Shifting philosophy behind pensions
When George Osborne announced changes to pension rules last year, we realised they were significant. Now the enormity of the changes is evident – amounting to nothing less than a complete reappraisal of the philosophy behind pensions, a shift that should benefit many people.
In order to understand why the changes are positive, we have to understand the system beforehand. Pensions until this year were seen solely as savings vehicles to help people sustain themselves and their families through the years after they retire.
Rules limited how much of their money people could spend in order to prevent them going through their savings too quickly and ending up a burden on the state.
Many were pushed into buying annuities, particularly poor value in the event of early death, with any unused capital value being retained by the life companies that sold them. And yet, after being forced into holding on to money and as a result dying with a chunk unspent, the government applied a huge 55 per cent tax on any pension assets that people desired to pass on to anyone other than a spouse, civil partner or dependent child.
Now, people can plan for their retirement, knowing they can spend their money as they see fit, and without worrying whether they will be penalised for accessing their pension fund either too soon or too late.
A pension is now a more versatile and cost-effective way of saving for the future and gifting your money on to following generations.
The changes come in two main groups: Greater flexibility in how you spend your pension money: Flexible drawdown – the ability to take money as you wish out of your pension pot – is being extended. Until recently, only those pensioners with guaranteed lifetime pension income of £20,000 or more a year (£12,000 since April 2014) were allowed to draw down the fund without restriction. From April 2015, the government is allowing people, no matter what their pension income, to take money out as they see fit.
Greater flexibility in passing on your pension: A pension is now very attractive for estate planning. From April 2015, people will be able to pass on their pension on death to anyone, using the same tax-free transfer previously available only for spouses, civil partners and dependent children. For anyone who dies under the age of 75, not only is the act of passing on the pension tax-free, the recipient can now take the money as a tax-free lump sum or can leave the assets within the pension environment, where they can continue to benefit from tax-free growth, and can take a tax-free income as and when required.
Pensions now challenge ISAs as a cost-effective way of saving. The main distinction is in the tax treatment at entry and exit: ISAs don’t benefit from any tax relief when money is placed into them, but money can be taken out without paying any income tax.
Pensions operate in the opposite fashion, with tax relief on the money going in, but income tax paid on 75 per cent of what is taken out (you also have to wait till you’re 55 to access a pension, while there’s no time or age restriction with an ISA).
Mostly, you will benefit more in money terms now from a pension, given the combination of the tax relief at the start and the 25 per cent relief on the total amassed.
This uplift is even greater for those whose marginal rate of income tax during drawdown is lower than it was when the pension contributions were made.
A pension is now also a very good way of passing money down the generations. A pension pot can quite easily be transferred to a dependent spouse or child, and when he or she dies, the remaining money can then be passed on tax-free to grandchildren. During all this time, the money can remain invested, growing tax-free.
Overall, the government has made pensions more attractive and a lot more flexible than before. The increased freedom to spend your money as you see fit, or pass it on without punitive taxes, means that many should be seeking assistance on how they can best benefit from the changes.
• Norman Dalgleish is a senior financial planner with Turcan Connell Asset Management www.turcanconnellwealth.com