GUEST POST FROM SAM JERMY
Turning Pensions into Porsches
I usually refrain from posting my reaction and opinion on a budget until at least a week has passed. This provides some time to ponder and digest the detail; much of which only becomes clear post budget day. In this blog post I will focus on the largely unexpected reforms being made to money purchase pension funds.
Over the week we have witnessed attention grabbing headlines such as describing the budget as the death knell for annuities. Lib Dem Steve Webb’s comments regarding his relaxed stance on people purchasing Lamborghinis with their pension funds has provided plenty of substance for debate. I now wait with nervous anticipation for marketing slogans such as “We Turn Pensions into Porsches”.
The proposed pension reform includes changes that were implemented from 27th March 2014. These include a higher maximum income available from Capped Pension Drawdown, a lower Minimum Income Requirement for Flexible Drawdown and a higher lump sum figure available under Triviality Rules. Ditching the technical terms, these changes basically mean.
People electing to drawdown their pension fund rather than buying an annuity will be able to take a higher annual income than that available previously. For example, a 65 year old can draw a maximum of £8,850 p.a. from a fund of £100,000.
People with secure pension income totalling at least £12,000 p.a. from sources such as the State Pension and a guaranteed annuity can now elect to have full flexibility on how much they draw from an invested pension fund.
Pension benefits can be withdrawn from age 60 as a lump sum for funds totalling £30,000; individual pension pots can be withdrawn as a lump sum for pension pot values up to £10,000.
As is typically the case with pensions, the above rules are all subject to complex qualification rules, commencement dates and restrictions. Professional advice should be sought before any action is taken.
The more dramatic changes to pensions will take place from April 2015. From this point, people over 55 years of age will have full flexibility in how much they drawdown from their invested pension funds and will not be subject to the above limits and restrictions. Note, the minimum pension age is proposed to increase to 57 in 2028. Whilst in theory a full drawdown seems attractive, the tax implications of large one-off withdrawals may make it less so. With only up to 25% of the withdrawal being free of tax, it is important to take into account marginal tax rates and any potential loss of personal allowances.
This future flexibility for pensions and investments has led to a fierce debate as to whether people can be trusted not to blow their pension pots in one go. The government’s stance is relaxed on this point as the introduction of the single-tier state pension is broadly at the level for means-tested benefits. Squandering a personal pension fund should not provide people with the means to claim additional state benefits. This does seem like an odd stance considering the government’s drive behind encouraging personal and workplace pension provision.
I do provide financial planning guidance to clients who have accumulated pension funds that are surplus to their lifetime income requirements. They are a small minority however. The vast majority of my clients are greatly dependent upon their pension funds to support their basic spending needs and lifestyle aspirations. Financial security during their retirement years is the key priority for most. For this reason, annuities should still have their place as they can offer guaranteed income levels for life. That said, I would expect to see significant innovation in the annuity market and increased competition to win annuity business. All positive news for the consumer.
There has also been talk of a ‘Buy to Let’ bonanza fuelled by people fully withdrawing their pension funds and investing into property. Again, what seems like a good idea in theory, in practice, may not be so. The tax liability on pension withdrawals, property purchases (Stamp Duty Land Tax) and the tax on rental income may result in a less than attractive overall net rental yield. The numbers need to be fully ‘crunched’ to determine the suitability and benefits of this option.
Other considerations include the pros and cons of holding investments within ISAs vs. Pensions. Watch this space for the next blog on this specific subject and have a look at my previous post on Divorce Finance Toolkit on the subject of state pension changes.
The implemented pension changes and forthcoming reform gives people greater flexibility to make their own choices regarding when and how to draw their invested pensions. With so many variables at play such as tax, investment risk, inflation risk and liquidity; planning becomes essential. A qualified financial planner can provide guidance and assistance to help people make informed decisions and achieve financial security in retirement.
Sam Jermy works for Family Law Financial Planning Ltd which is an appointed representative of North Laine Financial Management Ltd which is authorised and regulated by the Financial Conduct Authority. North Laine Financial Management Ltd’s FCA Register number is 446522. The views expressed in this guest post are Sam’s own. Please contact your own independent financial adviser or family lawyer if you believe the issues raised by Sam impact upon you. Alternatively, please post a comment or query below and Sam will do his best to respond.