Pension Flexibility 2015
The Taxation of Pensions Act 2014 received Royal Assent on 17 December 2014 and generally its provisions take effect from 6 April 2015. From that date there are four options available to individuals taking benefits from their defined contribution (DC) pension pots for the first time:
- Flexi-access drawdown (FAD)
- Uncrystallised funds pension lump sums (UFPLS)
- Purchase of a lifetime annuity
- Scheme pension
These are available only from age 55 (or earlier where the individual is in ill-health).
This is the new form of income drawdown, allowing savers aged 55 and over to take taxable income from their DC savings. The main feature is the removal of the maximum 'cap' on withdrawals.
When amounts are transferred into the drawdown arrangement, the individual can take a tax free lump sum from the remainder of the fund. This is 25% of the amount transferred and the lump sum. So if someone has a pension pot of £100,000, the transfer of £75,000 into flexi-access drawdown will enable £25,000 to be taken tax free.
Transferring some or all of a pension pot into a formal drawdown arrangement (together with the lump sum) is an example of crystallising the amount transferred. If the total amount crystallised (when added to any earlier crystallisations) exceeds the lifetime allowance (LTA), there will be a special tax charge to the extent the LTA is exceeded. The current LTA is £1.25 million, but it will reduce to £1 million with effect from 6 April 2016.
Uncrystallised funds pension lump sum (UFPLS)
A UFPLS allows access to a pension pot without entering a formal drawdown arrangement. They will be payable only if the individual has a sufficient LTA available. Normally 25% of the lump sum received will be tax free with the remainder taxed as income in the year of receipt.
If not all of the pot is transferred (because the full amount of potential pension is not needed), then it is quite possible to have crystallised and uncrystallised pots.
Purchase of a lifetime annuity
Members will continue to be able to use some, or all, of their pension savings to purchase a lifetime annuity if they want to after taking their tax-free cash. The annuity route does not attract the new flexibility available to DC schemes. Although the annuity rules will be relaxed, buying an annuity used to be a final decision which could not be changed.
However, it was announced at Budget 2015 that the Government would legislate from April 2016 to allow people who are already receiving income from an annuity to agree with their annuity provider to assign their annuity income to a third party in exchange for a lump sum or an alternative retirement product.
A scheme pension is a pension entitlement provided to a member of some pension schemes, which provide an absolute entitlement to a lifetime pension.
The member will normally access 25% as tax-free cash with the remaining funds converted into a scheme pension.
Amended rules allow for up to three small personal pension pots of £10,000 or less to be paid out as lump sums. The age limit for taking small pot lump sums is reduced from 60 to the normal minimum pension age (currently 55).
These are taxed in the same way as a UFPLS i.e 25% tax free and the rest is taxable income.
Amendment to pension scheme rules
There is a limited right for scheme trustees and managers to override their scheme's rules to pay flexible pensions and lump sums from DC pots.
People of any age will be able to inherit pension pots. Inherited pension wealth will not count towards the LTA of the beneficiary.
Under the new rules, when someone dies before the age of 75 the pension pot can pass to beneficiaries tax free as a lump sum, subject to the member having sufficient LTA available to cover the full amount of the uncrystallised funds in the pension pot.
If death occurs at age 75 or over, the beneficiaries can either:
- Draw down themselves from the pot, which will be taxed at their marginal rates, or
- Take it as a lump sum, which will be taxed at a flat 45% rate. From 2016-17, the 45% will be replaced by the beneficiary's marginal tax rates.
Individuals over 75 would have had the pension pot tested against the LTA left at that time. The pot value in excess of the LTA would have suffered the LTA charge.
The tax-free lump sum cannot be used for 'recycling'. Recycling refers to reinvesting funds into a pension scheme in order to obtain tax relief on the contributions. This anti-avoidance provision was introduced several years ago.
Those already in drawdown as at 6 April 2015
The options available depend on the type of drawdown. Flexible drawdown will automatically convert to flexi-access drawdown on 6 April. Capped drawdown will continue in its current format unless the individual wants to switch to flexible access.
Free guidance (not advice)
In early 2015 the "guidance guarantee" promised by the Government was formally launched under the name "Pension Wise". Under this scheme everyone aged 55 and over with a defined contribution (DC) pension pot will be offered free information and guidance by not-for-profit groups such as Citizens' Advice Bureau (CAB) and the Pensions Advisory Service (TPAS) acting on behalf of the Government.
Pension Wise will remain free to the consumer and funded by a levy on regulated financial services firms.
The advice will cover the following areas:
- How much is in your pension pot?
- What can you do with your pension pot?
- How long does your money need to last?
- Watch out for tax
- Shop around for the best deals