The Chancellor’s pension reforms focus on money purchase pension arrangements, sometimes called defined contribution pensions, which allow you to build up a fund of money to provide a retirement income and a tax-free lump sum. Acumen looks at the pre-Budget rules and outlines how they are evolving.
Pre-Budget 2014 rules
The pre-Budget 2014 rules – though not necessarily your pension scheme’s rules – permitted certain actions after the age of 55. You could draw up to 25 per cent of the fund free of tax as a lump sum. This could be at any time in an eighteen-month window, beginning six months before any pension income started. The balance had to be used to provide an income.
There were a variety of options, the main being to buy an annuity that normally guarantees an income throughout life – however long that may be – and can include benefits for dependants. However, the death benefits from annuities are limited.
Otherwise, you could choose capped drawdown, which allowed withdrawals directly from the pension fund, but they were subject to maximum amounts that were subject to review and broadly matched 120 per cent of a non-increasing annuity you could buy on the open market.
The other option was a select flexible drawdown, which is effectively drawdown without any annual limits or compulsory reviews of income. It was only available to individuals with at least £20,000 a year of secure (state or occupational scheme or pension annuity) pension income already being paid.
Under the old rules you could draw up the total value of your pension benefits as a lump sum if they were not more than £18,000 and you were at least age 60. This so-called trivial commutation was 25 per cent tax-free and 75 per cent taxable. Similarly, regardless of the total value, it was possible to turn into cash ‘small pots’ of two personal pensions and an unlimited number of occupational pensions, each worth up to £2,000.
Changes under the Pensions Act
The pension changes have mostly been introduced in two parts. The Finance Act 2014 includes a range of pension measures, most of which are interim provisions pending the changes due from April 2015.
The limit for capped drawdown was increased from 120 per cent to 150 per cent of the broadly equivalent market annuity rate for drawdown years starting on or after 27 March 2014. So, for example, if you are 65, the maximum capped drawdown as at January 2015 would be 7.95 per cent. If you began withdrawals shortly before that post-Budget start date, you would have to wait until the next drawdown anniversary before any change would become possible.
From 27 March 2014, the minimum secure income for flexible drawdown was reduced from £20,000 to £12,000. As the basic state pension is about £5,900 a year in 2014/15, many more people will now be able to take advantage of this option. However, this option will not be available to you in 2014/15 if a contribution has already been made to a defined contribution scheme for your benefit since 6 April 2014.
The total pension wealth limit for full commutation as a lump sum was increased to £30,000 from 27 March 2014. The ‘small pots’ ceiling was increased dramatically from £2,000 to £10,000 and the number of personal pensions that could be converted to cash under these rules was increased from two to three.
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