Pension Freedoms – one year on

It was in March 2014 when the Chancellor announced in his Budget speech what was to become possibly the biggest shake up of pensions since pensions taxation was introduced in 1921. From April 2015 it was no longer more or less obligatory for most pension savers to buy an annuity on their retirement.  Instead, they could take their pension pot as cash or draw down, in the Chancellor’s words “as much or as little of their pension pot as they want, any time they want”.  The people were to be “trusted with their own finances” or at least those who had reached age 55.

This was heralded at the time as giving retirees the opportunity to treat their pension savings like ISAs, but simultaneously there were fears that many could run out of cash too soon or splash out such as on a holiday of a lifetime. This was put into shorthand as the Lamborghini effect.  The pensions industry itself saw it as the death knell of the annuity.  But what is the reality?

Firstly, the reforms only apply to defined contribution (aka Money Purchase) schemes and do not directly affect final salary pension savings. Normally, only 25% of an amount drawn down is tax free.  In the 2015/16 tax year a drawn down of £100,000 would have incurred a tax liability of about £29,400, assuming no other income.  Nowadays, would-be raiders of their pension pots have to get their heads around the terminology as well as the meaning.  We have, for example, “flexi-access drawdown” and “uncrystallised funds lump sums” or UFPLS for short.  There are important differences that are particularly relevant to those still in work or have other sources of income.  A hot towel may be needed and an independent financial adviser highly recommended.

It is often overlooked that there is no duty on a pension scheme trustee to offer the flexibilities lauded in the Chancellor’s statement. In that situation it will generally be open to a scheme member to transfer funds to another arrangement, which does facilitate flexibilities.  Even then, 70% of final salary schemes reportedly do not allow partial transfers.  The Government was quick to recognise though that transfers out of final salary schemes to defined contribution schemes in order to access pension funds is fraught with risk.  It is, therefore, a requirement that those seeking to access funds valued at £30,000 or more must get advice from a specially qualified adviser, and the adviser must disclose certain information to the Trustee before it can go ahead.

When all is said and done, the objective is to ensure that sufficient pension savings are accrued to enable each retiree to afford and enjoy the lifestyle in retirement that they expect. This was the rationale behind Auto-Enrolment.  However, the low minimum statutory contributions mean that someone on average earnings who are auto-enrolled from age 22 and along with their employer paying in only the minimums, would have to work until age 77 in order to achieve a retirement income of two-thirds of their pre-retirement earnings.  Add to that the state pension age will rise to age 66 in 2020, with further rises in the pipeline.

Then there is inheritance tax. Like most tax rules it is complicated, but if the deceased was age 75 or over and had their pension in a draw down or uncrystallised (untouched) arrangement, the inheritor is likely to incur a tax charge potentially up to 45%.  At least this is an improvement on the previous 55% burden on inherited pensions.

Finally, when large sums of money are involved, there are certain to be unscrupulous individuals lurking, and even at this early stage there have been reports of scams involving pension pots.

The watchword is beware, and be advised.