Pensions: how flexible is flexibility?
With great fanfare, the Government is introducing the pension changes that from 6 April 2015 will give you complete flexibility when you access your pension savings from a money purchase pension scheme after age 55.
The main change is that people will be able to draw as much or as little as they wish, without having to buy an annuity. Of course the option of annuity purchase will still be available and may well be the answer for many people. Regardless of what you choose, you will be able to receive 25% of your pension savings as a tax-free lump sum.
At present, once you start drawing funds directly from your pension, you cannot make any further pension contributions. But from 6 April 2015, you will have a limited ability to make contributions into a money purchase pension. The limit will be £10,000 a year (in addition to any carried forward unused pension relief from previous years) rather than the full £40,000 that is available to others. And unlike this £40,000 standard annual allowance, you will not be able to carry forward the special annual allowance of £10,000; if you don’t use, you will lose.
The reason for this restriction in an otherwise very liberal regime is to stop people of 55 or more from making £40,000 pension contributions and then immediately paying themselves the £40,000 from the pension. That way they would have avoided all national insurance contributions as well as tax on the £40,000.
Even if you are subject to the money purchase annual allowance, the normal £40,000 annual allowance will still be available to cover savings into defined benefit schemes (e.g. those that provide benefits based on the employee’s final earnings). For example, if you have £7,000 of pension savings subject to the £10,000 limit, then £33,000 of the normal annual allowance will be available. If you go over the £10,000 limit, then the excess will be subject to an annual allowance charge and your normal allowance will be £30,000.
Already in drawdown?
But you may have already started pension drawdown. If you are in flexible drawdown, you will be treated the same as anyone else from 6 April 2015, subject to the money purchase annual allowance. But if you are in capped drawdown, you will retain the normal annual allowance assuming your income remains within the capped drawdown limits. One way of protecting your normal annual allowance could be to start capped drawdown now while it is still available, but to do this you must be 55 before 6 April 2015.
You might be tempted to draw all your funds from the pension as quickly as you can. Leaving aside the question of your future income needs, you should always take tax advice before deciding how much to draw from your pension. Any drawings above the tax free lump sum will be subject to income tax. Whatever you leave in the pension plan is free of tax on any investment income and capital gains and will only become taxable when you draw it.
And the Chancellor has announced another reason why you should consider not drawing all of your pension funds. They won’t be subject to inheritance tax on death, although those who inherit them will have to pay income tax when they draw them out after 5 April 2016 and 45% in 2015/16.
The detailed rules are complicated, so please contact us for advice.