Options for taking pension benefits
An individual over the age of 55 can extract benefits from their pension fund. 25% of the pension fund can be taken tax free. The balance of the pension fund is then usually taken as an income which is subject to Income Tax at normal rates. Taking income from a pension fund requires a choice between 1) Scheme Pension, 2) Annuity or 3) Drawdown. Provision on taking tax free cash is very similar which ever route is chosen and there the similarities end:
- Scheme pensions are linked to employment and the guaranteed / index linked benefits are based on your length of service and final salary.
- Annuities are essentially a contract that cannot be varied, produce a fixed income for life but no flexibility.
- Drawdown arrangements in comparison offer on going options and greater flexibility, but options need to be re-evaluated from time to time and investments need to be managed. The changes to pension legislation directly affect those in Drawdown and it is this particular option that is the subject of this Fact Sheet.
Greater income flexibility
Before 6th April 2015 (unless you had fixed pension income of £12,000 per annum) your Drawdown fund had an income withdrawal limit set by the Government Actuaries Department. This is known as the GAD limit and applies to anyone in ”Capped Drawdown” before 6th April 2015.
Under the new pension legislation GAD limits from Drawdown will be removed. This allows everyone access to what is now known as “Flexi-access Drawdown”. This means anyone over age 55 can draw as much from their pension fund as they like without the requirement to purchase an annuity. Income Withdrawals will be subject to individual’s marginal rates of Income Tax.
Restrictions on contributions
While the Government has removed a limit on income withdrawals they have placed a restriction on pension contributions for those in “Flexi-access Drawdown” to prevent abuse of the new flexibility. The current Annual Allowance of £40,000 per annum will be reduced for those in Flexi-access Drawdown to £10,000 per annum, only if the member draws income post 6th April 2015. This is known as the Money Purchase Annual Allowance.
Prior to 6th April 2015, a spouse receiving death benefits from a Drawdown arrangement could continue with income withdrawals, subject to Income Tax or take the remaining fund minus a 55% tax charge. A wider range of beneficiaries could also benefit from the remaining fund minus a 55% tax charge.
- From 6th April 2015 the death benefits available under a Drawdown arrangement will be improved because:
- If a member dies before the age of 75, the nominated beneficiary will receive the remaining fund tax free whether it is taken as a lump sum or accessed through drawdown.
- If a member dies after the age of 75, the nominated beneficiary will receive pension income payments subject to Income Tax at the beneficiary’s marginal rate. There will be no restrictions on the level of withdrawals that can be taken.
- Or if a member dies after the age of 75, the nominated beneficiary could receive the remaining fund as a one-off lump sum, subject to a tax charge of 45%. It is expected this this option is temporary until 2016/17, at which point the tax charge will be subject to Income Tax at the beneficiary’s marginal rate. These new rules allow the member to pass remaining pension funds down the generations.
Acumen Financial Planning welcomes these changes to pension legislation. We believe these changes will give individuals more choice and flexibility to spend their pension fund as they see appropriate, whilst at the same time allowing any remaining pension fund to be passed to family upon death.
Advice is essential
Whilst these changes present many opportunities, they also present risks to those in retirement. These risks can be managed.
Large unnecessary pension withdrawals could create excessive Income Tax charges. In 2015/16 income above £42,385 will be taxed at 40% or 45% for income above £150,000. Income below this level and above the Personal Allowance of £10,600 will be taxed at 20%.
It may be tempting to draw large sums from your pension fund. But as well as the excessive tax charges there is also the risk that excessive withdrawals will result in you outliving your pension fund by many years and relying on State Pension for the latter part of retirement.
Careful planning on expenditure patterns, standard of living and sustainable levels of income must be carried out annually. It is important to establish rates of investment returns required and how long your pension fund will last based on proposed income levels.
Assuming less people purchase an annuity, more people will require investment advice for their pension funds in Drawdown. The sequence of investment returns will play a major factor in the sustainability of withdrawals. The risk profile of all investors should be assessed before an asset allocation and diversified portfolio is designed.
It is vital that anyone approaching retirement should take expert advice to minimise tax, identify required and sustainable income levels and optimise investment returns.