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Flexible pensions from April 2015

Retirement | Pension Rules

By Justin Modray, published 15 October 2014.
Helpful? 55

Will you benefit from the new flexible pension rules due April 2015?

There have been a few announcements of late that should further increase the appeal of pensions from April 2015, when the changes are due to take effect. Let’s take a look at the key proposals and how you might benefit.

Flexible income

From age 55 you can start taking a taxable income from your pension(s), either by using your pension fund to buy an income for life (called an ‘annuity’) or by leaving it invested and drawing an income as required. Please note this does not apply to final salary pensions.

NowFrom April 2015

Annuity
Effectively swap your pension fund for an income for life (although temporary annuities lasting for up to a few years with a maturity value are available). Various options include building in a pension for your spouse and linking income to inflation.

or

Capped Drawdown
Leave your pension invested and draw an income of between £0 and 150% of a pension (based on a single life level annuity) calculated by the Government Actuary Department (GAD).

Flexible Drawdown
There is no maximum income limit provided you already receive at least £12,000 annual income for life (via state and other pensions).

Annuity
Will remain unchanged (except for some very minor tweaks, e.g. annuities where income reduces will be allowed).

Capped Drawdown
Will effectively become obsolete, although those already in capped drawdown can either continue within existing limits or convert to flexi-access drawdown to take a higher level of income.

Flexible Drawdown (to be renamed Flexi-Access Drawdown)
The requirement for £12,000 of other pension income to qualify for flexible drawdown will be dropped. So flexible drawdown will in theory be available for everyone who does not have a final salary pension or has not yet purchased a lifetime annuity.

Note: taking flexi-access drawdown will reduce the annual pension contribution allowance from £40,000 to £10,000.

Candid verdict: A genuinely useful change. However, not all existing pension schemes will cater for this and, unless you have other income to fall back on, drawing high levels of income could be a bad idea.

Taking too much income increases the risk of your pension pot running dry during your lifetime – it’s something of a balancing act between how long you’ll live, investment returns and whether you want to potentially pass on the pension pot to your spouse or other beneficiaries.

Flexible tax-free cash

From age 55 you can take up to 25% of your pension as a tax-free lump sum (final salary pensions instead apply a formula to give broadly similar amounts).

NowFrom April 2015

Unless you take your pension in ‘segments’ – then you have to take your tax-free cash and do something with the rest of your pension in one fell swoop.

And unless you are in the very small minority who currently enjoy ‘partial flexible drawdown’ then even if you take your pension (hence tax-free cash) in segments the 75% balance of money in each segment will have to buy an annuity or largely remain invested.

The ability to combine flexible drawdown with taking your pension in segments will, in theory, be available to all (non-final salary) pensions.

For example, you could take £10,000 from a £50,000 pension, of which £2,500 would be tax-free lump sum and the £7,500 taxable income. And then do the same again (or with different amounts) later on etc.

Candid verdict: This already exists for the minority who are in flexible drawdown and are taking their pension in ‘segments’ rather than in whole. Becoming more widely available will give many of us more welcome flexibility in retirement. But again, it hinges on how many existing pensions which do not currently permit segments and drawdown will decide to adopt these features.

Taking smaller pensions as lump sums

At retirement there is the option to take smaller pensions as a lump sum.

NowFrom April 2015

From age 60 you can:

Take one or more of your pensions as a lump sum (25% tax-free cash and the balance as taxable income) if all your pension funds total no more than £30,000. The jargon for this is ‘trivial commutation’.

You can also take up to 3 individual pensions of up to £10,000 each in a similar way, regardless of the size of other pensions you may have.

The same will still apply but become available from age 55.

Under the new flexi-access drawdown rules you could in fact do the same in any case, but these small pension pot rules will still be useful for pensions which don’t allow customers to take advantage of flexi-access drawdown – likely to be many.

Candid verdict: A sensible improvement to the existing rules by reducing the minimum age from 60 to 55.

Tax on death

This is another area of quite significant change for the better. Let’s take a look at the various scenarios. Please note I’ve used a bit of jargon:

Uncrystallised - you have not taken any benefits (tax-free cash/income) from a pension.
Crystallised – you have taken benefits from your pension.
(If you have a pension with some segments that have been crystallised and others which have not then the rules will apply to each part respectively)
Dependent – spouse/civil partner, child under 23 or dependent on you because of physical or mental impairment.
Beneficiary – anyone you nominate.

NowFrom April 2015
Death before age 75 & pension uncrystallised Tax-free lump sum for any beneficiary, or dependant’s pension taxed as income. Tax-free lump sum for any beneficiary, or tax-free flexi-access drawdown for any beneficiary
Death before age 75 & pension crystallised Lump sum for any beneficiary at 55% tax, or dependant’s pension taxed as income Tax-free lump sum for any beneficiary, or tax-free flexi-access drawdown for any beneficiary
Death after age 75 & pension uncrystallised or crystallised Lump sum for any beneficiary at 55% tax, or dependant’s pension taxed as income Lump sum for any beneficiary at 45% tax (will instead be taxed as income from 2016/17), or pension income for any beneficiary taxed as income

Candid verdict: Very welcome change. If you die before 75 beneficiaries will be able to take your pension tax-free as either a lump sum or income, regardless of whether you've taken pension benefits (although if you purchased a lifetime annuity that will die with you unless you included a spouse pension).

And if 75 or over any remaining pension will be able to be passed on to beneficiaries taxed as income in their hands (from 2016/17). Certainly advantageous versus the current 55% tax and for many and, remember, inheritance does not apply to pensions.

Are there any downsides?

We should remember the proposals are not yet set in stone, although they appear pretty definite. And there’s the obvious risk that far too many people blow their pensions then struggle through an impoverished retirement relying on state pensions.

A big potential issue is that many existing pension funds won’t amend their systems to accommodate the new rules (certainly by April 2015), so you may find yourself having to transfer to a pension that has. In a bad case scenario this could involve penalties for leaving your existing pension and higher fees for the new one.

And since the new flexible rules do not apply to final salary pensions we could see individuals transferring away from these schemes, which more often than not is a bad idea as they lose the benefit of a good, guaranteed, pension income. This might be the catalyst for another pension mis-selling scandal with those advisers motivated by greed giving inappropriate advice.

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Readers' Comments (2) - To post a comment please register or login .


Comment by pvcdoc at 5:33pm on 27 Oct 2014:

Good summary, Justin.


Comment by SnowMan at 11:41am on 29 Oct 2014:

That is a really excellent and helpful summary of the proposed changes. Many thanks.