Updated: May 22, 2019
In the recently announced UK budget in the Spring, George Osbourne unveiled the biggest pension revolution for almost a century. The plans will unequivocally give individuals far more freedom to choose what they ultimately do with their pension pot.
Since 1921 in the UK residents have had to use their Pension Fund on retirement to provide an income for life in the form of an annuity. The government is abolishing this rule. The idea behind the change is to encourage more savings.
Annuities have offered worse and worse incomes over the years, and many thousands of savers have resented saving all their working life only to be forced into buying something they consider to be poor value with the proceeds.
It has been the case for some time that those with small pension funds can cash them in, in full, without having to comply with the restrictions above. These limits have been increased substantially, from the 27th March 2014. Those with pension funds worth less than £10,000 will be able to cash them in, even if they have other pension funds.
Those with total pension funds of less than £30,000 will also be able to cash them in, in full – a significant increase from the previous level of £18,000.
The reform will mean that hundreds of thousands of people retiring each year will now have the freedom to take savings built up in a defined contribution scheme as one cash lump sum (subject to a marginal rate of tax)
Anyone with a guaranteed income of £12,000 or more per annum can draw as much or as little of their pension fund as they wish. 25% of the pension fund can be taken as a tax-free lump sum, with the balance taxed as earned income
There is of course concern that some may squander their lifetime earnings and that a seed is potentially being planted that could grow into another financial crisis. There could be ramifications for people who do not act responsibly and, as a result, may become dependent on the state in later retirement. Furthermore a member who cashes out a large pension pot will increase their taxable estate. The IHT allowance of £325k is frozen until at least 2018, so removal of wealth from the shelter of an IHT-exempt pension pot will result in more estates being caught within an ever- tighter IHT net.
Taking this worry aside however, those who could potentially be worse off are those who have Deferred Benefits (Final Salary) in public sector pension schemes such as the National Health Service, teachers pensions etc.
It seems overwhelmingly probable following the chancellors budget that those in public sector schemes will not be allowed to transfer out to a defined contribution scheme with effect from April 2015. This is because funded defined benefit schemes play an important role in funding long-term investment in the UK economy, which the Government does not want to put at risk. Because of this the government plans to introduce legislation to remove the option completely to transfer for those in public sector schemes. But this could also have a knock on effect on private sector DB schemes.
The consultation document proposes that the private sector may well be treated in the same way as the public sector, with either a disallowance of the ability to transfer out, or restrictions upon it; Although prohibition is unlikely there may well be restrictions placed upon transferring out here too.
This makes transferring out of Deferred Benefits, for both public and private sector, extremely important at this juncture.
As it stands now if you transfer your benefits, before April 2015 you know what the position is going to be. If you wait till after 2015 you don’t. So as we now know, the government plans to pass legislation from April 2015 that will remove all tax restrictions on access to defined contribution pension schemes, we expect this to include personal pensions and of course SIPPs. This means that those with these pensions will be able to draw as much of their pension fund as they wish, with 25% of the fund tax-free and the balance taxed as income.
A consultation is now underway to look at how you’ll be able to access your pension savings when you retire. This includes a much-welcomed review of the hefty 55% tax charge which can apply when pensions are passed on to your loved ones on death – a charge which many feel is far too high at the moment.
The other change affects flexible drawdown with your SIPP. Previously, you had to have guaranteed pension income of £20,000 a year to use flexible drawdown. From now on, you would only need £12,000, which means more people can control how and when they access their SIPP.
There are also many reasons why individual’s will chose to transfer their pension into a QROP’s. A key driver for most people is tax. People don’t like the thought that after they’ve died their loved ones will have to pay a lump of UK tax, in particular when they actually die after they’ve taken benefits. If you transfer to a QROPS, you don’t have the lump sum death benefit charge.
Now we know the UK are looking at reducing the level of the charge, although we don’t know as yet what this will reduce to. Whereas with a QROPS you have the certainty of knowing there will be no tax whatsoever.
Following the budget announcement we are now clear that from April next year, the government intend to enable people in the UK to access as much of their pension fund as they want. It is quite likely that won’t be the case for QROPS, but what we don’t know is how that benefit structure will be treated in the members country of residence.
It is extremely unlikely that it will be possible for an individual to strip out a huge pension fund from the UK and then claim, because of a double taxation treaty that there will be no tax payable in the UK. Because of this it is a strong possibility that HMRC may invent a special form of tax charge to capture this for the expat community
This volatility does not allow advisers and clients to plan for retirement with any confidence or certainty. A transfer to a QROPS in contrast will crystallize a client’s UK pension benefits and firmly place their retirement fund in a jurisdiction, which offers legislative stability.
It is important that all factors are taken into consideration when deciding whether to transfer out of a scheme into a SIPP or QROP’s but now time is also a huge consideration as the window of opportunity to transfer out of final salary pension schemes is closing.