum. This income will be paid for the rest of his life, and the amount of tax he pays will depend on his other income sources.* *Source: the Money Advice Service based on: joint annuity, guaranteed for 5 years, level income, monthly in advance payments 6 7

5 Remain invested - entering drawdown To help facilitate the pension reforms, a new form of drawdown contract, called Flexi-Access Drawdown (FAD) gives you a way of taking money flexibly from your pension pot. Your pension fund will remain invested, meaning that the value of your remaining fund will rise and fall depending on the prevailing relevant market conditions and the performance of your chosen investments. In most cases, you can take up to 25% of your pension pot as a tax free lump sum with the remaining 75% being taxed at your marginal rate of income. Within FAD you have the choice of taking just the tax free cash, just income or a mixture of the two. For example: Mr Brown has a pension pot worth 150,000. He enters FAD and decides to just take his 37,500 tax free lump sum. He will pay no tax on this withdrawal and can choose how his remaining 112,500 fund is invested. The following year he would like to take out 10,000. He cannot take any more cash out tax free and he is already a basic rate taxpayer. To receive 10,000 he will need to draw 12,500, which will be 10,000 once basic rate tax of 20% ( 2,500) has been paid. On death, any remaining money within your FAD pension pot can be passed on to a beneficiary or beneficiaries of your choice, free of Inheritance Tax. The tax treatment of these death benefits is covered later in this guide. Please note that many people underestimate their life expectancy and base their retirement budget on too short a term. You will continue to take investment risk within an FAD product. If the funds you are invested in fall in value you risk running out of money, a risk that is magnified by taking high levels of income or requiring the income to meet your retirement needs. Furthermore, if you should suffer sharp market falls at the beginning of commencing FAD, it may be difficult to recover these losses without taking more investment risk. 150, ,500 Drawdown 12,500 37,500 What about those who were in drawdown before these changes? Under the rules that applied up to the end of the 2014/15 tax year there were two different types of drawdown; capped and flexible. In capped drawdown the amount of income you can take each year is limited by factors set by the Government Actuary s Department (GAD). These factors change depending on current gilt yields and are intended to broadly reflect the amount of income a pensioner would receive from an annuity, although the maximum capped drawdown amount is currently higher than this level. These income levels are reviewed by the pension provider on a triennial basis. There is no income limit applied to flexible drawdown, but savers had to meet a minimum income requirement from their other pensions which were already in payment and were guaranteed before they were allowed to access a flexible drawdown product. Savers who were invested in capped drawdown (where their income was limited based on their fund value and Government-set factors) will remain subject to the old rules unless they ask for their pension to be converted into a FAD so they can utilise the new flexibility. This will allow them to retain the full 40,000 Money Purchase Annual Allowance if they keep within the capped drawdown income limits. Those who were in flexible drawdown will automatically be converted into FAD. We strongly recommend that if you are considering FAD, you should seek professional financial advice, with a yearly review as a minimum. This approach is unlikely to be suitable if you have a smaller pension pot, especially if you do not have access to other forms of secure income. 2,500 10,

6 Take a cash lump sum To enable savers to gain access to their pension pot without creating a Flexi-Access Drawdown fund, the Government has introduced legislation which allows Uncrystallised Funds Pension Lump Sums (UFPLS) to be payable. Under the new tax rules, individuals will have the flexibility of taking a series of lump sums from their pension fund, with up to 25% of each payment tax free and the remainder being taxed at your marginal rate of Income Tax. This could be the entire value of your pension fund or it could just be a proportion. For example: Mr Green has a pension pot worth 150,000 and he takes 15,000. He is a basic rate taxpayer earning 20,000 per annum. 25% of his 15,000 withdrawal ( 3,750) would be tax free with the remaining 11,250 subject to basic rate tax at 20%. This would leave him with 12, ,000 Withdrawal 15,000 Will providers offer these new options? At the time of going to print, it is too early to say how many providers will allow some or all of the new rules on all of their pension product range. The Government has introduced legislation that creates a permissive statutory override. This override will allow schemes to ignore their scheme rules and follow the new pension tax rules instead, in order to pay out payments flexibly or to provide a drawdown facility. However, this does not mean that all schemes and providers will choose to offer these new rules and it will be down to each scheme or provider to determine their approach. Contact us or your provider directly to determine if it does affect you. We believe it is more likely that pension schemes will offer savers the option to take their funds as a UFPLS rather than FAD, which will be harder for pension providers to administer. Providers may apply a charge to those who are looking to draw lump sums from their fund or enter FAD, or indeed potential charges for an UFPLS payment. How will I pay any tax charges? If Mr Green decided to take his entire pension pot as cash, he would face a much greater tax bill. While 37,500 would be tax free, 112,500 would be liable to Income Tax, leaving him with a tax bill of 46,867. In addition to this, the individual would start to lose their personal allowance from any earnings over 100,000, with an even more dramatic increase in the effective marginal rate of tax. at 20% 11,250 3,750 If you take income from a pension provider as a UFPLS or from a FAD they will normally withhold some Income Tax from your money. If they do not have your correct tax code they may not deduct the correct amount of tax, which could result in you making an overpayment, or an underpayment which could lead to further tax charges in the future. If you are in doubt about the amount of tax you would need to pay we suggest you seek appropriate professional advice. Taking large lump sums in a single tax year will normally create bigger tax bills than spreading the withdrawals over a period of years. It s likely to be in most customers interest to consider phasing their taxable income from their pension pot once they have received appropriate advice. 9,000 Receives Taking an UFPLS can have further consequences than paying an Income Tax bill. If you take an UFPLS you trigger the Money Purchase Annual Allowance (please see page 14), which restricts the amount you can save into a defined contribution pension to 10,000 per year, a big reduction from the standard 40,000. To avoid triggering this by taking a small pension pot you can use the Small Pots rule. Using the Small Pots rule allows you to take up to three defined contribution pension pots worth less than 10,000 each without triggering the Money Purchase Annual Allowance. 12,

7 Other considerations Changes being made to death benefits One of the biggest changes being made is a restructuring of the rules governing how pensions and annuity death benefits are treated and taxed. The headline change is that for defined contribution pensions all death benefits are tax free if you die before age 75, including any dependants pension payable from an annuity. Funds in FAD can be transferred to a beneficiary and they can draw a tax free income over their lifetime or take a lump sum. For those who die over age 75 the tax charge on lump sum death benefits is reduced from 55% to 45%. This tax charge will change again in the 2016/17 tax year, when any lump sums paid out will be taxed as income on the receiving beneficiary. Alternatively, your pension fund can be transferred to any beneficiary or beneficiaries and they can draw income from the fund subject to their marginal rate of tax. These changes are illustrated in the table below. Death before age 75 Death pre-75 Old rules New rules Tax free death benefits if you die before age 75 After age 75 the tax charge on lump sum death benefits reduced from 55% to 45% Death from age 75 Death from age 75 Lump Sum Survivor drawdown Annuity Old rules New rules Subject to 55% tax Taxed as income at marginal rate for dependants. Only possible to nominate spouse or civil partner or financial dependants Income taxed at recipients marginal rate of Income Tax. Only possible to nominate spouse or civil partner or financial dependant. Annuity protection lump sums taxed at 55% Subject to 45% tax (will be marginal rate of Income Tax on the recipient from 2016/17) Taxed as income at marginal rate of beneficiary. Nominate any beneficiary. Income taxed at recipient marginal rate of Income Tax. You can nominate any beneficiary. Annuity protection lump sums taxed at 45% (will be marginal rate of Income Tax on the recipient from 2016/17) Lump Sum Uncrystallised funds are tax free. Crystallised funds at 55% tax All tax free Pension funds can be passed on multiple times in the future, with the tax treatment dependent on the age of the person holding the pension fund when they die. Survivor drawdown Annuity Taxed as income at marginal rate of dependant. Only possible to nominate spouse or civil partner or financial dependants Guarantee period / spouse s or civil partner income taxed at dependant s marginal rate. Only possible to nominate spouse or civil partner or financial dependant. Annuity protection lump sums taxed at 55% Tax free, if taken via new FAD or annuity. You can nominate any beneficiary Tax free. You can nominate any beneficiary Tax charge will change again in the 2016/17 tax year Under the current rules these changes in tax will only apply to money purchase pensions and annuities. Those who have scheme pensions or defined contribution pensions will be taxed under the old rules

8 The Money Purchase Annual Allowance (MPAA) Under the current pension rules there is an annual amount you can save into a pension and receive Income Tax relief on. The threshold is currently 40,000, but remember you need to be earning money before you can reclaim any tax on contributions greater than 3,600 per annum. You can also potentially carry forward unused allowances from the previous three years although any contributions made are always assessed against your earnings in the tax year you make them. Under the new rules, if you trigger one of a range of specified events you will receive a reduced money purchase annual allowance of 10,000 per year. Once you have triggered the MPAA it will remain in place for the rest of your lifetime. You will not be able to carry forward any unused allowances from previous years towards the 10,000 limit. There are ways you can take benefits from a pension without triggering the MPAA. Some of these are: You take a tax free pension commencement lump sum You receive a trivial commutation lump sum (covered later in this guide) You receive a small pots lump sum You purchase a secure income such as a lifetime annuity You take a withdrawal within the GAD limits from an existing capped drawdown contract An important point to remember is that you are required to notify all of your existing pension providers if you trigger the MPAA, as well as any new schemes you join in the future. The main trigger events for the MPAA are: You take an Uncrystallised Funds Pension Lump Sum You take a withdrawal of income from a Flexi-Access Drawdown Changes to the Lifetime Allowance In the 2015 Budget the Chancellor announced that the amount an individual can accrue within a pension tax efficiently your Lifetime Allowance (LTA) is to reduce from 1.25m to 1m from April This is the latest in a series of reductions to the LTA which stood at 1.8m in As with the previous reductions, we expect there to be some transitional protections available to savers with large pension pots who may be affected, but the details of these have not been released at time of writing. While a 1m pension pot sounds like a very large number, this is only sufficient to secure an inflation proofed income of c. 25,000 per annum for a 60 year old man at current annuity rates which would not fund a lavish retirement (source Money Advice Service, 60 year old male + female, 10 year guarantee, inflation linked, no tax free cash, good health). For those savers who had a pension pot worth over 1.25m on the 6 April 2014 the option to apply for Individual Protection 2014 still exists until April For more information on protecting your pension against the LTA changes please seek professional advice, or contact your Origen consultant directly. There are some special rules for people who are also active members of a defined benefit pension scheme which are more complex. If you believe that this applies to you please seek professional advice, or contact your Origen consultant directly for more information. You convert a capped drawdown plan to a Flexi-Access Drawdown and take an income withdrawal 14 15

9 Changes being made to defined benefit pension schemes The changes being introduced in April 2015 are not restricted to defined contribution pensions. One of the biggest changes being introduced to defined benefit schemes is the removal of the option to transfer out for unfunded public sector schemes, such as the NHS or Teachers pension. After consultation, the Government will allow transfers from funded pension schemes, which covers private sector pensions such as Tesco s. You cannot transfer a defined benefit scheme once it is in payment. It may be that the new flexibilities will apply to some of your funds within a defined benefit scheme. If the scheme trustees decide to adopt the new rules they can pay funds accrued from Additional Voluntary Contributions (AVCs) in a flexible way. In order to protect customers, the Government has mandated that those who are looking to transfer out of a defined benefit scheme with a fund valued at over 30,000 must receive financial advice before they transfer. This is a service that we can provide; please speak to your consultant if you would like further information. Another change for defined benefit schemes is in regard to the triviality rules. This will allow those with a fund valued at less than 30,000 to take it as a lump sum from age 55, subject to Income Tax. This applies equally to defined benefit pension funds that are deferred or in payment. The Small Pots rule allowing funds up to the value of 10,000 to be drawn as a lump sum also applies to defined benefit schemes. While the new flexibility may appear to be attractive, defined benefit schemes offer valuable security and certainty of benefits. We believe that it will be in most peoples best interest to remain within their defined benefit scheme, although there will be circumstances where a transfer may be appropriate

10 Guidance or advice? The Government has launched Pension Wise, a service to help provide information and guidance to those at or approaching retirement with defined contribution pensions. The website is Everyone who has a defined contribution pension plan will have the right to receive free and impartial guidance when they come to retirement. There is currently no limit to the number of times you can use the guidance service in your retirement. To ensure that this is completely impartial it will be offered by The Pension Advisory Service (TPAS) for those who wish to deal over the telephone and the face-to-face service is being provided by the Citizens Advice Bureau. Your pension provider has a duty to signpost you to this guidance service and the FCA has issued some specimen standards they expect the service to offer. The guidance service cannot make a recommendation to you in terms of any course of action you should take. They will provide information on the different types of policy you have and the retirement income options available to you, but you will have to either make your own decisions or seek advice from a FCA regulated adviser following your guidance session. What should you do now? The Freedom and Choice in Pensions reforms introduce new and liberating opportunities but with that comes personal responsibility. To ensure that you can use your new found freedom wisely so that you can fully fund your retirement, take a look at these key considerations: There is a real risk that without careful planning and advice, you will exhaust your pension pot early and need to fall back on the State Annuities are still appropriate for most people, and still have a position in the market where security of income is a priority Tax planning is key - any solution developed now is subject to unknown marginal tax rates in the future There are now new opportunities to pass income onto your dependants The State Pension age has continued to increase in recent years and there is a move to a new flat rate State Pension from April 2016 The provider market is gearing up rapidly but some providers, especially smaller schemes, will be unwilling or unable to provide all the solutions available Reaching age 55 is the first milestone in your retirement planning and retired life; its important to plan carefully and appropriately If any of these changes affect you or your family and you would like to discuss them further, please contact your usual Origen consultant, or alternatively contact our Client Liaison help line: * Lines are open Monday to Friday 8.30 am to 5.30pm, Monday to Friday or us on: clientliaison@origenfs.co.uk *Calls cost 7p per minute, plus your phone company s access charge. All calls to Origen Financial Services Limited are recorded for business purposes

11 This update is intended to be for information only and not to be taken as financial advice. Before any action (or inaction) you may take upon any of the above suggestions, individuals must seek advice as to the suitability and tax consequences. Origen Private Client Solutions is a trading name used by Origen Financial Services Limited which is authorised and regulated by the Financial Conduct Authority. Our Registration Number is Our Registered Office: Infor House, 1 Lakeside Road, Farnborough, Hampshire, GU14 6XP. CA8034 Exp 05/04/2016