Posted: February 25, 2016
The world of pensions altered significantly in April 2015, and further changes are due in April 2016. You would be forgiven for losing track of these; pensions have become increasingly complex and politicised. Lee Giles, Chartered Financial Planner at Argentis, looks at some of the changes
Significant changes came into force last year, and it is worth just refreshing on these. From a minimum age (currently 55), you broadly have three choices when taking your private pension benefits (not including defined benefit schemes such as final salary):
Essentially you use your pension pot to purchase a guaranteed income for life. Alternatively you can withdraw up to 25% of the fund tax free, and use the residual amount to purchase the annuity. Up until April 2015 this was the most common route for pensions, and it is still appropriate in some cases.
Or “Uncrystallised Funds Pension Lump Sum” to give it its full title. This means you draw the whole pension pot (or parts of it if the contract allows) directly from the plan. Each withdrawal is treated as 25% tax free, with the rest charged at your marginal rate of income tax. This seems very simple, but of course you may deplete your entire pension provision. In addition there are consequences; the pension provider may deduct tax under month one coding “emergency tax” leaving you to claim back the excess paid. All of the “income” of the withdrawal will fall into one tax year. Also you will restrict what you could pay into money purchase pensions in the future under the Money purchase Annual Allowance rules (“MPAA”).
• Flexible Access drawdown (“FAD”)
As the name suggests, the most flexible option. It allows you to draw any proportion of your fund and control the income tax paid. You can also withdraw the 25% tax free element in isolation. The rest of the fund is again classed as “income” for tax purposes, and withdrawal of any income triggers the MPAA. The FAD route provides you with more control. The downside is that many contracts don’t allow this so you may need to transfer the pension, resulting in advice fees and product costs. This type of plan may also provide additional flexibility on death, allowing you to name any chosen beneficiaries that would receive your fund as a “nominee pension” or lump sum on death. However your investments remain at risk of capital loss, and your pension money could run out in retirement.
Summer Budget July 8th 2015
In the summer Budget the Chancellor announced further changes, some of which are due to come into force on April 6th 2016
• Lifetime allowance
This is the overall “cap” on pension savings before a tax charge is applied. This will reduce from £1,250,000 to £1,000,000. But even if you are below this, you could breach the limit simply with the investment growth inside the pension. For example, a pension valued at £800,000 growing at 7% per year, will exceed £1,000,000 in less than 4 years.
If you have a large pension pot, and wish to protect yourself against these changes, then you will be able to apply for Fixed Protection 2016 or Individual Protection 2016. However the application process won’t be in place until after April 5th, so you may wish to consider reviewing your contribution levels prior to April 6th.
• Changes to personal Input periods (“PIPs”)
Prior to the Summer Budget, pension input periods didn’t have to align with the tax year. This potentially allowed the timing of contributions to be manipulated to determine which tax year they fell into for annual allowance purposes. On July 8th, all input periods were “closed”, and the Chancellor created a special transitional arrangement for 2015/16, by way of “pre and post alignment tax years”.
The pre-alignment tax year runs from 6th April 2015 to 8th July 2015, and the pension input limit for this period is £80,000. The post-alignment tax year runs from 9th July 2015 to 5th April 2016, with a “NIL” allowance; however you can carry forward up to £40,000 unused allowance from the pre-alignment tax year.
This is all very confusing to most people, but it means that some clients who have made contributions in the first period will have up to £40,000 allowance remaining for this tax year.
You will also potentially be able to use your carry forward allowances from the last 3 tax years, but remember the 2012/13 allowance, which was a more generous £50,000, will disappear on April 6th.
• Reduced allowance for high earners
If you are a “high earner” you won’t be able to get as much tax relief on pensions after April 5th:
However, “earnings” also includes other taxable income such as savings income as well as pension contributions (including those paid by your employer). So you could be affected even if your earnings are lower than the above suggests. This is because the concept of “adjusted” and “threshold” income is introduced. Here’s an example:
Matthew earns £146,000 in 2016/2017. He also benefits from a 5% matched employer pension contribution to a group personal pension in the tax year.
Matthew’s “adjusted” income for the year is his income plus the *employer contribution:
£146,000 + (5% x £146,000) = £153,300.
As “adjusted” income is greater than £150,000 and “threshold” income** is greater than £110,000, the annual allowance will be tapered as follows:
Amount of £153,300 – £150,000 = £3,300 excess income
Annual allowance £3,300 / 2 = £1,650 reduction
Tapered annual £40,000 – £1,650 = £38,350 allowance
*Although it is included in the adjusted income figure, the employee contribution is not added on when calculating adjusted income as it is paid to a scheme that operates relief at source and so is already included in Matthew’s income of £146,000.
**Threshold income doesn’t include pension contributions (individual or employer).
So what should you do?
In essence, it may be prudent to review all your arrangements now and seek professional advice. Also bear in mind there is another Budget on 16th March, and there could be further changes announced.
The value of your Pension Plan, and any other investment can fall as well as rise and you may not get back the full amount invested. Past performance is not a reliable indicator of future performance. The benefits you receive are dependent upon future contribution levels, the age at which you take benefits and external influences such as investment returns, inflation, interest rates, annuity rates and charges. The benefits can therefore be lower than those illustrated. Any assumptions about the tax position of the plans and recommendations made in this report are based on current law and HMRC (Her Majesty’s Revenue & Customs) practice, which may be subject to alterations, including retrospective changes in the future.
The Financial Conduct Authority does not regulate tax planning
The tax treatment depends on the individual circumstances of each client and may be subject to change in the future.
Not all individuals are eligible for a pension.
Argentis Financial Management Limited is regulated and authorised by the Financial Conduct Authority.