This month, our personal finance columnist, Mitch Hopkinson, looks at proposed changes to pensions following the 2014 Budget, and how pensions access restrictions are being lifted to enable individuals to cash in their savings as a lump sum on retirement.
Mitch, a recipient of the ‘Financial Times Independent Financial Adviser of the Year Award’, is Head of East Midlands at deVere United Kingdom, the UK division of deVere Group, one of the world’s largest independent financial advisory organisations.
Another year and another budget goes by. But was it ‘just another budget’? I am sure that many people find it hard to connect with budgets as the changes are often negligible and when significant changes are made they are often difficult to comprehend, as they can involve changes to complicated tax rates, and lets face it, tax isn’t the most interesting of subjects.
But retirement is something that we should all be able to relate to. After all this is something that should happen to us all, unless we are not lucky enough to live that long (that no doubt will be the subject of a future article).
I thought it would be helpful to highlight the proposals for pensions with a series of questions and answers;
Before you tell me how great the changes are, what’s the snag?
At the moment the radical changes have been proposed and subject to consultation, so don’t put the deposit down on your Ferrari yet. There are lots of people saying that the general population cannot be trusted to look after their own money – if this is not countered the radical ideas won’t ever get off Steve Webb’s desk and in to legislation.
From 2028 the minimum retirement age is set to go up from 55 to 57.
If you take all of your pension at once you will pay a considerable amount of tax.
If you spend all of your pension too quickly you may die a pauper. But surely that’s better than giving it all to an insurance company?
So just how much of my pension can I have access to?
The proposal is that most people will have the ability to spend most of their whole pension fund, although how much will be down to the final legislation. Currently you have to guarantee you have a certain amount of income you can rely on, from 27th March this is £12,000 (it was £20,000 before).
If I take all of my pension out at once, how much tax do I pay?
In simple terms after your pension commencement lump sum is taken, the rest is added to your taxable income for the tax year. Thus the more you take, the more tax you pay.
So if it is this good, how can the government afford to do this?
This is where the clever stuff comes in. As you can take large amounts out of your pension, the government will raise tax much more quickly than if they had to wait for you to pay the same amount from your income every year. As some people will take large amounts out of their pensions all at once, this could mean that they will pay much more in tax and more quickly than if they had opted for a fixed income for the rest of their lives.
Won’t more people rely on the state if they spend their pension pots early?
Possibly, however, the state system is undergoing a massive overhaul. In the past this change to pensions would have meant that the state could well have had to fund more people’s pensions because they would have been able to claim credits. But with the new state pension coming in which should pay a larger fixed pension for everyone, the chances of this happening are remote, so it should be a win-win scenario.
If I can take all of my money out of my pension to spend in one go, will there be a restriction on what I can spend it on?
No this would be almost impossible to oversee. In fact the Pensions Minister has recently been quoted as saying that if someone wants to buy an expensive sports car, nothing should stop them from doing so. As a result it will provide some interesting opportunities, such as:
Bob has retired and wants to pay his mortgage off – he would like to use his pension for this and keep his other assets intact. At the moment he can only use the tax free cash from his pension to do this, and he would then have to use the rest of his pension to create an income to pay the mortgage off over time. In the future, Bob could cash sufficient of his remaining pension to pay down his mortgage. He will pay tax on the amount that he draws down, and here is the clever part for the government, because just as Bob has in effect brought his pension assets out of being doomed to pay an income for the rest of his life, so too will the government benefit from the extra up front tax that Bob pays for the privilege of getting his money now.
Sue retired a few years ago and at the time did not use her all of her pensions as she had a good income from her previous employers scheme. She felt she could leave her other personal pensions for the time-being. One of her grandsons has aspirations to become a vet, but owing to family circumstances he cannot afford the tuition fees. Ordinarily the situation might have ended there. However, with the ability to access her pension assets, Sue could choose to use these as a way to pay for her grandson’s ambition to become a vet.
So whatever your previous excuses for not paying enough into pensions I think now is a great time to make up for those past years and get contributing.
The long term position for pensions should be that they will become much more flexible, which should mean that their appeal will increase massively.
So what else did the budget provide for savers? Well, the amount that you can save in to an ISA is going up considerably to £15,000 from July 1st. In addition the ISA rules are becoming simpler in that you will be able to save the same amount in to both cash based and equity ISAs. The tax free allowance is going up to £10,500 which is going to take many people out of paying tax. However, as with all budgets there is a compromise in that many, many more people are falling in to the 40 per cent tax band as the rate at which this becomes payable is not increasing with inflation.
Mitch Hopkinson is a managing partner of deVere United Kingdom, part of the deVere Group, one of the world’s largest independent advisers of specialist global financial solutions to international, local mass affluent, and high-net-worth clients, through a network of 70 offices across the world and more than 1,000 staff. It has in excess of 80,000 clients and $10bn under advisement.