An end to pensions?

The changes announced by George Osborne in his 2014 Budget have turned established assumptions about pensions on their head.

Ever since personal pensions were introduced in 1988 for those who did not have the benefit of occupational schemes, a basic condition of tax relief has been that pension savings should ultimately be converted into a secure income, usually in the form of an annuity. That requirement is now to
be abandoned, with far-reaching implications for personal finance and the UK economy as a whole.

Disillusionment with annuities began in the early 1990s, when rates plummeted and people who were locked into arbitrary retirement dates saw their retirement income slashed. With little prospect of rates improving, the government’s response in 1995 was to introduce pension income drawdown, permitting retirees to delay annuity purchase until the age of 75 and, meanwhile, to draw an income, within defined limits, from their pension investments. More recently, a new form of ‘flexible’ drawdown was introduced which permits unrestricted access to funds subject to the policyholder securing a guaranteed income of at least £20,000 per year, usually in the form of the state pension, an occupational pension income or an annuity.

This minimum income requirement has now been reduced to £12,000 per year, and under the Budget proposals will be removed altogether with effect from April 2015. Personal pension holders and members of other schemes, whose benefits are defined by reference to contributions rather than final salary, will be able to access their pension funds at any time after the age of 55, subject only to income tax. For the chancellor, this has the not so insignificant advantage that funds are being released into the economy rather than being tied up in annuities.

Whereas final salary schemes, of which very few remain in the private sector, place the onus of providing a given level of retirement income on the employer, the value of defined contribution (DC) schemes is determined by the investments into which the contributions are directed. Risk has thus been transferred from employers to individuals. Consequently, whether they like it or not, all members of DC schemes are investors, and it is this context that the chancellor is also increasing the opportunity for investing via ISAs (which are being re-named NISAs); and while pension contributions are being restricted, NISA contributions are
being increased.

This opens up a spectrum of opportunities for planning income tax, capital gains tax and inheritance tax, of which every solicitor needs to be aware, on their own and their
client’s account.l difference between personal pensions and ISAs is that pensions provide tax relief on contributions. Seventy-five per cent of the benefits are subject to income tax; whereas ISA contributions are made out of taxed income but provide tax-free benefits. However, ISA savings are hostage to inheritance tax (unless invested in AIM shares qualifying for business property relief), whereas accrued pension savings are usually exempt from inheritance tax.

Tax savings might be achieved by switching between pension and NISA regimes or diverting capital released from pension plans into Venture Capital Trusts or Enterprise Investment Schemes, which offer different tax advantages. New financial products are being devised with the objective of combining the certainty of annuities with the flexibility of investment products, though charges will be a major factor.

However, it seems likely that many people will continue to seek the security of conventional annuities for at least part of their funds.

Planning may be affected by any change in tax reliefs. It has been suggested that the current regime is unduly favourable to higher rate taxpayers, who receive relief on pension contributions at their highest marginal rate but are often able to keep their withdrawals within the basic rate band. The suggestion has been made that relief should be standardised at 30 per cent, which would give those taxpayers paying 20 per cent an extra incentive to save.

Retirement provision has traditionally been regarded as consisting of two distinct
phases – accumulation and
decumulation – but the changes which are taking place underline the fact that retirement has become a process rather than an event. The associated tax planning is now an essential part of private client advice and a prime example of the synergy between legal and
financial work. SJ

 Ian Muirhead is director at SIFA