• Pension changes come into effect in April 2015
• The changes were announced in the 2014 Budget
• The pensions system will be overhauled to provide greater flexibility
• It will also become easier to pass pension pots between generations through inheritance.
• Changes will not affect those on final salary company schemes or those on the state pension
Pensions reforms occur periodically, and are designed to help improve the products, offers and services on offers available. As pensions reforms usually pass through Parliament, they do tend to take a great deal of time, and they often come into force at a later date than they are announced.
The latest raft of changes, announced in the 2014 Budget will come into effect in April. Here we detail what the changes mean and how they might affect you.
What are the changes?
As part of the recent reforms, the system will be overhauled to create greater choice and flexibility. In the 2014 Budget, a number of changes to the way that people access their pensions were announced (you can find more detail here).
While pensions were once a way to avoid having to have an income in later life, these new pension funds are hoped to be tax-efficient savings vehicles for those with large savings. As well as this, it is also hoped that it will be possible to pass the pension pot on from generation to generation.
Under the new scheme, no matter how you take out your defined contributions after you retire, your withdrawals will be treated as income, and the tax that you pay on withdrawing this money will depend on the amount of other income you have in that year if you’re aged 55 or over. At present, 55% is taxed for full withdrawal.
Savers will still have the freedom to take 25% of their pension as a tax-free lump sum, but instead of being herded into purchasing an annuity with the rest, those over 55 will be given the option of taking smaller lump sums, and in each case 25% of the sum will be tax-free. In part, this scheme has already been in place with ‘phased retirement’ and ‘vesting’ in the old pensions system.
Those who pass away can also pass on their pension without paying tax. Those who die before the age of 75 can pass on their unused pension as a lump sum to a person of their choice tax free if they have defined contribution pensions as of April 2015.
If someone dies over the age of 75 and they still have unspent defined contribution pensions, they can pass this on to a person of their choice who will be able to take it as a lump sum taxed at 45% or as income and pay their normal rate of income tax. This is a change to the current system where someone who inherits a pension pot from someone older than 75 has to pay tax at 55%.
How will this benefit me?
Firstly, it is important to point out that the changes will not affect those on final salary company schemes or those on the state pension.
If you’ve built up a large pension pot then it is likely that you’ll be the main beneficiary of this change as you’ll be able to avoid paying 40% tax when you draw it down due to the new freedoms offered.
You also don’t have to be retired to withdraw your pension. You can be 55, in work, receiving a salary and still be allowed to access it, even if you’re paying into your company’s pension scheme.
However, tax authorities are still alert to so called “salary washing” and the new rules are designed to limit this possibility. “Salary washing” would involve someone using their “additional voluntary contribution” scheme at work to maximise their payments into their pension – and then draw it down a year later, with 25% of it tax free.
What will happen to annuities?
Annuities will remain as the only way to guarantee a particular level of income. However, once it is purchased, it generally speaking cannot be passed to someone other than a spouse without a considerable level of expense. For many, the greater flexibility provided by pensions will now be more appealing.
If you’re concerned about how these changes may affect you, then there are a number of places that can give you impartial advice. The Citizens Advice Bureau is available either over the phone or face to face, while there’s also a bank of information available at the Pensions Advisory Service to help you answer any unanswered questions. Finally, the government have a ‘Nine Things You Should Know’ blog which acts as an effective FAQ.