Pension flexibility – the new rules
Posted: 23rd March 2015
There has been a great deal of publicity about the forthcoming changes in the law relating to pensions and their uses. The changes are comprehensive. They alter the tax position significantly as well as the uses which can be made of pension funds.
With continuing low historical interest rate yield, annuity rates have remained low for years, leaving pension fund owners in difficulties because when they took out the policies they expected annuities at far higher levels than are being quoted now. This problem has been compounded by a long period of lacklustre returns on the stock market.
Accordingly, the Government has introduced a series of changes designed to create flexibility in the market. The changes will mainly apply when a person 'becomes entitled' to a pension on or after 6 April 2015 or a lump-sum payment is made after that date. The changes do not apply to pensions which have been used to buy an annuity. Where an annuity has been purchased with the fund, the remaining value of the fund belongs to the provider of the annuity.
There are a variety of detailed provisions designed to prevent the use of pensions for tax avoidance. What follows, though relevant for most pension pot owners, will not apply in every instance and professional advice should always be taken.
There are different rules which apply to drawdown pension funds created before 6 April 2015 and those created afterwards, which are termed 'flexi-access' drawdown funds. Where a fund has been created before this date but not accessed, an uncrystallised funds pension lump sum' (UFPLS) of 25 per cent may normally be taken. Taking a UFPLS will lead to the annual allowance for contributions being set at £10,000 for money-purchase schemes.
The new system will allow the whole of a fund to be taken by way of 'draw down', with 25 per cent of the pension fund potentially free of tax. It is important to understand that if (say) £10,000 is required from a pension pot of (say) £200,000, there is no need to take it all as part of the 25 per cent tax free lump sum. If, for example, you could have additional taxable income of £6,000, you might opt to take £4,000 as part of the tax-free lump sum and the rest as taxable income.
It will thus be possible for many pensioners to use their pension funds tax-efficiently. Once 25 per cent of the fund has been taken as tax-free cash, then any sum taken will be taxable. However, 25 per cent of the income earned in the fund during the period in which it is being drawn down can also normally be taken tax free.
The rules also allow some changes to the benefits that can be offered by insurers to pension fund holders. For example, the current 10-year cap on a 'guarantee period' (where the pension is guaranteed for a period of years if the pensioner dies during the guarantee period) is to be removed. Trivial and 'small pot' pension will be accessible at 55 (or earlier, where there is ill-health), not 60 as at present.
Pension savings in drawdown or in defined benefits schemes can be passed on death to the beneficiaries of the fund owner without being taxed from 6 April 2015. The transfer will be tax free if they die before age 75. Income taken from the fund will be taxed at the recipient's marginal rate of Income Tax (IT). However, to qualify for a tax-free withdrawal, the lump-sum must be paid within two years of notifying the scheme administrator of the death.
Where the owner of the fund is over 75 on death, the beneficiaries can either continue to take the drawdown, in which case the income will be taxed at their marginal rate of IT, or take the entire fund, which will be taxed at 45 per cent, slightly above the current rate of Inheritance Tax. Currently, where the owner of a pension is 75 or more, or the pension is in drawdown, a 55 per cent tax rate applies. An untouched pension pot of less than £1.25 million will currently be passed on tax free.
Crucially, the rules apply as at the date of payment, not the date of death, so if the death occurs before 6 April 2015 and it is advantageous, delaying the taking of the pension fund until after 5 April 2015 will mean that the new rules apply.
Further details can be found in the HMRC leaflet 'Pension Flexibility 2015'. See also the HM Treasury announcement of 29 September 2014.
It is extremely important to take advice when considering what is best to do with your pension funds.Williamsons Solicitors can introduce you to expert financial advisers who will handle these matter for you. Email or call us on 01460 200450. Click on the following links for more details of our services relating to Wills and estate planning, Lasting powers of attorney and Probate and estate administration.