By KATARZYNA DMUCHOWSKA 10/12/2010
On 9th December the Treasury published draft legislation giving greater flexibility to pensioners in retirement. The changes signal a radical shift in pensions thinking, led by confirmation of the removal of the need to annuitise by age 75.
Removing age 75 restrictions
From April 2011 retirees will no longer have to buy an annuity or move to an Alternatively Secured Pension (ASP) at the age of 75.
Age 75 restrictions on having to take pension commencement lump sums will also be removed. However, the tax charge (see below) which will apply to lump sums taken post age 75 will mean in practice the lump sum could be advisable to be taken at this age.
Flexible withdrawals – Minimum Income Requirement
Additional flexibility proposed by the Treasury will remove the maximum income drawdown levels but only for the pensioners who satisfy a Minimum Income Requirement (MIR) i.e. have annuity or pension income, including State Pensions, of at least £20,000 per annum. The purpose of the MIR is to ensure individuals have sufficient income to avoid falling back on State Benefits and its level will be reviewed at least every 5 years.
Capped withdrawals
Individuals who do not satisfy the MIR condition will still be able to opt for income drawdown, the maximum income will however be capped at 100% of the level of income provided by a single life level annuity. This is lower than the 120% currently available. The Government’s proposal is to replace Unsecured Pensions (USPs) and ASPs with a single product – capped drawdown available from age 55 without restriction.
Minimum income
There is no minimum income for income drawdown in all circumstances, thus removing the current requirement for those in drawdown post age 75 to withdraw 55% of a single life annuity.
Tax on death - 55% tax rate on lump sum benefits
The new legislation imposes a 55% tax on death in income drawdown where the remaining pension fund is paid as a lump sum to beneficiaries. The charge applies to everyone in drawdown and compares to the current rules of 35% for those under the age of 75 and 82% for those over the age of 75.
Death benefits for those who die before age 75 without having taken a pension will remain tax-free, and there will be no tax charge payable if a dependents’ pension is paid on death rather than a lump sum.
Inheritance Tax
Under the proposed reforms, Inheritance Tax (IHT) will not typically apply to lump sum death benefits after age 75. This is a significant simplification compared with the existing rules, where IHT is chargeable on death benefits after age 75, but not before age 75.
Transitional Protection
The government announced in June that the lifetime allowance (the maximum pension fund you can accrue prior to a charge) was to reduce from £1.8m to £1.5m in April 2012. Yesterday, the Government have announced that savers with pension funds above £1.5m or who believe the value of their pension pot will rise to above £1.5m through investment growth without any further contributions or pension savings, will be able to apply to HMRC for a fixed protection amount of £1.8m. This protection will be lost if any further contributions are made to any pension arrangements post 6 April 2012. A form (not yet available) will need to be submitted by 5 April 2012.
Individuals with primary or enhanced protection are unaffected and will not need to apply for transitional protection again.
Timing
For current Unsecured Pension holders the Government propose that the new withdrawal limits should apply from the date of their next review following 5 April 2011, and that once new limits are set they will be reviewed every 3 years.
As far as current holders of ASP are concerned, the withdrawal limits for capped drawdown pensions will apply from 6 April 2011.
Life time allowance (LTA) at the new £1.5m level will apply from 6 April 2012 as per June announcement.
All other changes will apply from 6 April 2011.
Our view
Overall we welcome simplification of the rules and greater flexibility of retirement benefits. The changes will remove the unnecessarily restrictive and outdated rules applying to pensions in payment and will simplify the pensions’ tax framework. However, we recognise the risk that individuals in capped or flexible drawdown could exhaust their savings prematurely or achieve significantly worse outcomes than if they bought an annuity and they cannot insure against longevity via mortality pooling (as with an annuity).
We do agree with the Government that it will be important that individuals take appropriate advice before entering a capped or flexible drawdown arrangement.
If you would like to discuss the likely implication of these changes in more detail please call our Investment Professionals 020 7189 9999.