Are you Prepared for the Pensioners’ Prerogative

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The 2014 Budget made significant changes to the pension rules but the most dramatic are yet to come. From April 2015 pensioners in defined contribution schemes will see a significant power shift in their favour that gives them far greater control over the way they choose to fund their retirement.

The main change that has attracted most of the attention is the removal of annuity requirements previously faced by most pensioners. As was the case before the 2014 Budget, pensioners will be able to take 25 per cent of their pension pot as a tax free cash lump sum but the changes mean that they will now have far greater freedom to manage the 75 per cent remainder as they wish.

The government has been consulting on the implementation of the new changes with draft guidance from HMRC having already been released. As one might expect with pensions, simple objectives have masked underlying complexities.

Understanding the Basics of the New Pension Rules

The new rules that will be implemented in April 2015 mean that anyone over the age of 55 will be able to take the whole of their pension as a cash lump sum. Previously, for pensions over a certain size only 25 per cent could be taken as a lump sum at retirement with pensioners given six months to decide what to do with the rest. For the majority this meant buying an annuity.

There are important tax implications that arise from these changes though. As has been the case previously, the 25 per cent of the pension that could be drawn as a lump sum would be tax free; the difference now is that the rest will still be subject to tax at the individual’s normal marginal tax rate.

This new flexibility available to all pension savers means they can make choices according to their personal circumstances while being able to take advantage of new tax efficiencies. However, pensioners and those operating schemes should be in no doubt that the finer mechanics of the new rules will be far from simple bearing in mind HMRC’s draft guidance.

If Not an Annuity What Else?

Annuities have not offered pension savers great value for money since the financial crisis and the advent of record low interest rates, but one thing they have provided is a degree of certainty. The new rules provide access to much greater choice which is broadly a good thing but, as ever, greater freedom does come with less certainty.

Pensioners will have a variety of options for the 75 per cent remainder of their pension including purchasing an annuity, drawing it down gradually over time, drawing it down ‘uncrystallised’ and reinvesting it in another scheme with greater flexibility or simply drawing it down in one go to spend immediately as they wish. The virtues of these approaches will depend upon a variety of factors such as the size of the pension, the life expectancy of the individual and their overall wealth.

The greater complexity of the new environment will make it harder to navigate without independent advice which will be available free to pensioners on retirement. Given the flexibility of the new rules and the potential for changes in pensioners’ circumstances over time, ongoing advice may also be required.