News & views

22 December 2010

Pensions: Removing the effective requirement to annuitise by age 75

In June this year the Government announced that it was undertaking a review of pension legislation with the aim of removing the effective requirement to purchase an annuity by age 75.

The Treasury has now formally announced the permanent changes it wishes to make and published draft legislation which will form part of the 2011 Finance Bill, to take effect from 6th April 2011.

Unsecured pension and alternatively secured pension

The current rules governing both unsecured pension (before age 75) and alternatively secured pension (after age 75) will be abolished. There will no longer be a requirement to crystallise pension benefits at age 75 and both pension and lump sum benefits can be deferred until any age. However, the Lifetime Allowance test at age 75 on the value of uncrystallised benefits will remain.

In place of 'unsecured pension' and 'alternatively secured pension' there will be two new forms of income withdrawal known as 'capped drawdown' and' flexible drawdown'.

Capped drawdown

Similar to unsecured pension, capped drawdown will place an annual limit on the maximum amount of income that can be withdrawn. However, the maximum amount will be reduced from 120% of the equivalent annuity to 100%. This maximum income level will be reviewed every three years before age 75 (as opposed to the current five yearly reviews) and then annually following the pension year end after an individual reaches age 75.

Flexible drawdown

Flexible drawdown will enable unlimited pension income payments from defined contribution arrangements, including the ability to withdraw the whole pension fund as a single income payment. This will be available to those who can demonstrate they have already secured other sufficient minimum pension income (the 'Minimum Income Requirement' or 'MIR') to prevent them falling back on the State.

The MIR has been defined as pension income of at least £20,000 p.a. This will include pension annuities, final salary scheme pensions and any State pension in payment. There is no requirement for this minimum level of income to be inflation proofed or to provide any pension for dependants. Income from other non-pension assets, including purchased life annuities, will not count toward the MIR.

Consequently, flexible drawdown will allow an individual or, on death, a dependant to take income above annual capped income at any time. In contrast to capped drawdown the amount which can be taken under flexible income drawdown after securing the MIR, is limited only by the value of the available fund. Any sums taken will, however, be subject to income tax at the individual's highest marginal rate.

Transitional Arrangements

Whilst the changes will affect all new drawdown pensions from 6th April 2011, in order to provide a degree of certainty and adjustment, the Government has proposed that for individuals with an existing drawdown pension, the new rules governing withdrawal limits under capped drawdown should apply only from the date of their next scheduled compulsory review.

Tax position on lump sum death benefits

There will be no change to the taxation of uncrystallised fund lump sum death benefits before age 75, i.e. all the fund can be paid as a tax-free lump sum. However, the current 35% tax rate on lump sum death benefits from crystallised funds before age 75 will increase to 55%.

The same 55% tax rate will apply to all lump sum benefits on death after 75, for both uncrystallised and crystallised funds.

Inheritance tax will no longer ordinarily apply on death after age 75, however, HMRC will monitor carefully for any sign of abuse and may issue further legislation if required.

For those with no dependants, an individual will also be able to nominate a registered charity to leave benefits to tax free, both before and after age 75.

Protection from the new lifetime allowance

As well as announcing changes to the requirement to annuitise at age 75, the Government have also confirmed details of transitional protection that will be available when the lifetime allowance reduces from £1.8 million to £1.5 million from 6th April 2012.

Individuals who expect the value of their pension savings to exceed £1.5 million when they come to take benefits will be able to apply for 'fixed protection'. This will generally be available to everyone, regardless of the size of their existing pension funds and, as the name indicates, a fixed amount of £1.8 million will be protected from any future lifetime allowance charge.

To be eligible for fixed protection, accrual of benefits under all pension arrangements must cease by 5th April 2012 and an application for protection made to HMRC by that date.

Employer Funded Retirement Benefit Scheme (EFRBS)

In a further announcement, it has been confirmed that EFRBS, Employee Benefit Trusts and similar arrangements that are used to reward employees with the intention to avoid, reduce or defer income tax on the employee will be caught by very wide ranging legislative changes designed to treat this deemed 'disguised' remuneration as subject to income tax and national insurance on the employee.

This legislation works on the principle of capturing all such arrangements unless specifically exempt and extends to loans and sums or assets earmarked, in addition to actual payments.

Exempt plans include share incentive schemes, save as you earn, approved company share option plans and registered pension schemes.

Action

The changes have significant consequences for all those saving for or approaching retirement. For some individuals this represents a valuable opportunity to get more from their pension savings, for others the potential loss of valuable death benefits. Although the legislation includes a window of transition for applying for protection, and to review existing drawdown arrangements, the announcement will have an effect on everyone's retirement strategy. The overall message is that planning for retirement will become more diverse as tax relief becomes more restricted and will in future increasingly incorporate non pension based solutions.

If you would like to learn more, please speak to your usual contact at Towry.

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