Budget 2014: How to make the most of the pension revolution
Simon Read examines the Budget announcement of the biggest shake-up to the pensions system for almost 100 years to find out how you should react to it
The big news from this week's Budget is the relaxing of the rules that force retiring people to buy an annuity with their pension pot.
The change – which the Chancellor described as "the most far-reaching reform to the taxation of pensions since the regime was introduced in 1921" – will come into effect from July 2015.
But before then the shake-up of the pensions system starts next week with a range of rule changes coming into force from Thursday.
Here, we round up all the main pension rule reforms and who they will affect.
The key message with all the changes is that if you are affected – because you are retiring soon, for instance – get professional advice on your options by talking to your pension provider as well as an independent pension expert.
The long-term rule changes on annuities will mean that all of us who are still in work will be rethinking our pension planning as we have suddenly been handed more flexibility. Again, talking things over with a pension expert is vital to ensure you make the right decisions for your financial future.
What's happening next week?
The key move is that the Government has increased the overall amount of what it calls "pension wealth" that you can take as a lump sum.
At present, under "trivial commutation" rules, if you have less than £18,000 in your private pension pot, the entire amount can be taken as cash and you aren't forced to buy what would be a tiny payout from an annuity. A quarter of it is tax-free, the rest charged at your marginal rate of tax.
The amount will increase to £30,000 from next Thursday. This is the average size of pension pots of those retiring at the moment, and the amount is significant. This means – along with other changes coming into effect on Thursday – that around 400,000 more people will have flexible ways to get at their pension cash in the next tax year.
What are the other changes? At present, if you have a small pension pot – of £2,000 or less – you can take it as a lump sum. If you have more pots – built up at different times in your career – you can take two as a lump sum.
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From Thursday, the number of small pension pots you can take as a lump sum will increase to three. However, much more helpfully, the amount will increase fivefold to £10,000.
That means that if you have three smaller pots worth up to £30,000, you will have the same right to take it as a lump sum as someone with just one larger pension saving of up to £30,000.
Also from Thursday, reforms are coming in relating to drawdown annuities. If you have either a capped drawdown or flexible drawdown arrangement, you can find full details of the changes at gov.uk/government/publications/increasing-pension-flexibility.
What about the annuity freedom?
That's not coming into effect until April 2015. If you are planning to retire before then, it may be worth while delaying your plans until you are given that greater flexibility with your pension cash.
You'll still be able to buy an annuity after April 2015, of course– it's just that you won't have to. However, the proposals are, for the moment, just that. So it makes sense to delay making any decision until after the consultation period for the plans, when the future pensions and annuity landscape will be clearer.
The Government has said that everyone will be given the opportunity to receive free face-to-face advice before making a decision. It has earmarked £20m to pay for the advice but how that will work is yet to be seen.
The new rules will mean that savers will be able to get the entirety of their pension at any time after the age of 55. What is not changing is that you can take a quarter of your pot – up to certain limits – as a tax-free lump sum.
What will change is that you will then be able to take the other three-quarters of your retirement savings and only pay tax at your standard rate, whether that's 20 per cent, 40 per cent or 45 per cent. That will mean, of course, risking paying a higher rate if drawing the cash pushes you into a higher tax bracket.
Being allowed to take your whole pension as one lump sum would mean anyone with a £100,000 pot could take £25,000 tax-free and pay tax on the remaining £75,000 if they withdraw it.
Advice will be crucial. For instance, because of the tax charge it may make sense to delay taking the whole pot in one go to avoid falling into a higher tax bracket. In short, don't make a move until you've checked what effect it will have on your finances.
What about pensioner bonds?
These are savings schemes being introduced from next January. They will be issued by National Savings & Investments with an investment limit of £10,000 each.
Interest rates are yet to be set but the Chancellor promised they would be market-leading. Current estimates are 2.8 per cent for a one-year bond and 4 per cent for a three-year one.
However, the bonds will not be tax-free.
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