The Reality of New Pensions’
Flexibility
The spring of 2014 heralded
the Chancellor's budget which was significant in the changes it proposed for
financial planning and particularly the way pension benefits can be accessed into
the future. Some of these changes have already occurred, with the main changes
due in the new tax year (2015/2016).
As the summer of 2014 has
warmed many with its glorious sunshine, some enquiries have turned to the
thoughts of accessing their pension arrangements sooner rather than later.
Sadly, this might be a reflection of some of the historical and negative
baggage that surrounded pensions in the last decades. Ironically, this seems to
be in conflict with the new thrust of promoting Workplace Pensions via Auto-Enrolment.
The new flexibility
imported by the budget certainly creates new financial planning opportunities
and the ability for investors to use their funds in ways to meet their needs.
This greater flexibility has been welcomed by most, however, in our experience
at this time, the consequences of some of this flexibility have not been
publicised as well as they could have been. I hope that these potentially
negative outcomes are detailed by the press before April next year, rather than
waiting for the inevitable ‘sob story’ of those who have drawn their pension
benefits to great financial detriment.
Taxable benefit after the
tax free cash
The first point to consider
is that the Chancellor is effectively offering the opportunity of avoiding
annuity purchase, based on gilts (gilt-edged securities which are government
bonds), with the proviso that any amount drawn from a personal pension plan, as
an example, above the 25% tax-free cash limit would be subject to income tax at
the individual’s highest marginal rate in the tax year that the benefits are
drawn.
Example:
As an example, if an
individual was earning £30,000 gross a year and they had a sole pension plan of
£30,000 (and were above the minimum benefit age) they could draw 25% of the
fund as tax free cash (£7,500 tax-free) and the balance of the fund drawn would
then be subject to income tax. If the total remaining pension fund of £22,500 was
drawn, this would be added to their overall taxable income, bringing their
total income in the tax year, in this example, to £52,500 gross. In this
example, they could suffer higher rate tax (at 40%) on an amount of
approximately £10,600.
Final Salary pitfalls
In a different example, we
have also seen enquiries from those who maintain valuable final salary pension schemes,
who have received transfer values and are looking to transfer this value out
(usually to a personal pension) to draw benefits early. The most recent example
we have experienced was for a final salary pension scheme that was left many
years ago where the client was not aware that the benefits accrued increase with
inflation, offers spouse’s protection, and that a significant actuarial
reduction would be applied to the transfer value should they draw pension
benefits before the normal retirement age of 65.
In the example concerned,
the client had reached the age of 55. The combined actuarial reduction is
likely to be around half the value of the pension scheme, in addition to any
other reductions that may be applied. Therefore, the transfer value of, in this
example, £42,000, offers the opportunity to withdraw £10,500 of cash with the
balance being used to provide income or the ability to withdraw as additional taxable
cash from April 2015 onwards. However, the real financial loss to the
individual in doing so is likely to be somewhere in the region of
£30,000-£50,000. Taking this latter point into account, the transfer value of
£42,000 starts to look highly unattractive.
Guidance or Advice?
I am also concerned, and
have written to the Financial Conduct Authority (FCA), with regards to their proposals
to offer individuals ‘guidance’ (rather than advice) for the drawing of pension
benefits. I have little conviction that ‘guidance’ will be able to go into such
detail noted above and be able to confirm the potential for real financial loss
to the client in drawing pension benefits early.
Full advice
The points noted above are
only a taster of the complexities of pensions which offer significant value to
clients both now and into the future, particularly from final salary pension
benefits. We believe those who are considering drawing pension benefits early
need to take full advice as to the ‘real’ consequences of their actions before
being attracted by any tax-free cash sum or taxable cash that they could
withdraw either now, under the newly increased HMRC Triviality rules, or post-April 2015.
Summary
If you would like to
consider the points noted above further then please do not hesitate to contact
the team at Chapters Financial, who will be able to help you further with your
pension enquiries. No individual advice is provided during the course of this
blog. If you would like to receive further information regarding your own
individual situation and circumstances, please contact the Chapters Financial
team in either Guildford or Woking.
Keith Churchouse BA Hons FPFS
Director, Chapters Financial Limited
Chartered Financial Planner
Certified Financial Planner
ISO22222 Personal Financial Planner
Chapters Financial Limited is authorised and regulated by the Financial Conduct Authority, number 402899.
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