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New Rules affecting Pension Income Drawdown effective March 2014
Please note - Income Drawdown is a complex and constantly changing subject and the information provided here reflects the current situation. For more information call us today or complete our short enquiry form and we'll be pleased to help you further.
The 2014 Budget introduced wide-ranging changes to the pensions market, with a number of measures coming into effect immediately with effect from March 2014.
The limits on income drawdown and flexible drawdown have been reduced, and will then be totally removed from April 2015.
Before the 2014 Budget, a maximum of 25% of a person's pension pot could be taken free of taxation. If a person wanted to take more, it was subject to a 55% tax charge.
After the 2014 Budget, the tax charge has been reduced to a "normal tax" - which in the case of most pensioners is 20%.
New income drawdown limits from March 2014
The following changes also came into effect in March 2014:
- The minimum "secured pension income" * income requirement for flexible drawdown has been reduced from £20,000 to £12,000
- In any pension year, the highest income allowed has risen from 120% to 150% of the basis amount from the Government Actuary Department's (GAD) tables at all ages
- The size of the lump sum (the "trivial commutation limit") across pensions has increased from £18,000 to £30,000
- The amount that can be taken as a taxed lump sum from certain small pension pots has increased from two lump sums of up to £2,000 to three lump sums of up to £10,000
- The lifetime allowance and annual allowance remain in place, but the limits for both categories have been reduced
* "Secured pension income" means a company pension, or an annuity from a personal or company pension, or a state pension
Further changes will come into effect from April 2015:
- Everyone who is in a Defined Contribution scheme (whereby a person does not know in advance how much pension they will get when they retire) will be able to access their entire pension from the age of 55
- The pension commencement lump sum will remain tax free; any income taken after this time can be taken without limit and taxed at the saver's marginal rate
- The change will be fully retrospective so that anyone in drawdown can benefit from the change
- Transfer from public sector Defined Benefit schemes (also known as Final Salary Pension schemes) to Defined Contribution pension schemes will not be allowed. Private sector Defined Benefit schemes will be free to decide whether to adopt such controls
- Lump sum death benefits - The government's view as of March 2014 is that the 55% tax rate on lump sum death benefits is too high, and a consultation process for change will be undertaken
The Finance Act introduced new regulations effective from 6 April 2011, changing the amount that can be drawn from an income drawdown plan. The requirement to purchase an annuity at the age of 75 has been removed, and an individual will be able to continue in drawdown for their lifetime. This means it is possible to defer purchasing a pension annuity until the member is older when annuity rates and the pension fund value could be higher.
Benefits do not have to be taken from a registered pension scheme by age 75 - they can simply be left in the scheme as unused funds until they are needed. Where scheme rules allow, this now gives members the flexibility to delay taking their pension or tax-free lump sum until after age 75.
Benefits will still have to be tested against the lifetime allowance by age 75 (as a benefit crystallisation event). This means that lump sum death benefits paid after age 75, even from unused funds, will be subject to the 55% tax charge - unless it is a charity lump sum death benefit (which can be paid tax-free).
The following lump sums can also be paid after 75:
- Trivial commutation lump sums;
- Trivial commutation lump sum death benefits;
- Winding up lump sums;
- Serious ill health lump sums (but only from unused arrangements and subject to a 55% tax charge).
From 6 April 2011, the unsecured pension (USP) and alternatively secured pension (ASP) are replaced by a new single set of income drawdown rules as follows:
- In any pension year, the highest income allowed for the tax year 2014/2015 is 150% (120% 2013/2014) of the basis amount from the GAD tables at all ages
- The lowest yearly income allowed will be nil
- Lump sum death benefits are allowed from income drawdown funds at any age
- Such amounts paid out from unused funds are tax-free
- For deaths after 5 April 2011, any lump sum death benefit paid from an income drawdown fund (or after age 75 from unused funds) are taxed at 55%. The government's view as of March 2014 is that the 55% tax rate on lump sum death benefits is too high, and a consultation process for change will be undertaken
Pension flexible drawdown
This is a major aspect of the new income drawdown rules which came into from 6 April 2011.
Those who meet the new minimum income requirement (MIR) also have the option of flexible drawdown, which allows unlimited income to be taken at any time.
Under flexible drawdown there is no limit on the amount of income that can be drawn each year. If desirable, an individual can take their entire income drawdown fund out in one go. The usual tax-free lump sum is allowed, but any other withdrawals taken by the individual are taxed as income in the tax year in which they are paid.
If an individual becomes non-UK resident whilst in flexible drawdown, any income drawn when non-resident is subject to UK tax if they return to the UK within five tax years of the drawdown.
To opt for flexible drawdown, an individual must meet the minimum income requirement and stop all pension provision. In March 2014, the minimum income requirement for flexible drawdown was reduced from £20,000 to £12,000
Pension provision stops
When an individual opts for flexible drawdown they must have stopped all pension provision. In particular, there must have been no contributions (personal, employer or third party) paid to a money purchase scheme for them during the tax year; and they must not be an active member of any defined benefit (or cash balance) schemes.
Existing unsecured or alternatively secured pensions
Those already in unsecured pension (USP) or alternatively secured pension (ASP) before 6 April 2011 are being moved fully onto the new income drawdown rules over a period of up to 5 years.
Pension death benefit rules changes from April 2011
- Lump sum death benefits are will be allowed at any age. For deaths after 5 April 2011, the tax charge on lump sum death benefits paid from crystallised rights is 55%. The government's view as of March 2014 is that the 55% tax rate on lump sum death benefits is too high, and a consultation process for change will be undertaken
- Circumstances for tax-free charity lump sum death benefits has been extended
- The scope for an IHT charge against pension rights has been narrowed
Death before age 75
On death after 5 April 2011 aged less than 75, any lump sum death benefit is still tax-free if paid from uncrystallised rights, however normally taxed at 55% if paid from crystallised rights (such as income drawdown funds or a value protected annuity). The only exception is for charity lump sum death benefits, which can be paid tax-free from crystallised rights.
Death on or after age 75
On death after 5 April 2011 aged 75 or over, it is acceptable to pay lump sum death benefits. This is a major transformation from the previous position on death in alternatively secured pension (ASP), where only a charity could legitimately benefit from a lump sum on death. Any lump sum death benefit paid after 75 including those from unused funds is taxed at 55%.
From 6 April 2011, two significant changes make the risk of IHT charges even smaller:
- The abolition of the ASP rules mean that the IHT charges that previously applied on death in ASP does not apply for deaths after 5 April 2011.
- The ability for HMRC to levy IHT where they consider that someone has deprived their estate through an "omission to act" (for example, by delaying taking their pension) was removed for omissions after 5 April 2011.
Costs and risks
Income drawdown plans represent a higher risk to the individual than a secured income arrangement such as a pension annuity, as the underlying assets of the fund are usually invested in the stock market. To ensure the pension fund does not run out of money, the member will require investment advice and regular reviews.
The cost of managing a pension annuity contract is much lower, as the resources of a group of individuals are pooled and there is no need to review on an individual basis. The insurance company must ensure there are sufficient reserves to meet the liabilities, however, this cost is spread across the entire group of individuals. In addition, annuities require a simpler advice process than income drawdown with a one-off administration charge to establish the annuity contract of about 1% to 1.5% of the initial fund value.
Due to the higher costs associated with income drawdown, fund sizes should be at least £100,000 after taking a tax free lump sum. As the growth of the pension fund depends on investment performance, it is important to have alternative retirement income or savings in addition to an income drawdown plan in the event of poor investment performance.
The above information summarises some of the key changes affecting Pension Income Drawdown effective from March 2014 onwards.
However, there are additional details of which you should be aware so please contact us for further information and advice.
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