19th July 2010
Draw down forever!
The government plans to make the post-retirement rules for pensions more flexible from April 2011. These changes should help reassure savers that money saved via a pension is not locked away forever.
Who should read this?
This Briefing Note will be of interest to people who are close to or already drawing down from their pension (and their advisers). It should be useful to younger people wondering whether it is worth using a pension as a vehicle for saving for their financial independence.
This Briefing Note is about rules for individual pensions such as personal pensions or SIPP; not final salary pension scheme benefits.
The headlines
There are two useful changes which are due to come into force from April 2011.
First, there is no need to make any change to a pension fund at age 75. You will not be forced to buy an annuity.
Second, if you can prove you have a minimum income from other sources you will be able to “draw down unlimited amounts” from your pension fund.
What happens currently?
Currently from age 55 to 75 you can take a tax-free cash lump sum (usually 25%) from your pension fund and either buy an annuity or draw down an “unsecured pension” from the fund.
At age 75 if you don’t want an annuity you can take Alternatively Secured Pension. This option has strict income limits and an eye-watering 82% tax on any cash lump sum paid on death. It is not a practical option for most people and effectively forces people to buy an annuity.
What’s wrong with an annuity?
Not a lot. Annuities are a cost effective way of buying guaranteed life-time income.
An annuity is insurance against living too long. You hand over a premium (your pension fund) and the insurance company guarantees to pay you an income for the rest of your life – however long or short that is.
Objections to annuity purchase are often emotional, although this makes them no less valid. For example, most PageRussell clients will be on the “winning” side of the annuity gamble and live longer than average; but we understand why they may not want to take the risk. So we understand why having an alternative to an annuity is important.
Long-live drawdown!
From April 2011, the same options will be available whenever you take your pension benefits (which can be any time after your 55th brithday):
• Annuity
Buying an annuity will continue be appropriate for many retirees, especially as money-back guarantees will be allowed on death after age 75.
• Capped drawdown
This option will be similar to the current Unsecured Pension, although we suspect the maximum income limit will be reduced slightly. There has been no mention of a minimum limit, so we expect this to remain at £Nil.
• Flexible drawdown
This option will allow individuals to “draw down unlimited amounts from their pension pot, provided that they can demonstrate that they have secured a sufficient minimum income to prevent them from exhausting their savings prematurely and falling back on the state”.
The 25% tax-free cash option will remain available, even after age 75. Benefits drawn down will continue to be taxed as income.
Minimum Income Requirement
Flexible Drawdown is a useful innovation. But before we get too excited, we need to know what the “minimum income” requirement will be.
To count, any income will need to be:
• Already in payment (that is, not deferred)
• Guaranteed for life
• Inflation proofed
The Basic State Pension and State Second Pension (was SERPS) would count, as would any index-linked annuity or final salary pension. But salary from employment and dividends will not.
The amount of Minimum Income Requirement could be as low as £7,600 or as high as £22,000 a year per person.
What happens if you die?
On death any funds in drawdown (capped or flexible) which are paid out as a lump sum will be taxed at 55%. This compares with 35% now for Unsecured Pension and 82% for Alternatively Secured Pension. This is good news for those aged over 75, but potentially bad news for those aged under 75. Beneficiaries can avoid this tax by buying a dependent’s annuity or continuing in drawdown.
Untouched pension funds can be paid out as cash, free of inheritance tax before 75. It looks like after age 75 untouched pension funds will suffer a similar 55% tax charge.
Welcome reforms
On the whole PageRussell believe these planned changes are welcome and will give savers more confidence that money saved in a pension is not wasted. As ever the devil will be in the detail and there is plenty of time for these changes to be watered down before next April. We will publish updates on these changes when available.
In the meantime if you have any queries please email Tim Page at tim@pagerussell.co.uk
More information is available from HM Treasury .
Important declaration
This document does not recommend you buy, redeem or vary any regulated investment. It is believed to be accurate as at 16th July 2010; however no warranty is given as to its accuracy and no responsibility can be accepted by Page Russell Ltd for any action taken in reliance on its contents.
