What does the plethora of rules mean for your pension?
The Government is constantly tinkering with the way in which people can build-up and access their pension savings, but what does that mean for you?
The most fundamental changes to accessing pension savings were introduced in 2014 and 2015.
What didn’t change?
The minimum age at which you can draw a pension remains the same for the time being at 55, although it will increase to 57 in 2028 and, presumably, to 58 later. In other words aligning it to the increasing State Retirement Age, albeit 10-years earlier.
Also, the first 25% of any accumulated savings can be taken as tax-free cash (correctly Pension Commencement Lump Sum – PCLS).
That a pension is still intended to provide people with life-long retirement benefits, not a car, boat or holiday!
What were the previous rules?
Before I go on to review the changes, let’s consider what the position was prior to 27 March 2014.
The balance of the fund, after the PCLS, had to be used to provide an income for life. There were a number of options for generating that income, the main ones being:
- An Annuity. An annuity is a guarantee from an insurance company to pay a certain level of income for life in exchange for a non-refundable lump sum investment. There is a wide range of options at the outset, but the principle is the same – give up the savings in exchange for a taxable income. Certainly in recent years (other than 2023), annuity rates have been very poor, because of the general economic climate, especially through the recession. Also regulatory changes and our own longevity have adversely impacted the rates available. For more, see my blog.
- Flexible Drawdown. The fund was left invested and any taxable income required taken as a withdrawal from those investments, without limit. However, to qualify for “flexible” drawdown, the individual had to be in receipt of guaranteed pension income from elsewhere, which could include the State Pension, of at least £20,000 per annum.
- Capped Drawdown. For those without the requisite guaranteed income, capped drawdown was available, which still provided taxable income withdrawals from an invested pension fund. However, the level of income was capped at 120%of the prevailing annuity rate (set by the Government Actuaries Department) for that individual.
What did the new rules mean?
Flexible Drawdown for all. From April 2015, Flexi-access Drawdown was introduced and capped drawdown abolished, although some retirees remain in such a scheme. Consequently, there are no minimum guaranteed pension income limits to qualify for what was flexible drawdown.
In essence, since April 2015, a pension comprises two elements:
- Tax-free cash, and
- Taxable cash
So, theoretically, anyone retiring after April 2015 can withdraw all of their pension savings immediately, with the first 25% tax-free and the balance subject to Income Tax.
The Income Tax Rates for the 2023/24 Tax Year are as follows
| First £12,570 | 0% |
| Next £37,700 | 20% |
| Next £87,440 | 40% |
| Balance over £125,140 | 45% |
In addition, there is another sneaky band between £100,000 and £125,1400 in 2023/24, where the effective rate of tax is 60%, because of the gradual withdrawal of the Personal Allowance between those two figures!
Of course, other taxable income in the Tax Year of retirement also has to be taken into account, so, if someone earning £50,000 gross per annum retires on 05 October 2023, exactly halfway through the Tax Year, they will have already received £25,000 in salary.
Consequently, a one-off withdrawal might be inappropriate from a taxation point of view. Spreading the withdrawals over several Tax Years Could make much more sense.
What are the issues?
Professional advice at the time of retirement is even more important now than it ever has been, because of the far-reaching implications of all the rules.
The issues to consider include:
- Longevity. How long are you going to live and what are you going to live on?
- Annuities. They’ll still be available, in their various guises, and may still be the most appropriate means of securing a regular income in retirement.
- Drawdown. How the remaining pension funds are invested has a very considerable bearing on whether the income withdrawals are sustainable.
- Tax. What level of withdrawal can be taken without unnecessarily incurring a Higher Rate tax liability?
- Death Benefits. Since April 2015 the rules on death have ben much more simple and less taxing. Death prior to age 75 will mean that the entire fund is available tax-free. Death after age 75 will mean the fund will be taxed at the beneficiary’s prevailing tax rate. Those benefits are also outside of the net of Inheritance Tax, which is a further consideration.
Building-up pension savings
Lifetime Allowance
Introduced first in 2006, the Lifetime Allowance (LTA) was the limit on total pension savings permitted before the application of a penalty when accessing those benefits. The headline rate of the penalty was 55% but, in reality, it was 25%, assuming only an income was drawn. The LTA is due to be withdrawn but, with effect from 06 April 2023, the penalty rate was reduced from 55%/25% to zero.
In a way, the LTA does still apply, because the amount of PCLS available is limited to 25% of the last LTA, which was £1,073,100. Consequently, anyone with more than the old threshold in all their pensions combined is limited to a PCLS of £268,275.
Contributions
Contributions to a pension can be made by anyone from birth to age 75. Those contributions are limited to 100% of your “net relevant earnings” (P60 gross if you are employed, or taxable profits if you are self-employed or a partner), capped at £60,000 (increased from £40,000 with effect from 06 April 2023). There is, however, a de minimis figure of £3,600 for people with no net relevant earnings, or earnings below that figure.
For those with net relevant earnings in excess of the Annual Allowance of £60,000, there is a carry-forward arrangement, whereby unused Annual Allowances from the previous three Tax Years can be brought forward.
The de minimis figure is a useful financial planning tool for both children and those post-retirement who still want to build savings, particularly if they also have a potential Inheritance Tax issue. Personal pension contributions are made net, so a payment of £2,880 is grossed up by the pension provider by way of a tax reclaim of £720, to make the £3,600, irrespective of whether you are a Taxpayer. This is a 25% uplift, so a great boost to investment returns.
For a child, if you are wanting to save towards their education costs – see my blog – or to help them get on the housing ladder, then pension is inappropriate because of it’s inaccessibility. However, as a long-term savings scheme it is potentially unrivaled. In December 2022 Unbiased, the Find-an-Adviser website, wrote:
“Assuming that you pay in the maximum amount for 18 years, and that average growth stays at 4 per cent, then by the child’s 18th birthday the pension pot will be worth around £95,000. Now, even if no further payments are ever made into this pension pot, steady growth at 4 per cent would take the pot to over £620,000 by the time the ‘child’ reaches the age of 65″.
This, of course, doesn’t take into account inflation, but it is a great start towards a more prosperous retirement.
More Information
If you want more information on the plethora of changes in legislation, Wikipedia has a useful index.
What next?
If you are anywhere on the journey to retirement, from beginning to end, talk to me about how we can exploit all the current rules to your advantage.
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0800 074 8755info@clivebarwell.co.uk